TEXT-S&P summary: Kagoshima Bank Ltd.

(The following statement was released by the rating agency)

Oct 01 - =============================================================================== Summary analysis -- Kagoshima Bank Ltd. --------------------------- 01-Oct-2012 =============================================================================== CREDIT RATING: A/Stable/A-1 Country: Japan Primary SIC: Commercial banks, nec =============================================================================== Credit Rating History: Local currency Foreign currency 20-Jan-2005 A/A-1 A/A-1 16-Jun-2000 A-/A-2 A-/A-2 =============================================================================== Rationale

Our ratings on Kagoshima Bank Ltd. (A/Stable/A-1) reflect its solid customer base, strong liquidity, and dominant position in its home market of Kagoshima Prefecture, as well as a high level of capital compared to its overseas peers. On the other hand, the ratings are constrained by a shrinking loan-to-deposit margin, as is the case for many other domestic banks, due to sluggish loan demand and intense competition.

Standard & Poor's Ratings Services bases its ratings on Kagoshima Bank on the bank's "adequate" business position, "strong" capital and earnings, "adequate" risk position, "average" funding, and "strong" liquidity. The stand-alone credit profile (SACP) on the bank is 'a'.

Our bank criteria use our Banking Industry Country Risk Assessment (BICRA) economic risk and industry risk scores to determine a bank's anchor SACP, the starting point in assigning an issuer credit rating (ICR). Our anchor SACP for a bank operating only in Japan is 'a-'. The BICRA score is informed by our evaluation of economic risk. We view Japan as a developed and diverse economy with strong net external balance, which offsets the high level of government debt, and limited fiscal flexibility. With regard to industry risk, the banking sector is underpinned by a high and stable share of core deposits in funding and prudent regulatory monitoring. On the other hand, we consider the banking sector as fragmented with overcapacity, and those factors are evidenced by generally low earnings capacity.

Standard & Poor's assesses Kagoshima Bank's business position as "adequate." The bank's total assets stood at JPY3.6 trillion as of March 31, 2012. Although that's a moderate amount among 63 regional banks in Japan, it holds overwhelming shares in its home market in Kagoshima Prefecture. It has 44% in loans and 46% in deposits, which allow it to maintain a solid customer base and a stable revenue base for years. However, compared to other Japanese banks, including the major banks, its customer base is limited and has a high degree of geographic concentration. The bank maintains a prudent management policy, focusing on loans to small and midsize enterprises (SMEs) and housing loans. In recent years, it has increased lending to local enterprises in growth areas, such as agricultural, healthcare, and environmental businesses. It has also been focused on expanding in neighboring Miyazaki Prefecture.

Kagoshima Bank's capital and earnings are "strong" in our assessment. We expect the risk-adjusted capital (RAC) ratio to range between 11.5% and 12.0% for the next 18 months or so, which is high in global comparison. In our view, however, its core operating profit, which indicates its fundamental profitability, may decrease. This is because demand for bank loans is limited and interest spreads are narrowing, reflecting intense competition. Nevertheless, we believe the bank will be able to maintain is capital ratio.

Our risk position assessment for Kagoshima Bank is "adequate." We expect the risk position and risk asset volume of the bank's loan portfolio to remain stable. The bank's net nonperforming loan (NPL) ratio stood at 1.5% as of March 31, 2012, which is manageable, in our view. However, the net NPL ratio may have been constrained by various measures taken by the government to facilitate SME financing. If the Japanese economy deteriorates further and SMEs make little progress in improving their business performance, NPLs may increase, which may weaken the bank's asset quality. Investment banking and trading businesses account for only a limited portion of Kagoshima Bank's entire business, which lowers the complexity of its risks. Reflecting the nature of regional banks' businesses, it has less loss experience, in terms of frequency and amount, compared to major banks. The bank maintained a net profit even when the market was hit by the collapse of Lehman Brothers Holdings Inc. Although it keeps interest rate risks within a manageable range, the outstanding balance of available-for-sale securities, which are mainly made up of bonds, is rising. In addition, the average duration of the bonds is becoming longer. A key credit factor in our analysis is whether the bank's interest rate risk would become excessive for its capital ratio.

Kagoshima Bank's funding is "average" and its liquidity position is "strong," in our opinion. The bank has a stable core deposit base, which is diversified into small lots, underpinned by its solid market position in the area that it operates. However, its deposit base is limited to a specific area and its financing methods are less diverse and flexible than those of major Japanese banks. As such, compared with nationwide banks, including major banks, the soundness and stability of Kagoshima Bank's funding is average, in our view. Meanwhile, the loan-to-deposit ratio is low, standing at 70% as of March 31, 2012. Its broad liquid assets, including government bonds and cash, largely exceed the outstanding balance of its short-term wholesale funding. Those factors support our "strong" assessment of the bank's liquidity position.

Standard & Poor's views Kagoshima Bank as having a "moderately high" likelihood of receiving government support in a time of need, which is the second-highest category in our assessment. This view is based on our assessment of the government of Japan (AA-/Negative/A-1+) as "highly supportive," as well as our assessment that the bank has "moderate" systemic importance given its important role in the local financial system. The rating on the bank is equivalent to its SACP and does not incorporate extraordinary government support in the form of notch-up. Under our criteria, we do not notch up the rating on the bank when the SACP is 'a' and the sovereign rating on Japan is 'AA-'.


The stable outlook reflects our view that Kagoshima Bank will maintain its financial base at a level commensurate with its current rating over the next one to two years, and weather the impact of sluggish earnings amid a weak economy. We expect the bank to manage potential credit risks, supported by its strong business franchise in its home market and solid capital base.

We may raise the rating on the bank if it improves its core profitability, which should serve as a buffer for credit costs, beyond our assumptions. Conversely, we may downgrade if the bank's asset quality deteriorates materially and leads us to lower our assessment of its risk position. The rating on the bank may also come under downward pressure if losses increase and if its RAC ratio falls below 10%.

Related Research And Criteria Banks: Rating Methodology And Assumptions, Nov. 9, 2011 BICRA On Japan Maintained At Group '2', Nov. 9, 2011

Banking Industry Country Risk Assessment Methodology And Assumptions, Nov. 9, 2011

((Bangalore Ratings Team, Hotline: +91 80 4135 5898, Bhanu.priya@thomsonreuters.com, Group id: BangaloreRatings@thomsonreuters.com, Reuters Messaging: Bhanu.Priya.reuters.com@reuters.net))