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Nomura Holdings, Inc. (NYSE:NMR)

F2Q 2012 Earnings Call

November 1, 2011 5:30 am ET

Executives

Takumi Shibata – Executive Vice President and Chief Operating Officer

Junko Nakagawa – Chief Financial Officer and Executive Officer

Analysts

Masao Muraki – Deutsche Securities

Tsujino Natsumu – JPMorgan Securities

Mitsumasa Okamoto – Merrill Lynch Japan Securities Co., Ltd.

Shiel Dasan – Securities Capital Markets

Katsunori Tanaka – Goldman Sachs

Operator

Good day, everyone and welcome to today’s Nomura Holdings’ Second Quarter Operating Results for Fiscal Year Ending March 2012 Conference Call. Please be reminded that today’s conference call is being recorded at the request of the hosting company. Should you have any objections, you may now disconnect at this point. During the presentation, all the telephone lines are placed for a listen-only mode. The question-and-answer session will be held after the presentation.

Please note that this telephone conference contains certain forward-looking statements and other projected results, which involve known and unknown risks, delays, uncertainties and other factors not under the company’s control, which may cause actual results, performance or achievement of the company to be materially different from the condition, political events and investor sentiments, liquidity of secondary markets, level and volatility of interest rates, currency exchange rates, security valuations, competitive conditions and size, number and timing of transactions.

With that we’d like to begin the conference call. Mr. Mr. Junko Nakagawa, please go ahead.

Takumi Shibata

This is Takumi Shibata, Group COO of Nomura. First, I’ll explain the future measures that we will implement, and then I will ask CFO, Ms. Nakagawa to go over the Q2 highlights. After that we will open the line to questions.

We announced a cost cutting of $400 million when we reported these Q1 results. Today, we have decided to cut a total of $1.2 billion including this $400 million that we have already announced. Simply put, we are trying to adjust our expense or cost base from one suitable for the 2009 revenue environment, down to a level suitable for the 2011 revenue environment.

And by bringing down the breakeven point, we are trying to enhance our business execution capabilities. And in order to optimize the regional allocation of our management resources, we will reallocate some of the resources that we allocated to EMEA into the Americas and Asia. And for EMEA, under a new expense structure, we will build the foundation for growth.

We will become a leaner company, and once we have optimized the regional allocation of our management resources, we will actively meet the needs of our clients. The importance of our global network as well as clients being the center of our business, will remain unchanged and these will continue to be the long-term commitment of Nomura.

Now, I will ask Ms. Nakagawa our CFO to go over the Q2 highlights.

Junko Nakagawa

This is Junko Nakagawa, CFO. I'll use the presentation to go over the Q2 results of the year ending March 2012.

The current quarter was a challenging one with the market deterioration – market condition deterioration and also turmoil in the financial markets based on the

eurozone debt crisis.

Q2 net revenues for Nomura Holdings was 301.6 billion yen, which was down 9% Q-on-Q, but it was up 9% year-on-year due to Nomura Land and Building becoming a subsidiary.

For the Retail and Asset Management divisions, these two divisions remained resilient with continues inflow of funds despite the tough market conditions. However, the Wholesale division suffered a decline in revenues of 44% Q-on-Q, due to sluggish trading and market volatility impact.

As a result, the pre-tax loss for the overall firm was 44.6 billion yen and net loss was 46.1 billion yen. The pre-tax loss and the net loss for the first half were 10.3 billion yen and 28.3 billion yen respectively. Please turn to page 4.

As our COO explained earlier, we have decided to cut costs by $1.2 billion, including the $400 million that we announced when we reported our Q1 results. This additional $800 million will be a firm-wide cost cutting, but mainly in the Wholesale division.

In order to optimize the regional allocation of our management resources, we will shift some of our resources from EMEA to the Americas and Asia. Europe or EMEA, will build the foundation for our growth under a new expense structure, and by revising or revisiting the cost structure and making the global network more efficient, we will bring down the break-even point and aim to improve our profitability. Page five please.

Here we show the summary of the Q2 and the first half results for March ’12. Net revenues for each segment and also the pre-tax P&L, please turn to page six, and for the results of each segment, please turn to page seven onwards. I will start with the Retail division. Pages seven and eight please.

For the Retail division with the deterioration of market environments globally, the total sales declined Q-on-Q, and net revenue was 84 billion yen, which was down 11% Q-on-Q. Pre-tax income was 10.7 billion yen, which was down 51% Q-on-Q.

