Dark Skies at Aozora Bank
Japanese lender's shares hit limit down. JPY's bipolar swings in last 30 hours. JGBs rally on strong 10Y auction.
"Aozora” in Japanese means “blue sky (or skies)” - which thereby makes it an amusing name for this particular Japanese bank and its history. Aozora was formerly some other shitty bank for which I don’t care to remember the name- as when the great Japan asset bubble burst in the early ‘90s, that bank was the dirtiest shirt in a filthy laundry pile, such that it had to be nationalized. A few years later, that entity was then bought by none other than SoftBank (which, despite IT’S name is NOT a bank, but rather a moonshot betting “blue sky’s the limit” long tech at top-tick investor) - and renamed its newly acquired lender Aozora - blue skies bank. Subsequently, blue skies bank became the biggest unsecured creditor to Lehman’s collapse in the world - among any/all entities listed (seriously).
FT: SEPTEMBER 16, 2008
Additionally, the Japanese regulator ordered Lehman to take necessary measures to ensure it can repay funds to any depositors. The FSA’s move to ringfence Lehman’s assets in Japan comes as it emerged that Aozora Bank, a mid-sized bank, and Mizuho, Japan’s second largest bank, were among the top creditors to the collapsed US investment bank. Aozora, listed in Lehman’s Chapter 11 filing as its single largest creditor with unsecured loans of $463m, said on Monday that it had hedges and collateral held against the loans that meant its exposure was significantly less than the Chapter 11 filing suggested. Furthermore, Aozora’s exposure was to the Japanese entity of Lehman, whose assets the FSA has ordered to be ringfenced. “In terms of our capital, it’s a manageable amount,” Aozora said.https://www.ft.com/content/feef8668-8356-11dd-907e-000077b07658
Oh, yeah - and there’s also this:
…but once again at the time, management said that its a manageable amount. Again.
So- what’s the latest with blue skies bank? Well if the U.S. banks are going to have a commercial real estate storm, then of course Aozora can’t-not participate in some way. And participate they did/are.
Overnight in Asia (during US hours) - New York Community Bancorp unveiled a stunning $552 million in loan loss reserves for its deteriorating commercial real estate lending portfolio, which is 10x more than expected, and slashed dividends from 17 cents → 5 cents. Markets slammed (green & red blinking ticker: NYCB) shares down, at one point cutting its market value by nearly half - and took both the regional and broader bank indices down with it for the biggest sector drop since March ‘23.
That said- that move was a Market-on-Open pile on sell. From 9:31AM EST onwards, shares actually rebounded as much as +25%, but still ended the day down significantly lower (as did the bank indices).
A few hours later, ~30mins after Japan cash equity open, Aozora Bank (Japan ticker 8304) opens limit down -20% and by 10am halts trading for the rest of the day.
Aozora reported an expected -¥28 billion net loss for FY23, vs the most recent forecast from November of a +¥24 billion net profit due to its significantly outsized balance sheet exposure to US commercial real estate, for which Aozora increased an additional ¥32.4 billion in reserves against souring U.S. CRE loans. Aozora also accelerated sales of its foreign securities, much of which comprised of FX hedged US Treasuries, as unrealized losses mounted.
Aozora’s dividends, which were also last maintained in November to be ¥154 for the fiscal year, are now cut to zero dividends paid out for Q3, and no guidance for Q4 (i.e. likely nothing for the entire back half of the FY, effectively cutting the full FY div payout in half).
Cool.
Now - in case this isn’t apparent - I am NOT a bank analyst (not that being a bank analyst would do any good anyway - just look at the shocked market caught off guard). Therefore, I have no idea what I’m talking about- plain and simple. All I know is how to look at green and red blinking tickers - and I do a mediocre job at that.
That said, here’s my commentary I’ll leave you with, potentially and likely worthless as it may be.
The reason I gave that wonderful history of Aozora, as well as the intraday price action of NYCB pulling down US banks indices, is because the question is now about the broader systemic risk - who else holds what, and if/when/how/how much more in realized CRE and fixed income losses are coming.
For U.S. - I have no idea (and frankly it seems I’m right in line with everybody else).
For Japan - I also have no idea, but I do have observations.
