Net interest income drove 1Q results, balancing both the SMTPFC equity stake and JPY 20B share buyback; 2Q guidance and shareholder return revisions are the key focus

Summary

Net income attributable to owners of parent company for FY2026 1Q came in at JPY 32B (+JPY 4.9B YoY, 24.8% progress toward full-year guidance), with ROE (TSE basis) at 8.9%, marking a solid start to the year. Core banking profit reached JPY 51.3B (+JPY 10.9B, 27.7% progress), driven by net interest income expansion, with the domestic loan-deposit spread improving to 1.225%. The effect of the rise in housing loan base rates following the December 2025 rate hike is expected to fully materialize from 2Q onward, and the June 2026 policy rate increase to 1.0% represents an additional upside factor. During the briefing, management characterized the 15% equity stake in SMTPFC (Sumitomo Mitsui Trust Panasonic Finance) as a transaction that enhances ROE without expanding the balance sheet, and suggested that upward revision of full-year guidance—incorporating upside factors including approximately JPY 5B in negative goodwill—is under consideration for announcement at the 2Q earnings.

Key Points (Earnings Takeaways and Growth Actions)

• Management Strategy and Market View
  • The effect of the housing loan base rate increase following the December 2025 rate hike will fully materialize from 2Q, accelerating the expansion of the loan-deposit spread.
  • Management explained that strategic investment and shareholder returns are not necessarily a trade-off, and that both were executed this time.
  • Under the recognition that regional bank consolidation has begun to move significantly, management positioned itself as a player that wants to be at the center of consolidation, having already integrated Kanagawa Bank ahead of peers.
• Current Business Progress and Drivers
  • Domestic loan yield rose to 1.534% (+0.277pt), loan-deposit spread widened to 1.225%, and loan interest income increased by JPY 13.2B.
  • Corporate fees declined JPY 2.2B due to the lapping of a large deal in the prior-year 1Q, but the pipeline is comparable to prior year and large deal closings have begun in 2Q.
  • The markets division front-loaded JPY 6.1B in capital losses within the JPY 8.1B annual budget loss-cut allowance; disposal of JGBs yielding below 0.5% has been completed.
• Strategically Important Initiatives and Inflection Points
  • On July 30, the company executed the definitive agreement to acquire a 15% stake in SMTPFC (approximately JPY 20B; scheduled closing date October 1). The four-party business alliance envisions know-how transfer in credit assessment models and electronic contracts, as well as syndicated leasing.
  • On August 5, the company announced a JPY 20B share buyback. Unlike the prior buyback, no general cautionary language was attached, with management explaining they have conviction in completing the program.
  • For retail deposits, a new time deposit campaign was launched with an online cap of JPY 10M and an in-branch cap of JPY 20M (1-year in-branch rate of 1.3%) to curb deposit outflows.

Outlook and Strategy

• Management is scrutinizing upside factors including earnings progress, the June rate hike, and approximately JPY 5B in negative goodwill from SMTPFC. Guidance revision was deferred at 1Q, with indications that it is under consideration for 2Q earnings. Any revision will be accompanied by a review of shareholder returns.
• The SMTPFC investment will be accounted for under the equity method, so the consolidated balance sheet will not expand, and the impact on CET1 is minimal. Management also referenced the possibility of additional share buybacks in H2 to bring the CET1 ratio closer to the mid-term plan target.
• Specific uses for the negative goodwill remain undecided at this point. However, in a separate Q&A exchange, management mentioned the possibility of using it to clean up investment trusts that have been held with unrealized losses for an extended period.
• The policy of reducing strategic shareholdings to below 10% of consolidated net assets by March 2030 remains in place (19.5% as of end-June 2026, book value JPY 91.2B).

Positive Factors

• Revenue expansion and cost discipline are advancing simultaneously, with the OHR improving to 43.1% (−3.7pt).
• Loans outstanding reached JPY 17.3T (+3.1%). SME lending grew +6.8% (+7.4% excluding Bank of Yokohama's asset management company-related lending), and lending to high-net-worth individuals grew +3.0%.
• Structured finance average balance reached JPY 872.2B (+17.2%). LBO loans and going-private transactions are the key drivers, with early achievement of the JPY 890B annual plan target within sight.
• Net unrealized gains on available-for-sale securities reached JPY 235.1B (+JPY 63.9B vs. end-March). Portfolio yield rose to 1.06% through JGB replacement, and duration shortened to 3.2 years.