Within Retail the sales of shares and bonds trended robustly, and by diversifying the asset class and currency, we were able to provide products, which meet our clients needs on a very broad basis. And we achieved a net increase in client assets of 1.1trillion yen. The tough market conditions, which I mentioned earlier, are expected to continue for a while, but we will continue to focus on consulting sales and meet our clients’ need.

Next the Asset Management Division. Pages nine and 10 please. The net revenue for asset management was 16 billion yen, which was down 15% Q-on-Q. And pre-tax income was 4.7 billion yen, down 37% Q-on-Q, however, it was up year-on-year.

And with the decline in markets and the yen appreciation, AUM declined, however, there was 236.1 billion yen of inflows into ETF. And also, we continued to enjoy an inflow of funds into public stock investment trusts and the investment advisory businesses.

We will continue to provide services to improve our investment management capabilities and also value-adding services to differentiate with our competitors and improve our management performance. Page 11, please.

This is the overview of the Wholesale division. Due to the market volatility, trading was sluggish and also the fund raisings in primary markets was sluggish as well. And net revenue for wholesale was 79.3 billion yen, down 44% Q-on-Q, and pre-tax loss was 73.1 billion yen. I will give you the breakdown of the Wholesale division on page 12 onwards.

Global Markets net revenue was 72.6 billion yen, down 44% Q-on-Q, and the pre-tax loss was 48.6 billion yen. For Fixed Income, client activity improved and Japan FX and Rates continue to show solid performance. However, due to the sharp decline in market liquidity, the trading of Securitized Products, et cetera, were sluggish.

For Equities, although the client revenues increased, the slowdown or sluggish trading in derivatives and CBs brought down the overall revenues and we saw a decline in revenues for each region overseas. Page 14, please.

Investment Banking was hit by a 40% quarter-on-quarter decline in the global investment banking fee pool, the lowest figure since 2002. As a result, gross revenue fell 26% on the previous quarter to 23.8 billion yen. Loss before income taxes was 24.5 billion yen. While our global DCM business, including the solutions business, and mergers and acquisitions were strong, this could not offset weakness in the ECM business.

As you can see on page 15, however, our global mergers and acquisition business is expanding driven by Japan outbound M&A. We are number one on the Japan outbound M&A league table with a market share of 45%. In Asia ex-Japan M&A, we improved our ranking from number 19 last year to number 9 this year.

Please turn to page 16 for an overview of non-interest expenses.

Non-interest expenses increased 17% on the previous quarter to 346.2 billion yen due to a full three months of expenses booked for newly consolidated entities as a result of converting Nomura Land and Building into a subsidiary. Excluding these effects, non-interest expenses declined quarter-on-quarter. Personnel expenses also decreased sequentially when stripping out the effects from the newly consolidated entities.

Moving forward, we will implement the cost reductions mentioned earlier and ensure a more intense focus on pay for performance. The reductions will be implemented in our three business segments and across corporate functions. The entities consolidated as a result of converting NLB into a subsidiary will not be subject to the cost reductions. And page 17 for an update on our balance sheet.

Total assets at the end of September were 36.9 trillion yen, gross leverage was 18.1 times, net leverage was 11 times. We had shareholder equity of 2 trillion yen and liquidity of 5.6 trillion yen, therefore our financial position remains robust.

In addition to our Basel 2 Tier 1 ratio and Tier 1 common ratio, we have included preliminary figures for Basel 2.5. Under 2.5, our Tier 1 ratio at the end of September was 12.2% and our Tier 1 common ratio was 10.5%.

Please turn to page 18. As shown on the left, approximately 80% of our balance sheet consists of highly liquid trading assets. Assets and liabilities are matched by raising funds in each region mostly through repo transactions. However, even under stress that could disrupt repo markets, we are able to maintain a liquidity portfolio surplus without the need for additional unsecured funding over one year.

Also by increasing the maturity profile of our borrowings and maintaining sufficient capital we have a solid balance sheet structure. Before I finish, I want to give you a brief outline of our exposure in the GIIPS countries, peripheral countries in Europe.

Please turn to page 19. Our net country exposure in European peripheral countries is $3.55 billion. Of this, 83% matures within six months and is mostly short-term government bonds in countries where we hold Primary Dealer licenses; 74% is with sovereign counterparties and 20% is with financial institutions and is highly liquid. Assets are inventory assets used for client trading and are marked to market on a daily basis.

We continue to monitor the situation from various angles including the credit situation in each country ratings, liquidity, maturity profile and hedging. Our focus remains on ensuring robust risk management.

