Mizuho Financial Group, Japan's second-biggest bank, cut its annual profit forecast by a quarter to $4.6 billion on Tuesday after a major borrower fell into financial trouble.
The borrower, consumer credit firm Orient, this month asked Mizuho and others to inject 150 billion yen ($1.27 billion) in fresh capital after its losses ballooned to an expected $4 billion yen for the year ending March 31.
Orient also asked Mizuho for a debt-equity swap worth 140 billion yen. Mizuho says it is still considering both requests.
Analysts had mostly dismissed the danger of Orient's problems spilling over to Mizuho, and the earnings downgrade could come as a surprise to investors.
In their latest forecasts before the announcement on Tuesday, 14 analysts polled by Reuters Estimates expected an average net profit of 733.1 billion yen, slightly more than Mizuho's previous forecast of 720 billion yen.
Mizuho cited "an increase in credit-related costs, a decrease in net gains related to stocks as well as other factors" in cutting its net profit forecast to 540 billion yen ($4.6 billion). It also cut its recurring profit estimate by 43% to 620 billion yen.
The bank did not give details, but sources familiar with the situation confirmed that the losses stemmed from its relationship with Orient.
Mizuho has upwards of 300 billion yen in loans outstanding to the company, and the sources said its troubles have forced Mizuho to downgrade the debt and boost reserves against potential default.
Mizuho is a major Orient shareholder as well as a creditor. Mizuho Corporate Bank and Mizuho Bank, the group's corporate and retail banking arms, together own 6% of the company's voting stock as well as several hundred billion yen of non-voting preferred shares.
Orient issued the preferred shares to Mizuho in return for past financial assistance. Japanese banks kept many large borrowers afloat during the country's 1990s downturn through debt forgiveness and debt-equity swaps.
"The way they dealt with bad loans in the past is coming back to haunt them," said Jason Rogers, a credit analyst at Barclays Capital.
While Japan's recent economic upturn has lifted stock prices generally and sharply increased the book value of banks' shareholdings, the problems of individual companies or sectors can still leave lenders vulnerable.
Orient's share price has fallen by nearly half since February and by more than three-quarters since November 2005, before a clampdown on Japanese consumer lenders by courts and regulators caused an industry-wide slump.