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Morningstar | Resona Reports Strong Fee Growth Boosted by Tablet Interface Reducing Paperwork for Insurance Sales

Resona reported stronger results than we expected for July-September 2018, with annualized ROE of 9.8% (13.0% excluding unrealized gains on securities) even without the significant tax benefits from the April 2018 consolidation of Kansai-area regional banks that had boosted its results in recent quarters. Net fee income was up 21% year on year, with a boost from the Kansai Mirai consolidation as well as strong organic growth (11% year on year at Resona Bank, 21% year on year at Saitama Resona Bank, and 11% year on year at Kansai Mirai on a pro-forma basis). The fastest area of fee growth was for sales of fund-wrap products and insurance, which benefited from the rollout of a simple interface allowing sales staff to accept applications by tablet rather than requiring extensive paperwork from customers. We expect the strong growth to continue in coming quarters. Fee income including trust fees contributed 30% of Resona's total net revenue.

Net interest income, which contributed 65% of net revenue, was up 22% year on year but continued to trend slightly lower on an organic basis as loans rose by 3% year on year on an organic basis and the average interest rate on loans was down by 6 basis points year on year, the same rate of decline as in the previous quarter and an improvement from 2016-17 when interest rates were most adversely affected by the Bank of Japan's negative interest rate policy. Because of Resona's heavy revenue weighting of net interest income and its large portion of housing loans and residential property loans (45% of total loans), we think a full recovery in Resona's earnings will depend on a move toward higher interest rates from the Bank of Japan, even more so than for other major Japanese banks. If higher interest rates do arrive in Japan, we see Resona as very well leveraged to benefit from higher revenue, although such a development may also mean higher credit costs than the near-zero levels that have prevailed for the last seven years.

We maintain our no-moat rating and FVE of JPY 625, which is 9.0 times our projected earnings for the fiscal year ending March 2020 and 0.67 times book value per share of JPY 929. Although Resona's valuation is undemanding and earnings will likely benefit from cost savings at Kansai Mirai as IT systems are integrated and overlapping branches closed, until the Bank of Japan gets closer to raising interest rates, for the time being we would recommend investors look at other Japanese banks with similarly cheap valuations that are not quite as exposed as Resona to still-falling yields on domestic loans.