That concludes the overview of our second quarter results.

Today, Nomura also announced a four yen dividend per share for shareholders of record as of September 30, 2011 as is indicated in the financial report. Once again, Shibata, COO.

Takumi Shibata

As I’ve stated earlier, by becoming leaner and by optimizing the regional distribution of our resources, Nomura will be able to meet the needs of our clients better and more proactively.

Many globally active financial institutions will have to cut expenses, raise capital and shrink balance sheet, reflecting the current business environment and new regulatory regimes.

Nomura will cut its expenses like other houses. However, we have already reinforced our capital position and our balance sheet is marked to market and highly liquid. We believe that this is our competitive advantage. We will use this advantage to ensure the quality of our advisory services, for our customers reinforce our commitment to the secondary securities markets and increase our contribution to the primary securities market.

When the market is in a phase of shrinkage, Nomura aims to optimize its size and increase its relative market shares.

At this moment, we would like to have our questions-and-answers. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) The first question is from Muraki of Deutsche Securities.

Masao Muraki – Deutsche Securities

In relation to the business restructuring, I would like to ask about the overviews and also the actual impact on the figures. In realigning or restructuring your business, you mentioned that you will shift your resources from EMEA to Americas and Asia, which I understand. But what would be the exact capital allocation, how will you shift your headcount, could you provide some additional detail on that?

And shortly before your announcement, Credit Suisse announced their new strategy and in that they say that they will cut the risk assets in fixed income by 50% and the capital which is allocated to fixed income, which is 55% of the total, they will reduce that to 39% and reallocate it to the retail division. This seems to be Credit Suisse’s strategy?

In terms of your economic capital, roughly two-thirds is allocated to global markets and merchant banking, in the business realignment or the reallocation of resources, how will you look after you have implemented these changes?

And in your previous guidance you have just announced a target of 19 trillion yen under Basel 3, but in total compared to your previous guidance, will your risk assets increase or will you not use as much risk assets as you have previously envisaged?

My second point is, the impact on your earnings or revenue, first of all the expenses, what would be the timing of putting the expenses. And once the schedule for restructuring is clear, will you be booking, or will you be allocating reserves for restructuring, how will you book the expenses. And when will you start seeing the impact and when will you achieve the run rate of $1.2 billion? Could you provide more detail on the schedule of the restructuring and the cost cutting please?

Junko Nakagawa

First of all, the direction, your question about the overall direction of our strategy, let’s first of all confirm the basics, our basic strategy. The restructuring that we will conduct, this is a strategic restructuring. There will be strategic restructuring and also some tactical restructuring.

For example, the restructuring of divisions and shutting down certain divisions or regions, this restructuring that we have in mind, we will not conduct that kind of restructuring. Our strategy will continue to be client focused and also focused on the importance of global network, this will remain unchanged, and within our existing strategy we will implement various tactics, strategic tactics to cut our expenses.

In terms of timing, you also asked about the timing. We will start implementing these measures as early as possible. And in Q1, we announced the cost cutting, when we reported the results of Q1, so far the progress has been roughly 60%. And this restructuring, which we announced today, most of it will be completed within this fiscal year. And in terms of the actual progress including the charges that we will have to book, we will be announcing the progress when we announce the results for Q3 and Q4.

Over the next two to three years, the restructuring will be very quick not over the next two to three years, but much quicker than that, that’s the timeframe we have in mind. In terms of the strategy for each reason or for the various reasons as you know, are from acquired the Lehman Brothers Europe and also the Asian operations. And we acquired a lot of business operations in EMEA or Europe and less in the Americas.

So in that sense we will make our European or the EMEA operations probably linear and shift or reallocate those resources into Americas and Asia. As of today, most about 60% of the regulatory capital is allocated to EMEA roughly 30% to Americas and 10% to Asia. We will reduce some of the allocation to EMEA and just that to the Americas and Asia. This is excluding Japan, this breakdown of 6.31, and I’ll have our CFO explain further details if there is anything to add.

Masao Muraki – Deutsche Securities

So just one follow-up question the shift from EMEA, you mentioned that this is not the so-called strategic restructuring. So you will not restructure the business divisions and you will continue to maintain the full line business operations, but strength the overall size of your firm or your overall business, that’s my first question. And in relation to the risk assets Basel 3 basis 19 trillion yen, the world has changed quite a bit since you announced this target, but are you still sticking to this 19 trillion yen target under Basel 3?

