Nomura to Get Stress Test from Japan's SESC

Nomura Holdings (NMR) is now expected to post a whopping net loss of JPY700 billion for the fiscal year ended March 31, 2009. What at first looked like a savvy strategic move to pick up the failed Lehman Brothers' Asian, Middle East and European operations has created a black hole of temporary losses including the cost of bonuses to retain Lehman staff, valuation losses on real estate, loans and shareholdings, as well as mark-to-market losses on securities for sale to investors.

This loss comes after the company tapped the capital markets last month for a JPY280 billion stock offering to bolster its regulatory capital base in anticipation of such losses. With such losses looming, why anyone subscribed to the offering is beyond me. Japan's Dai-ichi Mutual Life Insurance Co. is now the top shareholder in Nomura after acquiring 100 billion yen in subordinated convertible bonds issued this past December. Dai-ichi Life's interest in Nomura is 8.37% counting the stake that would result if the subordinated bonds are converted into stock. After the subordinated covertible bond issue, the company offered up some 750 million new shares this March to raise roughly JPY300 billion.

Unlike its US peers who apparently took advantage of relaxed mark-to-market rules, Nomura appears to be taking a strick mark-to-market yardstick for a full-scale housecleaning to get all the losses out in the fiscal year just ending, and is airing all of its dirty laundry. The company is determined to globalize its operations and reduce its over-dependence on its domestic retail business as the main cash cow. Nomura is even reportedly prepared to move its group headquarters to London or New York if needed.

Japan's Securities Exchange and Surveillance Commission (SESC)) is placing a great deal of importance on its upcoming inspection of Nomura's books, as the SESC has been coordinating with the Financial Services Agency ((FSA) and Bank of Japan since last fall in preparation for a far-reaching overhaul of broker inspections to probe the fiscal soundness of companies in the sector--i.e., a broker sector stress test, if you will. As everyone knows, the investment banking operations of the major global brokers that created the so-called "shadow banking system" were at the center of the global financial crisis. Consequently, the FSA and SESC are trying to get their regulatory act together to scrutinize the operations of Japan's (few) remaining big brokerages more carefully.

The SESC assumed brokerage inspection duties from the FSA in 2005, so that the FSA could concentrate its resources on the still-recovering banking sector. However, as the FSA has the in-house specialists, it will "loan" these employees to the SESC, and may have its inspectors conduct inspections with the SESC. Heretofore, identifying risk factors that threaten the financial viability of brokerages has not been a priority for the Commission. They now will begin looking for non-performing assets and efforts to dispose of thes assets. In examining boker equity adequacy, they will be applying the same calculation methods the FSA currently uses in the inspections of the banks. The FSA and SESC will also set up a new monitoring unit that will share information about financial health and risk management in the sector with overseas regulatory authorities.

At the end of 2008, Nomura Holdings and three major banking groups received the dubious honor of being put on the FSA's list of financial institutions to be jointly monitored by international monetary authorities. However, while unannounced inspections are usually the norm, the SESC will this time notify brokerages beforehand so they can make necessary preparations, given that these inspections will go beyond business as usual. The regulator's first meeting about Nomura is expected in May, after the release of FY08 earnings.