The era of zero and negative interest rates globally is drawing to a close, creating a major investment opportunity—including for dividend investors. More on that in a moment.
The last bastion of negative interest rates is Japan, where the Bank of Japan (BOJ) first introduced negative interest rates to the world in January 2016; however, that is likely to end sometime in the first half of 2024. Market-watchers expect the Bank of Japan to finally normalize its monetary policy and re-introduce higher interest rates, both for borrowers and for depositors.
The reason for the change in heart by the BOJ is pretty straightforward. In Japan, core inflation (which excludes fresh food and energy) has stayed above 4% for six straight months and remains near a 41-year high.
This is great news for all of Japan, but especially Japanese banks and their shareholders. Let me explain why with an example.
Good Days Ahead for Japanese Banks
Hironori Kamezawa, CEO of Japan’s largest bank, Mitsubishi UFJ Financial Group (MUFG), summed up things nicely in a recent statement: “We are returning to a world where interest rates are positive. We are seeing light at the end of the long deflationary tunnel.”
At the bank subsidiary of Sumitomo Mitsui Financial Group (SMFG), 68% of loans have variable rates linked to the Tokyo Interbank Offered Rates (TIBOR). Sumitomo typically makes loans to businesses at a six-month TIBOR, plus a spread of 1% or so. Another 15% are mortgages, most of which have variable rates that change with “the short-term prime lending rate.”
The problem has been that, in recent years, both the six-month TIBOR and the short-term prime lending rate have barely moved. But that is about to change in favor of the banks.
Because of the rise in 10-year Japanese government bond yields, which hit nearly 1% this month, banks can now earn a decent spread by taking customer deposits (banks are paying around 0.2%) and investing them in Japanese government bonds (JGBs)—which are classified as risk-free assets under Bank for International Settlements rules. Only a year ago, 10-year JGB yields were capped at 0.25% by the BOJ.
Boom Time for Japan’s Banks
Investors have already picked up on this favorable change for Japanese banks.
Only a year ago, Japanese bank stocks were just about the most unpopular investment on the planet, trading at just 40% of their book value. Things started changing after the BOJ allowed the cap on 10-year JGB yields to rise to 0.5% in December 2022. Since then, Japanese banking stocks have risen in tandem with 10-year JGB yields, and are now up about 35% this year, compared with just under 30% for the Nikkei Stock Average.
The stocks have not only followed yields up, but also profits: they’re up for Japan’s five biggest banking groups 56% on the year, to about 2 trillion yen ($13.3 billion) in the April-September half as they reaped healthier margins on loans.
This represents a record-high tally for the five companies—the aforementioned Mitsubishi UFJ Financial Group and Sumitomo Mitsui Financial Group, as well as Mizuho Financial Group (MFG), Resona Holdings (RSNHF) and Sumitomo Mitsui Trust Holdings (SUTNY). Their profits are expected to beat records for the full year as well, at around 3 trillion yen ($20.2 billion). Net operating profits at the groups’ banking subsidiaries increased 16%, to 1.78 trillion yen (nearly $12 billion) on improvements in spreads between funding and lending rates.
Bear in mind we have yet to see the full effects on profits of the tweaks to yield curve control already implemented by the BOJ. The complete end of its negative interest rate policy, which has crushed lending profitability, will boost bank profits even further.
This change in the banks’ fortunes led to the unveiling of plans to boost shareholder returns.
Mitsubishi UFJ Financial Group recently announced a $2.6 billion share buyback program. Sumitomo Mitsui Financial Group raised its full-year net income forecast and said it plans to spend as much as 150 billion yen ($989 million) repurchasing stock. And Mizuho Financial Group boosted its annual dividend guidance along with its earnings target.
Bank Stocks’ Gains and Dividends
It would not surprise me to see Japanese bank stock climb another 35% in 2024, not only because of potential changes to the BOJ’s policy, but also because the banks’ price-to-book ratios remain low.
And, like here in the U.S., it will be difficult for the BOJ to suppress inflation under 2% over the next few years. That could lead to higher interest rates in Japan and a real possibility of bank stocks doubling within two years. In addition to the expected capital gains, it is highly likely Japanese banks will be raising their dividend payout to shareholders regularly over the next few years.
This makes these stocks a buy. Lucky you, three of them—MUFG, SMFG, and MFG—trade on the New York Stock Exchange. The latter two have a current yield of 3.5%, with the MUFG yield at 2.68%.
However, MUFG stock has outperformed its rivals, up 31% year-to-date and nearly 70% over the past year. SMFG is up 25% year-to-date and 51% over the past year, while MFG is up 24% year-to-date and 51% over the past year.
I’d lean toward MUFG. I expect the biggest Japanese bank to boost its dividend payouts and buybacks the most.