Junko Nakagawa

In terms of the size, we are trying to shift our expense structure to one that meets the revenue environment of 2009 instead of the one that meets the current 2011 revenue environment. So we are trying to become a linear company and there may be some services, which we will see as to be able to provide, but overall, there will not be an impact on some of the major divisions, which have a big impact on our overall business. And in addition to the 19 trillion yen, you mentioned for Basel 3. This is the target figure calculated under Basel 3.

And in our case, we are trying to – we are currently already complaint to Basel 3 even without assuming the future earnings that we will generate. So we are not in a situation where we have to reduce our risk-weighted assets. As for our competitors, there will be Basel 2.5 and then Basel 3. And the business such as fixed income, which did not use up too much regulatory capital, we think they will be forced to shrink these types of operations. But in Nomura’s case, our current business structure is structured as if Basel 3 were already in place. So we are not forced to change our business portfolio from external reasons. However, we will continue to watch the market environment and allocate our resources on a flexible basis.

So as our competitors reduce their commitment for liquidity providing in their fixed income business, we believe there will be opportunities to increase our earnings from that. And just to reconfirm, as of September end, if you look at the balance sheet as of September end, although the detail grew for Basel 3 are still not set based on our understanding of Base 3 and if we apply our assumptions, Tier 1 ratio is in the upper 8% level up to 9% in that range, and for Tier 1 common ratio, it's more than 8%, higher than 8%.

As I mentioned earlier, lot of the financial institutions have to cut costs and have to strengthen their capital and based on the new regulatory framework, they have to mitigate their risk-weighted assets and reallocate their risk-weighted assets. And compared to that, we have already – all we have today is one out of the three in order to respond to the new environment.

Sorry for the wrong answer, but I hope that answers your question.

Masao Muraki – Deutsche Securities

Thank you very much for you clarification on Basel 3.

Takumi Shibata

Just one correction from the interpreter, (Inaudible) mentioned that we will shift our expense base from one suitable for the 2009 environment to meet the 2011 revenue environment.

Operator

Our next question is from Tsujino Natsumu from JPMorgan Securities. Ms. Tsujino, the floor is yours. Thank you.

Tsujino Natsumu – JPMorgan Securities

There are four questions that I would like to ask, that’s quite a bit that I would like to ask. The first one is a simple one. Cost reduction of $800 million, is it mainly reduction in personnel expenses. Is that correct? And the second question, how should do with trading page 13 on the left hand side, I’ve been looking at that. And I calculated using the numbers announced before and in terms of global markets, non-client inflow assets are in a slight negative that is what I assume. In the past FY 2010 first quarter, I saw a similar figure but the number here is negative I believe, where there a special factors behind this?

So with respect to risk management, you’re seeing that no major changes necessary and it was mainly due to external environment, is that correct? As if you could please elaborate that’s my second question. And third question is a follow up on the second question, October along with trading and GN business, what is the situation October onward. And my last fourth question, the domestic sales income, pretax income, in the first quarter was $22 billion, it’s now down to a little over $10 billion. That’s I believe mainly due to reduced fees from investment trust. Sales of the investment trusts have been hovering high and so it will be difficult to grow even further and you must be affected by market environment and that spurn to decrease.

So pretax income of $10 billion or plus, SMBC-Nikko Securities income, dialog retail, income compared to your peers in the industry. Well, so far you have been posting a relatively high level and you are now down from that level that used to be higher. And so what are the measures about you will be taking for this?

Takumi Shibata

So the simple questions will be answered by Shibata and the more difficult ones will be answered by Nakagawa. So to address your first question $800 million cost reduction, the breakdown thereof roughly speaking, personnel expenses will account for 70% of the total reduction. That is about right, I believe. And your second question, so revenue from customer flow compared to that the overall top-line is limited that was what you suggested in your question. And is Nomura gambling the money or did we make mistakes in proprietary trading, I believe that was the gist of your question.

Well that is not the case. So we have a part of inventory in our customer business and in this quarter we reduced the inventory quite drastically in the United States. There was limited inventory, CDS prices went down quite considerably, and CDs for example, we reduced SME inventory to very low level, but in order to serve our customers, a minimum level of inventory that we have to hold, and that has come down quite considerably. In actual terms, that is one of the factors.

And another factor is that the fees that we received from customers; well, if we can reflect that in profit and loss, but for example, when we do equity trading and we get a 10 basis point fee from customers, but in the following facilitation a trade cost still has to be incurred.