If I had to guess, it seems that Aozora is indeed an idiosyncratic case among Japanese lenders. Again, the history of Aozora - for anyone who is repeatedly saying “some unknown obscure Japanese bank” - no, they’re not “unheard-of.”
Lehman’s number one largest unsecured creditor upon LEH bankruptcy is quite the title to have. Not only did Aozora have more notional exposure to toxic US real estate in ‘08 than Japan’s 3rd largest megabank Mizuho at the time, but also recall - if not for MUFG, the largest Japan megabank, and its balance sheet health and capacity at a time of a global banking tsunami, there would be no Morgan Stanley today - as MUFG bailed out MS (and MUFG now enjoys its stake in MS as a major earnings contributor). So, in 2008 MUFG, was not at all in the same position as Aozora and Mizuho.
Perhaps MUFG was the idiosyncratic one at the time - either way, “Japan banks” (even the three Japan megabanks MUFG, SMFG and Mizuho) are not at all a monolith - and Aozora has certainly proven itself to be a repeat outlier offender.
That’s why NYCB can get cut in half, US banks have their worst indiscriminate sector-wide sell off, and Aozora opens limit down - but meanwhile TOPIX banks index is fine on the day: down -0.6%, in line with the broader TOPIX index, and actually outperforming the NKY225.
Now, by no means am I saying “therefore Japan banks are insulated and fine from here on out.” Absolutely not “in the clear” and no such signal will ever come to existence.
What I am saying is that if material losses reveal themselves in the Japan bank sector, even if it’s within related CRE lending, those are separate matters from whatever the hell Aozora’s current adventure into realized value destruction is. It’s very possible to be coincident + concurrent, as well as idiosyncratic at the same time.
Full disclosure - I am a holder of 8306 MUFG, 8316 SMFG & 8473 SBI Holdings.
Here are some highlights from Aozora’s releases from today, as well as compared to what they were reporting and saying just one quarter prior.
Aozora FY23 Revisions / Lending Losses
All materials from Aozora Bank Investor Relations, and all annotations are mine.
Aozora Bank Securities Portfolio:
Here is where I think there is overlooked significance that is not a Aozora-idiot-idiosyncratic matter - banks’ securities portfolios. Namely holdings of USTs and JGBs - the latter which saw a four-fold increase in interest rates within 12 months after 7 years of an explicit central bank guaranteed cap on yields / floor on prices.
(All material above from Feb. 1, 2024 Aozora Bank FY2023 3rd Quarter Financial Results released )
November 13, 2023 Interim 6-Month Results
Note - no risk to dividend in November as I’ve highlighted in purple. Now take a look at 2 questions I pulled from management’s Q&A with investors/analysts from this release in November ‘23 - knowing what we now know has transpired.
FY2023 Interim Financial Results Telephone Conference Q&A Summary -November 13, 2023:
Q6: If your securities portfolio, U.S. office loan portfolio, and CET ratio have deteriorated to the current levels, I think there could be an idea that both earnings and dividend forecasts will be revised downward. Some analysts are in fact forecasting lower earnings and dividends. Please share with us your discussion that leads to your conclusion not to revise your earnings and dividend forecasts downward amid increased credit-related expenses.
A6: As we have discussed, the fact that our core business, Aozora's Strategic Investments Business, has grown faster than planned this time is in line with our current basic policy. We have decided to maintain our earnings and dividend forecasts, as we were able to achieve 50% of our full-year earnings forecast during the interim period, while increasing provisions to loans for U.S. office buildings. We will basically maintain this approach going forward, but may adjust it as necessary in the event of any unexpected events, including positive ones, in trends for foreign exchange rates, yen interest rates, and other factors. At present, our policy is to execute the plan in light of our business focus and capital adequacy.
Q7: I think the market would be more comfortable if you prioritize the enhancement of capital. What are your thoughts on this point?
A7: We have heard a range of opinions here, but at this point, our basic policy remains the same: to firmly develop the businesses we are focusing on now, and to deliver the dividend we have promised.
Full transcript here
“We” (those who’s job it is to monitor this stuff) all missed it - see S&P’s credit rating commentary below from March ‘23.
