Based on first quarter financial results, the credit quality of Japan’s big banks is generally improving says Standard & Poor’s Ratings Services,

Due to progress in the disposal of bad loans, six of Japan’s seven major banks returned to profitability in the first quarter of fiscal 2004 (ended June 30), S&P notes. Against this trend, UFJ Holdings Inc. continued to record net losses. Total consolidated net profit of the six bank groups, excluding UFJ, was 569 billion yen for the first quarter, which exceeded one quarter of their total net profit forecasts for the year.

The rating agency says that comparisons with previous years are hard, as this was the first time the bank groups have disclosed detailed quarterly financial results. “However, in general the results show the banks have made progress in disposing of bad loans, while remaining challenged in improving earnings significantly and by potential interest rate risks in their securities investments,” it says.

Looking ahead, the banks may be exposed to the risk of a rise in interest rate risks, which could lead to an increase in unrealized losses, S&P cautions. “However, the amount of risk is indeterminable because hedge, duration, and basis point values are not disclosed,” it says.

None of the bank groups have so far revised their earnings forecasts for fiscal 2004, although UFJ intends to announce a forecast revision after a detailed review.

Almost all the bank groups aim to increase profits and revenues by offsetting losses on disposals of bond holdings through increased fee and interest income, S&P reports. “However, the banks are unlikely to be able to generate a sufficient increase in earnings to cover losses on bond holdings in fiscal 2004, given the intensifying competition in lending to corporate customers and fee income businesses. In addition, the possibility of a resurgence in credit costs cannot be completely eliminated, as the cost of shedding NPLs to large borrowers could increase further.”