And so, sorry for being lengthy, but the services that we provide for customers’ facilitation trade and the inventory that we have to keep for the sake of customers, the costs that have to be incurred and there is a liquidity and that is one of the factors behind.

The third question is rather difficult to answer, and I hope you will allow me not to answer the question. But with respect to our retail business, the environment in the second quarter was such that for the people in the retail business, for our clients itself, the environment was such that there was a strong need for accounts floatation. For example; high yield investment trust, their performance deteriorated and existing portfolios, their values, has also strong. So by the sales of investment trust did not grow as much as we initially expected.

On the other hand, foreign bonds grew in sales volumes and your question is, in the next third quarter how are we going to respond to this?

We will fit to a consultation based by sales activity, we will provide consultation to customers, and we will of course continue to introduce products to meet the investment needs of our clients, and on top of that we will continue to market foreign bonds. Of course, IPOs or POs, such equity transactions that we have not done recently. At least in the top line, we are seeing such potential transactions, therefore once the market stabilizes, if not recovers, retail segments performance will recover, and ago up once again.

Given the second chance is; we should try to take advantage of the condition. We should review the cost structure once again and try to achieve the efficiency enhancements in the retail division and cut costs, a $100 million of cost reduction is a firm wide basis, and of course that does include retail as well as asset management. And able to say Wholesale Division as well, that will be a large part. And Retail as I said is already part of it and has its own cost reduction program.

Yes. So no answer for my third question about trading position management, about the small losses that was incurred this time. In July, August and September, are the losses during this period, were large in August, is that correct, are they skewed in August?

Junko Nakagawa

Well, (Inaudible) that seems to be very tough. She is not letting us go. So as you said, July, August, September during that period, it’s true that all performance in August was not very good. September saw a slight recovery though. And regarding trading risk management, our fundamental tax effects are such that when our client activity is low, the temptation is to take our larger positions and just like the famous banks are up by trading desk, we may be able to get large earnings that maybe one possibility, but our thinking is that where activity level is low in the market we will have to enter and try to tidal with that.

So firm-wide, we have tried to reduce risk quite substantially. So without taking too much balance sheet risk, well of course, we will have to take profit or loss on risk, and once client activity goes up in line with that, we will take larger positions. And, well in fact, we’re not being able to provide the specifics as to what’s been happening since October and onward, but at least we can say that we are on a recovery trend.

Tsujino Natsumu – JPMorgan Securities

Thank you very much

Operator

The next question is from Okamoto of Merrill Lynch Japan Securities.

Mitsumasa Okamoto – Merrill Lynch Japan Securities Co., Ltd.

This is, Okamoto. You used the word tactics, so I would like to borrow that word and use it myself. Could you explain the changes in your tactics over the past three months? You announced the cost cutting and then you announced the additional cost cutting today. What caused this change in your tactics? And also in the reallocation of your management resources, when you say management resources, I believe it includes the capital, personnel all sorts of items, but when you say reallocation as was previously asked in the question, how will you reallocate your resources. So you will cut cost, but on the other hand in terms of the revenues that you generate, when you reallocate your resources could you provide more color on what you actually do?

Junko Nakagawa

Your first question for the cost cutting, we announced the $400 million at the end of Q1 and at the end of Q2, we added $800 million of cost cutting, we announced additional $800 million. So what changed over the past three months is your first question. So let me address that or let me try to address that first.

For Q1 – as of Q1, the word we used at that time was improvement of the productivity. I believe that’s the phrase that we used if you look at the market condition of Q1, which were quite weak. So our target was to improve our productivity of our business and this additional cost cutting of $800 million.

Well, you may have been disappointed when you first heard the $400 million figure, but now you will be asking why we are adding $800 million of cost cutting. One of the main reasons behind this was the future market environment and it is starting to get more and more clear. And this is only our view, so it may differ from other people’s views.

But if you look at the market conditions in Europe today, the Greek issue, it took two years to address the Greek issue – Greece issue and after two years it's still – a little people view it as not totally result. So the next 18 months – 24 months will be cloudy, it maybe sunny some days, but it will be cloudy the other – the rest of the time and that we – that’s our view of the next 18 to 24 months, which maybe wrong, but that is our view, so based on that view, we are responded to that view and try to get through these cloudy times with a lower expense base.

After these times of turmoil are over we think a new world will come, but we think this will continue for two years or so and we have to re-calibrate our business to meet – the business over the market conditions. And also taking this opportunity, when we look at our clients including the corporate clients and also the financial institutions, such as banks, they need various solutions, which we will continue to actively provide by allocating resources to these businesses.