Concerns and Risks

• Higashi-Nippon Bank's ROE is in the 3% range, OHR is 75.9% (2.1pt deterioration), and net banking profit stands at JPY 1.4B (18.4% progress)—all at low levels. Management explicitly stated that multi-faceted discussions are needed, including a review of the bank's appropriate scale.
• Unrealized losses on yen-denominated bonds (excluding held-to-maturity) are JPY −41.1B, with an estimated additional impact of JPY −2.2B per 10bps parallel shift in rates.
• Uncertainty in the M&A market driven by sharp equity market volatility could impact the structured finance deal pipeline.
• Total deposits declined −1.1%. The −25.8% decline in public-sector deposits reflects a deliberate decision not to chase aggressive rate competition, but the battle for retail deposits comes with higher funding costs.

Performance Highlights

Combined gross banking profit of the three banks was JPY 78.3B (+JPY 8.9B), driven by net interest income of JPY 72.3B (+JPY 13.5B), resulting in core banking profit of JPY 51.3B (+JPY 10.9B, 27.7% progress). On an FG consolidated basis, recurring profit was JPY 45.4B (+JPY 7.1B), net income attributable to owners of parent company was JPY 32B (+JPY 4.9B, 24.8% progress), and ROE (TSE basis) was 8.9%. The markets division posted a loss of JPY 1.1B after booking JPY 6.1B in capital losses, which were front-loaded within the full-year loss-cut allowance.

Segment Performance Note: As banks do not have direct equivalents to revenue and operating income used by general corporates, gross banking profit and recurring profit are shown for comparison.

• Net Income Attributable to Owners of Parent Company: JPY 32B (+JPY 4.9B YoY, 24.8% progress)
• ROE (TSE Basis): 8.9% (+0.6pt YoY)
• Core Banking Profit (excl. Investment Trust Redemption Gains/Losses, Three Banks Combined): JPY 51.3B (+JPY 10.9B YoY, 27.7% progress)
• OHR (Three Banks Combined): 43.1% (−3.7pt YoY)
• Domestic Loan-Deposit Spread: 1.225% (FY25 1Q: 1.064%)
• Loans Outstanding (Three Banks Combined, Domestic): JPY 17.3T (+3.1% YoY)
• Deposits (Three Banks Combined, Domestic): JPY 20.3T (−1.1% YoY)
• Credit Costs (Three Banks Combined): JPY 2.2B (credit cost ratio: 0.05%)
• NPL Ratio (Three Banks Combined): 1.2% (end-June 2025: 1.2%)
• Structured Finance Average Balance: JPY 872.2B (+17.2% YoY)

