Aozora Bank : Q&A Summary（139KB）

Online Investors Meeting "Business Strategy for FY2024"

(February 16, 2024)

Question & Answer Summary

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Q1: Will you continue to downsize your U.S. CRE loan portfolio? Please also provide your outlook for any provision to, or reversal of, loan loss reserves going forward.

A1: With regard to our U.S. non-recourse office loans, our managed exposure reduction plan will be maintained for the next fiscal year. We made adequate provisions to loan loss reserves during this fiscal year while taking into consideration future downside risks, and we don't expect any significant amount of additional provisions for next fiscal year. There is even the possibility of a reversal in loan loss reserves, but this scenario is not included in our current plan.

Q2: Are your non-recourse office loans biased towards transactions proposed by specific originators (banks versus nonbanks, major banks versus regional/specialized banks)? Or do you select each transaction based on its characteristics?

A2: Aozora carefully selects properties with good quality in terms of LTV and other terms and conditions from among proposals from leading and high quality sponsors with a long-term investment horizon, with mostly Class A properties as well as transactions arranged by leading financial institutions with proven track records.

Q3: As for your CRE office loan portfolio, are there any different characteristics from average CRE loans, or were you more conservative than other banks in downgrading borrowers or making provisions to loan loss reserves?

A3: The majority of our U.S. office loan portfolio are loans to Class A quality properties. In

our most recent review we assessed property valuations from a forward-looking perspective, taking into account the risk of price declines over the next two years. Following these valuations, we downgraded borrowers of loans with an LTV of over 100% to NPLs, in principle, applied a stress test scenario and made additional provisions to loan loss reserves accordingly. As a result, our loan loss reserve ratio is relatively high compared to other U.S. banks.

Q4: How much of the increase in NPLs was due to redemption, repricing, property reevaluation or cash flow and DSCR?

A4: As for the classification to NPLs, we reevaluated all of our U.S. non-recourse office loans, reviewed property valuations from a forward-looking perspective while taking into account the risk of price declines over the next two years, and then downgraded borrowers of loans with an LTV of over 100% to NPLs, in principle. Please be advised that these new NPLs also included transactions without any current problems in terms of cash flow.

Q5: I'd like to know an average size of your non-recourse loans as well as a breakdown of Class A, B and C properties.

A5: Our total U.S. non-recourse office loans were 1,893 million dollars and the number of borrowers was 47 as of December 31, 2023, as disclosed in our FY2023 3rd Quarter Financial Results Overview material. The average transaction size was approximately 40 million dollars. The majority of the loans were to Class A properties.

Q6: My question is about the probability of achieving your fiscal year 2024 earnings plan. While your plans for net revenue and net earnings have been disclosed, I'd like you to explain the probability of achieving profit attributable to owners of parent of 17 billion yen, touching upon G&A expenses as well as credit-related expenses and gains/losses on stock transaction below business profit line. Please also specify both upside opportunities and downside risks in your future earnings, including promising areas in terms of profit growth and any risk factors that need to be monitored closely.

A6: We expect that overall G&A expenses will slightly increase compared to this fiscal year's budget of 63 billion yen due to higher personnel expenses. Credit-related expenses are expected to be at a normalized level. We don't expect to take any significant gains/losses on stock transactions, so unrealized gains on stocks could be regarded as an earnings buffer. For these reasons, we believe that the probability of achieving 17 billion yen is relatively high.

The upside potential for profit growth include our strong customer-related business and the impact of higher yen interest rates. As we disclosed in our fiscal year 2023 interim financial results, given the 10bps increase in yen interest rates, net interest income is estimated to increase by approximately 2.4 billion yen. Downside risks are thought to be additional credit-related expenses, but we believe that the risk of future losses is significantly reduced as we've made adequate provisions to loan loss

reserves for our U.S. non-recourse office loans.