Heading a clean balance sheet under such – these times, gives us an advantage compared to our competitors. And the definition of management resources you raised some examples but the basic understanding right now is on the expenses when we say management resources. So we are not in a situation where we have to raise equity or shrink our balance sheet in certain regions, certain country. So at the moment, when we say reallocation, we are mainly talking about our expenses.

And right now, we believe it’s a transition period with a lot of changes going on and we believe this will continue for around two years. So we have to apply our management resources very flexibly. And the areas where we will apply the resources could differ from our competitors. We will flexibly allocate our resources based on the return on assets and return on equity. If a lot of players move out of fixed income business, that means that we will be able to expect a certain size or sizeable returns from fixed income. So we will be flexible. And we have not formed a clear view of what will happen over the next two years. That is quite difficult to do.

Mitsumasa Okamoto – Merrill Lynch Japan Securities Co., Ltd.

Thank you very much.

Operator

Next question is from Daiwa Securities Capital Markets, Shiel Dasan. Shiel Dasan, the floor is yours.

Shiel Dasan – Securities Capital Markets

Thank you. My first question follows regarding the credit risk. VAR has been reduced and during the second quarter I believe VAR have been – are going down, is that because of reduced credit risk or trading position was that reduced, what was the pattern behind that reduced VAR, so that’s my first question. And second, earlier you talked about resource reallocation and that you are mainly taking about expenses, so away from EMEA more towards Asia and Americas you’re going to reallocate resources and other ways in Asia and Americas does that mean that cost well wised in the future, so those are the two questions that I would like ask?

Junko Nakagawa

So VAR reduction the factors behind as we what we pointed out. And as I said earlier in these uncertain times and conditions and when most of the clients on this side lines, so for example hedge fund our investment 75% of the money in cash and (inaudible) investors. They are tied to retain as much cash as possible given the real spend they have [experience here] to.

So as of firm, the mission that we have – we believe there is customer facilitation and so considering that we can not touch it by ways for inventory so, reduction in valid risk means as that we have reduced our inventory quite drastically, reduction in inventory behind that is of course reduced the revenue. We’ve have been expecting that and the traders given the current trading environment they cannot be fully satisfied and some are dissatisfied, but we have to come back to our mission and exercise the control.

This is not a very seemly situation there is no hero in the market. And as far as the expenses we would continue to be agile and flexible if we see this as opportunity we may hire more people. So expenses may go up in the market going forward, but what we can say at this moment is, if we decide to hire more personnel, we have to make sure that they have to be accretive and we may reshuffle people within the same segments or division or reduce human resources in some parts and have new hires as part of self funding.

And with respect to expense increase, we will do what we have to do, but basically we will retain a cautious sense otherwise $800 million cost reduction becomes inconceivable. Thank you. About the first question and in some one else’s question, as order flow increased trading position pricing was reduced and there was leakage found and by reducing inventory you are trying to respond to that so that you can prevent looses from recurring is that the correct understanding.

So there are two types of losses that could arise from our current business, one is the facilitation related to our trading for clients, in the case of equity, over a relatively short period of time, we will have to look for next customer, and in the meantime price could change, and that is the nature of facilitation trade.

Frankly speaking, the quality of Nomura’s facilitation trade was not up to the standard that we have required, we deducted that early, and we changed personnel in that area, and as a result facilitation related risk is reduced, and now another reason as to why we could incur losses in client business is inventory, and the as I said inventory was reduced drastically.

Distribution inventory, but in the U.S. CMBS even if we may want to reduce inventory there is minimum amount of inventory that we have to hold for example in CMBS and CB convertible bonds of course the market itself is all right, but in order respond to your customer demand, so we need a certain level of inventory in CBs as well, CMBS and CBs in these two areas market price – market prices plunged in these areas. We reduced our inventory, but prices kept on going down, but CMBS, RMBS and CBs. In order to do business in these areas these are risks that cannot be avoided. So we did reduce distribution inventories to a great extent, but they are not reduced to zero and thus we have been affected and the value of the inventory is reduced.

Shiel Dasan – Securities Capital Markets

Thank you.

Operator

Next question is from Goldman Sachs Securities, Mr. Tanaka.

Katsunori Tanaka – Goldman Sachs

This is Tanaka from Goldman, three questions. First two points are in relation to the $800 million cost cutting and last is about the Skylark about the $800 million cost cutting, the previous person asked as well but you explained that this is a firm wide cost cutting in your materials – presentation materials. But in your explanation you explain the reallocation from EMEA to the Americas and Asia and is this reallocation from EMEA to the Americas and Asia. What is the absolute amount of cost cutting as a result of this reallocation?

