Japanese banks are currently allowed to generate tax credits against provisions made against doubtful borrowers, based on the future tax benefit the bank is expected to gain once the borrower actually defaults. Banks can use these DTAs as part of tier-one capital, as long as they forecast taxable profits over five years.
But concerns that banks were making overly optimistic earnings predictions prompted the country’s accounting authority, the Japanese Institute of Chartered Accountants, to announce in February that it would closely examine banks’ five-year profit forecasts during year-end audits. This stricter evaluation resulted in a sharp reduction in Resona’s DTAs, which combined with the drop in equity markets, prompted the group to revise its 2002 net loss forecast to ¥838 billion compared with earlier forecasts of ¥290 billion, and pushed its capital adequacy ratio down to 3.78%.
“Resona’s capital adequacy ratio was just under 8% at the end of September, so it has been a very significant drop-off to get it below 4%,” says Jason Rogers, Japanese credit analyst at Barclays Capital in Tokyo. “The fact that [Resona] has gone for more public funds isn’t surprising, but the fact that it has gone below 4% as a result of this change of the deferred tax treatment does surprise me.”
Resona’s pre-merger banks, Daiwa and Asahi, both received public funds as part of the government’s attempts to re-capitalise the banking sector in 1998 and 1999. However, the new bailout - likely to be a combination of preferred stock and common stock purchases – is expected to be enough to give the government effective control of the bank, say analysts.
The stricter evaluation of deferred tax assets has raised fears that more major banks could also be forced to look for public fund injections. Deferred tax assets accounted for around 50% of tier-one capital at most of the major banks as of September 2002, although many institutions are now beginning to reduce their reliance on them. Mizuho Financial Group, the country’s largest bank, announced in January that it would cut DTAs by ¥800 billion, while UFJ Bank and Sumitomo Mitsui Financial Group have similar initiatives in place.
“If you look at their balance sheets, the other mega-banks are in a similar situation to Resona, with the exception of Bank of Tokyo-Mitsubishi,” says Yoshio Shima, managing director and head of credit research at Deutsche Bank in Tokyo. “So, the other banks have a similar problem, although Resona was in a weaker position so nationalisation will not necessarily happen to the other banks.”