S&P Global Japan's Aozora Bank Outlook Revised To Negative From Stable On Bond Losses; 'BBB+/A-2' Ratings Affirmed March 17, 2023
We expect dividend payouts will remain high regardless of a decline in earnings capacity and slowing accumulation of retained earnings. On the other hand, we think the bank has no choice but to somewhat limit an increase in risk for now to maintain a certain level of financial soundness. We had previously believed Aozora Bank was highly likely to maintain higher profitability than other domestic banks, a certain size of earnings base, and adequate capital. However, a likely further decline in profitability will likely weaken the basis for such views.
Aozora Bank continues to conduct risk management and maintain profitability of business units other than its market segment, in our view. For instance, its corporate lending in the U.S. and its real estate nonrecourse loans have performed well. We will closely watch measures the bank takes to improve profitability relative to risks in its next medium-term management plan, due to be announced in fiscal 2023, and the feasibility of such measures.
https://www.spglobal.com/ratings/en/research/articles/230317-japan-s-aozora-bank-outlook-revised-to-negative-from-stable-on-bond-losses-bbb-a-2-ratings-affirmed-12671285
Again, my personal observation (not analysis) is - markets will punish and reprice those that are facing danger, and will eventually discern that which is and isn’t in trouble as it relates to lenders’ balance sheet exposures and losses/“crises.” As per SVB/US regionals + Credit Suisse in March 2023 - which were primarily U.S. and Swiss/EU matters accordingly.
Note that even with CS, Japan megabanks were holders of AT1 bonds and took hits when SNB/Swiss regulators decided that capital structure doesn’t matter - equity holders get something before bond holders. Yet, those very Japan megabanks, such as MUFG who faced lawsuits by their clients for CS AT1 losses, were also the very first to go back INTO issuing AT1s later that year.
Final point for now-
Regarding Bank of Japan policy “normalization” and how they “MUST” and “INEVITABLY WILL” get front end rates out of negative, no more JGB buying / YCC etc) - to reiterate my view again - MUST they? Unconditionally? Why? To combat low single digit externally generated / imported inflation that’s leveled off? At a time where financial institutions and lenders are facing major marked to market losses on JGBs?
BOJ just got another reason to not blindly rush into stripping easing away “ASAP.”
JPY
As per a paid subscriber’s direct question asking me about what’s up with JPY strength overnight - (and for anyone else among the paid subscribers - while I may not always have an answer, you’re always welcome to ask me about anything, and if it’s something I feel would be broadly beneficial, I’ll surface your question and answer for all to see)-
First of all, yes indeed JPY had been on the move, but not just during the Powell press conference - JPY had been swinging both ways in the last 1-2 days. Much like USTs and equities.
But the sharp move down in USDJPY to almost break below 146 was actually not a FOMC/Powell reaction - it had occurred earlier in the day - and futures driven (chart timeline in EST)
And since nobody (human active managers) trade markets (in enough size to move them) hours prior to an FOMC release - we can chalk a lot of that up to systematics - hence futures flows triggering one another to move, cross asset:
But we need to take the full picture into context of what JPY had been doing (on what catalyst) leading into FOMC day- because that gives context to whether this is position entering, exiting, reversing an overextended move back to “neutral” or what have you.
See chart below:
Note that while it may seem to be the U.S. AM releases (prob QRA) that triggered the JPY strength, the move thereafter seems to be simply a self-driven market momentum snowballing - nothing was happening in mid-morning EST in terms of releases, when JPY was most active in price action and volume - and nobody (human active market participants) would be really actively blasting the markets in such a manner on a Fed day.
JPY futures volume jumps on the day - and net new positions opened - not exited.
JGBs
Are rallying.
Here are the catalysts:
Most notable move is today during Japan hours - as 10Y JGB auction results showed strong demand via bid-to-cover well above 3:
Watch for a potential continued bid to push US yields down further in the near term, now that we’ve broken back into the 3-handle.
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Thx Weston, bipolar says it all
Weston it would be great to get your thoughts as dollar yen tests 150. BOJ upcoming events. Mechanics of JG response. Seemed like when it gets above 150 JG sells treasuries but it'd be neat to understand details (I think its Ministry of Finance, not BOJ does the selling). Does JG let dollar yen rise to 160 and so forth.