My second point is in the Americas or in the U.S is your costs are going to decline? You explained that you will gain market share while cutting your costs, but considering your current franchise in the U.S you are right in the process of building your franchise and you’re just starting to see the early results, and if you cut costs in the U.S. or the Americas as well. Can you maintain your business franchise, while cutting costs. My third point about Skylark Q3, what is the impact on Q3, if you could provide any details, and if there are no impact – if there is no impact, how have you conduct the markdowns or the markups in the past. These are my three questions. Thank you.

Takumi Shibata

Very tough questions all three of them, the first two I will answer. And the third question about Skylark I will have Ms. Nakagawa our CFO answer. This $800 million cost cutting, while we say it’s the firm wide cost cutting, we also say or we keep mentioning EMEA and wholesale division. For retail division, there are – there is room for cutting some of the cutting some – conducting some general cost cutting.

And breakdown between the front office, and back office, we will consider as well. There are a lot of very talented personal in our sales or retail administration divisions. So we will let them to, what say really wanted to do and this is part of the cost cutting. The second question was also very deep question. The U.S. franchise we just started building it. And if we cut costs dramatically, we will not build the franchise, but rather demolish the franchise, I think that’s the point of your question.

And generally speaking, we’ll be cutting cost on a firm wide basis including retail, as well as asset management, they will participate in the cost cutting, and U.S. will also participate, there will be no secret [callers] in this effort. But considering the franchise business, our commitment remains unchanged. And in any organization there are some who, some people who contribute, but a certain percentage do not contribute that much and we have to make our business more efficient. But in terms of our commitment and the franchise, which we are currently in the process of building in the U.S. we have absolutely no intention of stopping the buildup of the franchise in the U.S.

And for EMEA, which will become leaner, our commitment remains unchanged as well. So it was not meant that Nomura will withdraw from Europe or EMEA and shift to the U.S. So Americas, Europe, EMEA, Asia all three locations are important for our global network and especially for us conducting the client business.

Now, I will ask Nakagawa our CFO to address your third question, about Skylark.

Junko Nakagawa

First of all, whether we have conducted markdowns in the past. Yes, we have conducted several markdowns and policies. We cannot disclose the actual amount of each markdown. The impact on Q2, we have not conducted any markups in Q2. So Q3, in the current quarter, we will be reporting at the end of the Q3. So please wait for our announcement. Have you ever conducted a markup for Skylark? Sorry, we cannot comment on specific transactions. Thank you.

Operator

Next [Shinoda Santa], Morgan Stanley Securities. Shinoda Santa, the floor is yours.

Unidentified Analyst

Thank you. I have two questions. My first question is as follows. So a total cost reduction of $1.2 billion. What are the market assumptions that are behind that? Are you expecting the current situation to continue into the future or are you expecting that the current situation will further deteriorate? What are the assumptions behind the $1.2 billion? And if your assumptions prove to be right and suppose 1.2 billion yet cut is made, what is going to be the level of ROE? So that’s my first question.

And the second question has to do with Skylark. I believe the investment balance in Skylark is 100 billion yen and I’m sure that is already sold off. And if that is correct from the second to the third quarter risk-weighted asset, how much reduction is going to be made in terms of RWA? So these are the two questions that I would like to ask.

Junko Nakagawa

So what are the market assumptions behind our cost cutting program? That was your first question. For example, a real disaster scenario, black swan (inaudible) somewhere and that could be bank run. So in U.S. and that could spread to the world or European capital flows out of Asia and China, which we rely on the growth in China could be subdued. Is that the scenario that we have in mind; no, that is not our assumption.

In 2009 and 2010, looking back on those years, in 2009 throughout the year, trading volume was quite large. And are we expecting the same this year; no. And 2010, as you know, was sluggish. And in our case as well, in the second half of 2010, there was a quick recovery in revenue, however. And are we expecting the same to happen this year; no. So having said what I said, the market environment in 2011 will probably continue into 2012. Market conditions will not change very much into the next year. And with respect to ROE, as I’ve been saying in many ROE meetings, we are working very hard to be possible this year and next year, given the expected environment, we would like to recover so that we will be able to earn certain level of profit, so those are the assumptions.

So regarding Skylark impact on RWA, risk weighted assets, the impact is limited to several hundred billion yen.