Q&A List

• Q: The policy rate assumption was raised from 0.75% to 1.0% in June, and the impact estimate on gross banking profit was released, yet there was no upward guidance revision at 1Q. Was there an internal discussion about revising, and if so, why was it deferred?
  A: Given earnings progress, the June rate hike, and the negative goodwill impact from SMTPFC, many factors are in upside territory. However, the negative goodwill amount could fluctuate depending on allocation methodology, and this is currently under review. If we revise our earnings outlook, shareholder returns would also be revised accordingly, so we wanted to raise the resolution of internal discussions before making an announcement, and therefore deferred it at 1Q. There is a possibility of a rate hike in September as well, so we cannot be definitive, but our current thinking is that we would like to consider revising guidance at 2Q earnings if possible.
• Q: Corporate fee progress against guidance appears low even for a 1Q. Is it correct to understand that the full year is on track after adjusting for the large deal lapping effect? How do you evaluate performance aside from the lapping impact?
  A: The prior-year 1Q was exceptionally strong, so the YoY decline looks outsized, but we recognize the annual budget already incorporates a negative variance. The pipeline is very robust, corporate actions among listed companies in the Greater Tokyo area remain active, and the deal inventory is comparable to the prior year. Some deals have already been closed in 2Q, and we are at the stage of discussing how much we can exceed the budget rather than how much we will fall short. It's not just on track—we see upside. We are currently scrutinizing the full-year landing including the policy rate increase, and want to create an opportunity to explain with greater granularity.
• Q: What was the rationale behind the 15% equity stake in SMTPFC? Were you able to acquire it cheaply, similar to L&F Asset Finance?
  A: Since last year's L&F Asset Finance acquisition, we have been in ongoing dialogue with SMTB on various topics, and SMTPFC was one of the targets under negotiation. Our leasing subsidiary, Hamagin Finance, has been limited to small-ticket finance leases under Banking Act constraints, making it difficult to scale and lacking know-how including in credit assessment. We concluded that a capital participation in SMTPFC could fulfill this need and reached an agreement. Whether we bought cheaply is difficult to comment on given the counterparty, but from SMTPFC's perspective, they can envision a growth strategy leveraging Bank of Yokohama's customer base—the top regional bank—rather than operating standalone. Under the four-party business alliance, we will receive know-how in model-based credit assessment, which will contribute to upgrading and streamlining Hamagin Finance, and syndicated leasing will enable asset expansion. Rather than whether it was expensive or cheap, we understand that SMTB chose Fuyo General Lease and us based on their view of what constitutes the best ownership structure.
• Q: Even if Higashi-Nippon Bank achieves its full-year plan, its ROE is considerably lower than the consolidated group. With industry-wide ROE trending upward, the gap stands out. What is management's view on the challenge, given the capital allocated, and what improvement measures are in place?
  A: An ROE in the 3% range is a significant challenge within the group. We are seeking the optimal solution given the bank's scale and its positioning in Tokyo's intensely competitive market. In this mid-term plan, we are focused on rebuilding relationship banking for SMEs. We deliberately did not set aggressive revenue targets, effectively creating a plateau period. Meanwhile, as funding costs rise, we are working through how to generate loan revenues that exceed those costs—determining which size of enterprise and which needs to target—and it will take a bit more time to reach the optimal answer. That said, an ROE of around 3% is clearly not acceptable, and we intend to engage in multi-faceted discussions as the FG, including the appropriate scale for Higashi-Nippon Bank.
• Q: You booked JPY 6.1B in capital losses in 1Q, against an JPY 8.1B loss-cut budget. Do you feel the need for further losses? Is there a need for additional write-downs leveraging unrealized losses, or portfolio rotation in the securities book?
  A: Capital loss realization can be endless if you want, but we are proactively addressing positions that are in negative carry because the future burden grows heavier. That said, we have fully processed the portion yielding below 0.5%, and additional processing tied to further rate hikes is not expected to be on a significant scale. On the other hand, there are investment trusts that have been sitting with unrealized losses for years—a source of opportunity cost on top of ongoing trust fees. Considering stable funding ratios and liquidity ratios, it is better to convert them into productive capital rather than leave them idle, and the negative goodwill could potentially be used for that purpose. In any case, we want to deploy these resources in ways that contribute to future earnings.
• Q: Structured finance average balance of JPY 872.2B, up 17% YoY—very strong. What is driving the growth? Is there a possibility of early or above-plan achievement against the JPY 890B annual target?
  A: The growth is not coming from non-recourse real estate or large data centers, but rather from LBO loans associated with corporate going-private transactions and M&A. Including refinancing deals, the pipeline inventory is very substantial, and large transactions have been closing into 2Q, so there is a real possibility of achieving the balance target ahead of plan. However, there is uncertainty around how the M&A market will behave amid sharp equity market volatility. In any case, the trend is upward, and we are proceeding with early achievement in our sights.

