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Morningstar | Mizuho Decides to Book Costs Early to Provide Clean Slate for Medium-Term Plan

Mizuho Financial Group lowered its net profit guidance for the fiscal year ending March 2019 from JPY 570 billion to JPY 80 billion, as it now plans to book an extraordinary loss of about JPY 680 billion in the fiscal fourth quarter. Of the JPY 680 billion, JPY 500 billion is to write down the value of fixed assets (JPY 40 billion for branch closures and the remainder of JPY 460 billion to write down the value of software) and JPY 180 billion is mainly for losses on foreign bonds.

Mizuho’s loss recognition comes one year after CEO Tatsufumi Sakai replaced predecessor Yasuhiro Sato as head of the group. It was prompted, in our view, by the upcoming release of the group’s medium-term plan, in which we expect each of its five in-house companies to release targets for metrics such as preprovision operating profit and ROE for the next three fiscal years. We could imagine that the management of each of the in-house companies wanted a clean slate to start before they were held accountable for numbers to be achieved on their watch. Further, the creation of the five in-house companies in 2016 (previously, Mizuho had had 10 different segments more directly aligned with its legal entities, whereas the in-house companies are designed to reach across the group to reduce siloization) led to a requirement for more precise cost accounting.

In particular, Mizuho’s new IT system, which has cost more than JPY 400 billion and was to be amortized over five to 10 years, became harder to justify as an asset on the balance sheet once its contributions to the identifiable cash flows of each in-group company, rather than to Mizuho as a whole, were scrutinized. We still think the new system represents a good investment as it moves Mizuho away from inflexible mainframe-based legacy systems toward a modular design that can be more easily adjusted to meet evolving business needs and manage costs in future.

By expensing the system in one fell swoop rather than amortizing it, we estimate it should save more than JPY 50 billion in annual cost, which could make the difference between the Retail & Business Banking Company, or RBC, targeting a profit in the medium-term plan or targeting a loss. This is because the revenue outlook for RBC is severe (Mizuho, unlike its megabank rivals, does not have a large consumer-finance business and its credit card operation is in flux) and time will be needed before previously announced branch and personnel cuts can reduce expenses. Mizuho said in November 2017 that it would cut 50 of its 500 branches by March 2022 and another 50 by March 2025, but the savings from these closures remain in the future. The additional JPY 40 billion loss taken this time reflects a change in approach, whereby costs to close and merge branches will be recognized when the decision on the specific branches is made, rather than waiting until the closures take place. Mizuho is closing more branches than its rivals Mitsubishi UFJ Financial Group, or MUFG, and Sumitomo Mitsui Financial Group, or SMFG, but the need is common across the industry as consumer behavior has changed with the rise of smartphones, lowering the number of visits to physical branches while opening up new opportunities to the banks for cross-selling, but only if branch design and locations are adjusted. MUFG and SMFG already booked losses of JPY 43 billion and JPY 25 billion, respectively, last fiscal year to cover the cost of reorganizing branches to better meet current customer needs.

Besides the JPY 500 billion write-down that mainly affects the RBC division, Mizuho also is taking a JPY 180 billion loss aimed at improving future results from its Global Markets Company, or GMC, division. Of this, about JPY 150 billion is to write down the value of foreign bonds to remove unrealized losses on the JPY 9.3 trillion portfolio. The other JPY 30 billion is to introduce a new credit valuation adjustment, or CVA, system for its counterparties when hedging foreign securities with over-the-counter derivatives.

We maintain our no-moat rating on Mizuho and our fair value estimate of JPY 199 (USD 3.66). Our fair value estimate is not affected by this write-down because our valuation methodology is based on cash flows rather than the recognition of costs under financial accounting, but now represents a price/book ratio of 0.59 times instead of 0.57 times previously. At our fair value estimate, Mizuho shares would yield 3.8% based on the group’s unchanged annual dividend of JPY 7.50. Our fair value estimate is about 16% above the current share price given the low valuation, but like the company we are cautious on the outlook for profits over the next few years given potential worsening in the credit cycle and the unreliability of high stock prices, which have supported profits in recent years as Mizuho has booked gains on sales of shareholdings.