Unidentified Analyst

Well, I have a follow-up question on the first point. The $1.2 billion cost reduction. When will that start?

Junko Nakagawa

So expenses in the first quarter were around 300 billion yen and that was impacted by Nomura Land and Building and that was part of the expenses. And so there will be two months worth of expenses to be posted in the second quarter, that’s 80 billion yen and altogether 380 billion yen. And of course it depends on ForEx and if you subtract $1.2 billion, the amount will be 350 billion yen and market situation is expected to continue. And if the cost reduction program is fully implemented, is that the correct assumption the numbers that I have given, are they correct? Nakagawa will answer your question.

Junko Nakagawa

So, Nomura Land And Building, the impact from consolidation is a little below 100 billion yen. In terms of revenue and expenses, the impact is about the same and on an annualized basis we are implementing the cost reduction program, so in the first quarter 300 billion you add 100 billion and use of the chart $1.2 billion? Well $100 billion is it an annualized figure?

Junko Nakagawa

Well, that is the impact in the second quarter. So some 350 billion yen and 100 billion is already part of that.

Unidentified Analyst

So 350 billion yen minus $1.2 billion, is that the correct calculation? And once cost reduction is successfully implemented, the average cost level will be the outcome of that calculation.

Junko Nakagawa

I think your calculation is correct, and the way in which cost reduction program will impact our operations as Shibata earlier said, we will start reducing cost from where we can immediately, but there will be areas which will longer time. So it will be sometime before we can see the full effect, but the basic thinking itself I believe is correct as you’ve – as said.

Unidentified Analyst

Well, sorry for asking all the details. Thank you for your answer.

Operator

Next question is from Credit Suisse Securities, (inaudible).

Unidentified Analyst

Two questions, first of all give us about the Tier 1 common ratio under Basel 3 and under the current calculations, you mentioned it was roughly 8% and including the mitigation, you can easily respond to or comply with Basel 3. And in order to bring the ratio to 10% or the target of 10% does that remain unchanged? My second question is about expenses again. And in your previous explanation about the $400 million cost cutting, you explained that the progress is roughly 16% and charges will be booked in Q3, Q4. But in relation to the 400 million cost cutting, which you announced earlier and the 60% progress, where there are actually any expenses booked in Q2 and what was the actual amount of expenses that you’ve booked in Q2?

Junko Nakagawa

For the first question, I will answer. And I will have (inaudible) answer the second question. For Tier 1 common ratio of roughly 8%, considering the competitive environment, we have to consider the competitive environment, so if our competitors converge to around 9% and we cannot become like (inaudible) and say we will achieve 10%, so we have to consider our competitors as well.

And under Basel 3 as well as Basel 2.5, the capital charge for securities companies, securities brokers and also securities division of banks will be raised for 2.5 to 3 times. So the – under the new definition, the 8% that we have calculated, there is a certain size of cushion compared to the current level. So we will not adjust our target of 10%, but it does not mean that we will definitely fix to this figure, that will be unnatural. So we will continue to watch the situation. And if the trends go towards 11%, there will be some litigation as well.

And as I mentioned earlier, we will not depend on the future earnings to comply with Basel regulations. We will try to comply based on the current earnings and without any additional litigation. So we think we have sufficient flexibility to comply with the Basel regulation. And in addition to the 400 million of cost cutting, which has already – which we have already made progress, and your question was about the severance costs related to it. We have already booked the severance costs in Q2, but the amount is – have been very much controlled, so 1 billion – a little bit over 1 billion yen and this is booked in the personal expenses.

Unidentified Analyst

An additional question, you explained that the severance charges are very small, very much controlled, but does this mean you'll be booking large figures in Q3 onwards or will you not be booking that much?

Takumi Shibata

In relation to the $400 million of cost cutting this is the annualized cost cutting. So the impact is not exactly, there is not a direct or straight impact. And so the impact of the cost cutting will not be that large in terms of the charges. And for personnel expenses, we have already made progress. So going forward we will be focusing mainly on the non-personnel expenses. So there is very limited chance that there will be charges required for future cost cutting.

Operator

It’s time to conclude the question-and-answer session. So a few closing remarks from NHI.

Junko Nakagawa

Ladies and gentlemen thank you very much for being with us for today’s meeting. And of course we will continue to monitor the situation and continue to make serious efforts at managing our businesses. And I look forward to continued understanding is important. Thank you.

Operator

Thank you for taking your time and that concludes today’s conference call. You may now disconnect. Thanks for your telephone conference call to a close. Thank you very much for being part of this meeting.

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