Additional Q&A

• Q: Following the front-loaded portfolio rotation in 1Q, what happened to the approximately JPY 200B in low-yielding yen bonds below 0.5% that existed at end-March? What is the outlook for further processing?
  A: Among the sub-0.5% positions, JGBs were loss-cut well ahead of schedule. Some remaining corporate bonds have short residual maturities and we are considering holding to maturity; we booked JPY 6.1B in capital losses this quarter. We built an JPY 8.1B loss-cut allowance into the budget and front-loaded somewhat larger loss cuts within that framework. Through portfolio rotation, we are maintaining a thick unrealized gains cushion while rotating into higher-yielding assets to underpin future net interest income.
• Q: This buyback used a standard scheme. Unlike last time, there is no language suggesting "execution may not proceed if a large investment arises." Should we infer that there is no imminent sense of inorganic opportunities?
  A: We also executed a JPY 10B buyback at the same time last year. Rather than signaling a full-year quantum, we are first demonstrating a size we can complete in the near term. The absence of conditional language this time reflects the fact that SMTPFC is already underway, and we have visibility that no other such transactions are expected before the buyback is completed, giving us confidence in execution. Aligned with any revision of our full-year outlook, there may be a juncture in H2 where we consider additional buybacks to bring the CET1 ratio closer to the mid-term plan target. Strategic investment and shareholder returns are not necessarily a trade-off, and this time we executed both.
• Q: Shinsei Bank has signed regional growth investment cooperation agreements with 14 regional financial institutions. How do you view the risk of losing structured finance share near Kanagawa? What strengths can you leverage to expand your client base?
  A: We understand the SBI framework as a partnership where many participating banks lack lead arranger experience and want to access structured finance through SBI. We, despite being a regional bank, have the capability to serve as lead arranger for LBO loans and other transactions, and our front-line bankers say no other regional bank can do the same. We are already conducting similar activities where we take on risk and participate out portions. While one could view this as competition, in the Greater Tokyo market we are cooperating and coexisting with megabanks to grow the market. As deal sizes increase, even megabanks find it difficult to take on risk alone, so regardless of whether participation comes via us or SBI, having more regional banks joining as risk-taking partners is a positive for us as well.
• Q: Loan yield improvement varies in magnitude across Bank of Yokohama, Higashi-Nippon Bank, and Kanagawa Bank. What drives the differences within the FG?
  A: The differences arise from client segment characteristics. Kanagawa Bank serves the smallest clients, so its yield levels are inherently higher, but when competing against shinkin banks, it is harder to raise rates in line with market dynamics. Bank of Yokohama primarily serves clients with high financial literacy, making price pass-through easier, and its yield improvement pace is faster partly because it has been building structured finance assets in recent years. Higashi-Nippon Bank sits in between.
• Q: What is the deposit strategy for corporate and retail segments? The retail deposit campaign was successful last year, but should we assume limited room for further deposit beta increases? What is the approach to acquisition strategy and cost?
  A: The sharp decline in public-sector deposits is primarily because more players are bidding at aggressive rates in tenders, and we are deliberately not chasing. Our policy is to firmly capture customer-base deposits, and we are implementing initiatives for both retail and corporate. Last year's campaign gathered JPY 300B in two months, of which approximately 60% remains on book. Clients who redeposited in large amounts—JPY 500M or JPY 1B—tended to leave in pursuit of higher yields, while those who deposited in smaller amounts—JPY 10M or JPY 20M—have largely stayed, confirming the tendency for customers to keep funds at their local bank. Accordingly, we have now launched a new rate campaign with an online cap of JPY 10M and in-branch cap of JPY 20M (1-year time deposit, 1.3% in-branch rate). We plan to run campaigns on an ongoing basis. Additionally, we are focusing on mass retail account acquisition through our proprietary banking app.
• Q: The AUM business including investment trust sales appears solid. With the new NISA now launched, what is the progress, your confidence level, and remaining growth runway?
  A: Insurance includes an inheritance tax advisory function for high-net-worth clients, and we are strengthening proposals from that angle. Yen-denominated insurance product features have improved and there has been a shift from foreign-currency products, but we want to continue meeting inheritance planning needs. On the other hand, the economic benefit of yen-denominated insurance is nearly indistinguishable from time deposits in some cases, and we will respond while reading client demand. We are not looking to place significant revenue weight or expectations on this segment.
• Q: Was the cautionary language attached to the previous buyback specifically because of the SMTB leasing subsidiary deal, and it was removed this time because that deal is now concluded?
  A: It was not because of any specific transaction. If there were a specific deal constituting insider information, we would not have been able to announce the buyback at all, and we did not view the SMTPFC transaction as an impediment to the buyback at the time either. That said, various opportunities are always in motion, and not knowing when a deal might materialize is the same now. At the time, the share price was surging and had crossed above 1x P/B, and there was internal debate about whether strategic investment should be prioritized over buybacks at those valuation levels. The cautionary language was intended as a general disclaimer rather than a condition precedent, but analysts pointed out that if it is general in nature, it is better not to include it. This time, we have conviction that the JPY 20B can be completed, so nothing was attached. If buyback size is larger and the execution period longer, there may be instances where such language is included.
• Q: What is the approach to the housing loan business? Is there room to reconsider the product from a risk-weighted asset deployment perspective, including the angle of client retention?
  A: Housing loans have unique asset characteristics in terms of profitability and long duration, and we understand other regional banks are grappling with this as well. We have not set aggressive growth budgets for this fiscal year, partly due to uncertainty around new housing starts in Kanagawa Prefecture. Since rate resets occur semiannually, we manage profitability based on 6-month TIBOR and similar benchmarks, but the current wide gap between 6-month and 1-month TIBOR means that profitability assessments vary significantly depending on the management accounting methodology used. We intend to flexibly adjust our strategy in response to the environment, monitoring the moves of megabanks and internet banks.
• Q: What are your observations on regional bank consolidation? Is the focus primarily on intra-prefectural consolidation for now, with cross-regional deals less likely?
  A: We have the strong impression that things have begun to move significantly. Rather than reacting to others' moves, we have already brought Kanagawa Bank into the group ahead of peers, so we are calmly assessing the landscape and, as a player that wants to be at the center of consolidation, working to build relationships that position us to capture the best opportunities. Cross-regional consolidation among regional banks is emerging, and there may be cases targeting synergies between deposit-gathering and asset deployment functions, or efficiency gains through head office and system integration. However, the most straightforward model is vertical integration within the same prefecture, where synergies are clearest. We believe our preemptive TOB for Kanagawa Bank was the right decision.