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Morningstar | Japan Post Bank Reports Weakest Quarter Since IPO on Higher Hedging Costs

Japan Post Bank reported its lowest quarterly profit since listing in 2015, with the weakness driven by higher currency hedging costs on its JPY 60 trillion portfolio of foreign securities. Its annualized return on equity of 1.6% compares with its post-IPO average of 2.7%. Japan Post Bank, which has the most deposits of any institution in Japan at JPY 180 trillion but only JPY 6 trillion in loans, continues to gradually shift its portfolio toward foreign bonds and risk assets as its older holdings of Japanese government bonds roll off. However, instead of seeing a secular profit boost from the increased asset risk, as envisioned at the time of its IPO, its ROE has stopped improving since early 2018 and now seems stuck in reverse. The reason is that despite U.S. and European corporate bond yields being significantly higher than the coupons on Japan Post Bank’s maturing JGBs, the sum of U.S. dollar Libor and basis swap spreads, which is highly correlated with currency hedging costs, has risen at least as quickly, if not even faster, as happened in October-December.

Outside of the profit and loss statement, Japan Post Bank recorded on its balance sheet a reduction of JPY 719 billion in unrealized gains (6.4% of book value), of which JPY 414 billion was for foreign bonds and JPY 598 billion was for investment trusts, reflecting wider U.S. corporate bond spreads during the quarter. Unrealized gains on JGBs increased by JPY 165 billion.

On the positive side, the dollar/yen basis swap spreads have come down since the start of the new year to the levels of mid-2018, and dollar Libor has stopped rising as well since the Federal Reserve paused interest-rate hikes. We maintain our existing earnings forecasts, which are based on an assumption of Libor and basis swap spreads staying near the 2018 average over the next several years, and our JPY 952 fair value estimate, which is 25% below today’s closing price and would represent a price/book ratio of 0.33 times.

Japan Post Bank trades at 17.5 times our earnings forecast for the year ending March 2020 and would still trade at 13 times at our fair value estimate, a premium to the average of 8 times for Japan’s major banks and 11 times for regional banks based on consensus forecasts. However, the shares get some support from Japan Post Bank’s dividend yield of 3.9%, which would rise to 5.3% at our fair value estimate. Most of Japan Post Bank’s public float is held by retail investors, many of whom purchased at the IPO in pursuit of stable dividends.