Monday, March 14, 2011

Banking and supercatastrophe

The second substantive post on this blog was about 77 Bank - a bank in Sendai - the capital of Miyagi Prefecture.  This is the epicenter of the Tsunami/Earthquake damage.

The original post - like this blog at the time - probably had less than 20 readers.

I have repeat the post below.

Warren Buffett once said that Fannie Mae had more supercatastrophe risk in it than Berkshire Hathaway.  He figured the really really big hurricane or earthquake could do more damage to Fannie than Berkshire even though Berkshire is the largest supercat insurer in the world.

Buffett was - I suspect - right.

We now unfortunately have a gruesome test of Buffett statement on finance and supercatastrophe.  There is probably more uninsured damage in the destruction of North East Japan than in any other event in history - and uninsured damage falls sharply on banks.

77 Bank - deeply concentrated in the disaster zone - is the test.  It is not a test I would want to repeat.  But I think we will - at the end of this - be able to confirm Buffett's observation that banks don't like supercats.


The original post - which was titled Japanese Regional Banks - a mirror on America

77 Bank is a regional bank in Sendai (the capital of Miyagi prefecture). The Japanese guys I know think of Sendai as a backwater – a place where the “cool guys” hang out on motorcycles wearing purple clothes. Economically it is just another rapidly aging backwater where the young (other than those that hang out on motor cycles wearing purple clothes) are moving to Tokyo.

The name 77 Bank harks to tradition. During the Meiji restoration the Emperor gave out numbered bank charters. Traditional regional banks still label themselves by the number. and many other numbered sites belong to banks.

77 Bank has a very large market share (near 50%) in Sendai. The market is more concentrated that the great oligopoly banking markets of Canada, Australia, Sweden etc. It should be profitable – but isn’t.

Here is its balance sheet:

(click for a more detailed view).

Note that it has USD42.6 billion in deposits. This compares to $35.8 billion for Zions Bancorp – as close to an American equivalent as I can find.

77 only has USD26.4 billion in loans though. If you take out the low margin quasi-government loans it probably has only USD20 billion in loans.

This bank seems to be very good at taking deposits – but can’t seem to lend money.

This is typical in regional Japan. It is also a problem – because when interest rates are (effectively) zero the value of a deposit franchise is also effectively zero.

So – guess what. It sits there – just sits – with huge yen securities (yields of about 50bps) doing nothing much.

It’s a big bank. It has next to no loan losses because it has no lending.

Here is an income statement:

(click for a more detailed view)

Profits were USD87 million on shareholder equity of 3251 million. You don’t need a calculator – that is a lousy return on equity for a bank without credit losses.

You might think that given that they have no profitability and no lending potential they might be returning cash to shareholders. Obviously you are new to Japan. Profits are 27 yen per share and the dividend is 7 (which they thoughtfully increased from 6).

In a world where banks everywhere are short of capital 77 bank is swimming in it. Here is the graph of capital ratios over time:

This bank has an embarrassment of riches – and nothing to do with them.

Welcome to regional Japan.

An American Mirror

The title of this post was “An American Mirror”. And so far I have not mentioned America.
America is a land with little in deposits and considerable lending. There are similar lands – such as Spain, the UK, Australia, New Zealand and Iceland.

There are also mirror image lands – 77 is our mirror image.

Macroeconomic investing calls

We live in a world with considerable excess (mostly Asian) savings. Banks with access to borrowers made good margins because the borrowers were in short supply. Savers (or banks with access to savers) were willing to fund aggressive Western lenders on low spreads.

77 Bank has been the recipient of those low spreads. It has not been a fun place for shareholders as the sub 3% return on equity attests.

The economics of 77 Bank (and many like it) will change if the world becomes short on savings. There is NO evidence that that is happening now – and so 77 Bank will probably remain a lousy place for shareholders.

The market produces what the market wants

This is an aside really. We live in a world with an excess of savings. This is equivalent to saying that we live in a world with a shortage of (credit) worthy borrowers. So we started lending to unworthy borrowers – what Charlie Munger described as the “unworthy poor [whoever they might be] and the overstretched rich”. We know how that ended.

Unfortunately the financial system cannot make worthy borrowers. It can only lend to them when it can identify them.

This Subprime meltdown heralds the death (for now) of lending to the unworthy. The shortage of the worthy however is as acute as ever – and money for the worthy is still very cheap.

The subprime meltdown does not solve 77’s problems.


babar ganesh said...

won't destruction of property cause people to spend money replacing and rebuilding (ie increase demand) thereby lowering savings and increasing demand for credit?

maybe this won't help banks immediately, but in the intermediate term?

Anonymous said...

Tempted to buy some Komatsu, hard to see how they will not play an important part in the rebuilding.

And in other news...there was a China Agritech (CAGC) press release very early on the 13th. Big surprise: The 10K will be late, with no estimate of when they will file it.

From the press release:

"the Company will not be able to meet the March 16, 2011 filing deadline for its Form 10-K and will be filing for an extension of time to file its Form 10-K. In addition, because the Form 10-K will not be able to be filed until the investigation is complete, the Company is not able to predict when the filing will take place."

John Hempton said...

77's biggest problem BEFORE FRIDAY was that it made so little profit that any losses went straight to the balance sheet.

There was too little pre-tax profitability to offset the losses.

After Friday its problems are of a completely different complexions. It is utterly totally in irrevocably insolvent.

The same is true of a lot of people whose entire asset base was washed away in the supercatastrophe.

I guess being insolvent is better than being dead ... it is almost tasteless to mention the insolvency - but I sure as hell do not understand Fungus's comment.


Johnno said...

21 forgot me.

Anonymous said...

John, did I hear correctly on the radio that your brother Nick is playing Blues Alley (DC) in the next few weeks?


John Hempton said...

I thnk Nick is playing Blues Alley tonight.


UR said...

out of interest, do Japanese bank charge fees for running the accounts? You can make a substantial profits as a bank by doing so even if you struggle to lend.

J Mako said...

Hi John,

Do you remember where you read Buffett's comment? I'd like to read up on it.

狂猪 said...

Can Japan repeat the zombie bank solution to prevent another collapse of its banking system? It seems very hard to pretend the loans are still good given what has happened.

On the other hand, Japanese mortgage are recourse loans. This is similar to Spain. In Spain, mortgage loan performance has held up remarkably well because of recourse (97% performing). Also, recourse will minimize the bank's actual lost.

Stepping back, is the current problem sufficiently big to cause another Japanese banking system collapse?

I've read some where the damage estimate is $200bn US dollars. If the banks share of the lost is 20% than it is ~$40bn. $200bn for a $5 trillion economy seemed manageable.

Anonymous said...

buying or selling 77 now??

John Hempton said...

On 77 bank - neither buying nor selling

Observant readers of the comments will note that I removed some comments having previously included them.

that is because the link went to a blog adorned with the slogan Arbeit Macht Frei - which was what the Nazis wrote on the door of Auschwitz.

I have no particular desire to benefit that sort of thing with links.

Sorry if the exchanges in the comments no longer make any sense.


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