Q7: While the contribution of GMO Aozora Net Bank's (GANB) net revenue was remarkable, as seen on page 5 (FY2024 earnings plan) of today's presentation material, it seems to me that improvement in the net income of GANB was somewhat weaker compared to its net revenue growth in the current fiscal year. At the fiscal year 2023 interim financial results investors meeting, you mentioned that GANB needed to address issues including debit cards. Please provide your outlook for a recovery in GANB's net income by referring to expenses (including cash back) from both a short- and medium-term perspective.

A7: GANB increased its net revenue significantly to 1.8 billion yen and improved its business profit to a deficit of 0.3 billion yen in the third quarter alone. Net revenue from transfer transactions, which do not require cash back to customers, also increased during the period. GANB is expected to increase net revenue in the fourth quarter and beyond, with a view to becoming profitable on a single month basis during next fiscal year.

Q8: I'd like to ask about your investments in human capital. I think that human capital is one of the most significant factors for earnings recovery in the next year and beyond. Could you explain the thoughts and policies of the new management team?

A8: We think that it's very important to secure talented personnel to expand our Strategic Investments Business. The Mid-term Plan sets out that we'll increase our investments in human capital by approximately 2 billion yen in three years (up to fiscal year 2025) as the source of funds for offering adequate rewards and upskilling opportunities to employees who take on new challenges as well as hiring mid-career professionals.

Q9: Do you think your CET1 ratio target of 7% is sufficient? If not, how will you enhance your capital? Will a decline in your capital ratio levels have a negative impact on your business, such as difficulties in funding or the risk of postponement of your investments for growth?

A9: Prior to setting our regulatory capital targets, we assessed the sufficiency of our capital levels by applying a stress test scenario to our loan assets. Unless the current portfolio is largely restructured, we believe that 7% is an adequate level for us. If we were to significantly change our portfolio composition, we'll conduct an appropriate review of capital levels at that point of time. As of now, we don't anticipate any risk

that could lead to a negative impact on our funding or in a postponement of our investments for growth.

Q10: With regard to shareholder returns, are you committed to the absolute dividend amount of 76 yen or more for the next fiscal year, or do you rather focus on the payout ratio considering the capital level constraints?

A10: For the next fiscal year, we expect net earnings to return to profitability at early stages on the back of our strong customer-related business. It all depends on the recovery in our bottom line net earnings, but we aim to resume dividend payments in the first quarter of fiscal year 2024 and increase the full-year dividend.

Q11: Two weeks have passed since your announcement of the revision to the earnings forecast for fiscal year 2023. I'd like to see how the deposits have moved during the period. Were there any decreases by tens of billion yen or hundreds of billion yen?

A11: Since our liquidity reserves are maintained at the 1.4 trillion yen level, we have no concerns overall. Deposits from retail customers declined slightly just after the announcement on February 1. However, as we have a large and diversified number of retail customers with relatively smaller account balances, overall deposits remained stable and the current situation has been relatively stable. We intend to maintain sufficient liquidity going forward. Given the large size of our retail deposit base, a change in its level by tens of billion yen wouldn't have any significant impact overall.

Q12: Looking from the new CEO's (Oomi) viewpoint, what do you think is a pressing issue? Do you think there are any issues other than the U.S. non-recourse office loans?

A12: While Aozora's Strategic Investments Business has been performing well, I believe it is most important to continue our efforts to ensure that growth doesn't stop and to maintain a good relationship with our customers in a highly competitive environment.

Q13: In terms of your capital level, you mentioned that assuming that the portfolio doesn't change significantly from the current position, the CET1 ratio of 7% would be an adequate level. However, I understand that you intend to expand Aozora's Strategic Investments Business, mainly LBO finance, under the current Mid-term Plan. Do you

think that the 7% level would still be adequate for the time being?

A13: We established the Mid-term Plan on the premise of growth in our business areas such as LBO finance business. We may consider some adjustments to the plan, but we believe that there won't be any significant changes.

Q14: You mentioned that 56 billion yen of unrealized losses in the securities portfolio is estimated as of March 31, 2024. Why didn't you decide to sell all the securities with unrealized losses? Given that the sale of all the securities with unrealized losses wouldn't impact either net assets or the CET1 ratio, did you consider the potential impact on the capital adequacy ratio based on the domestic standard?

A14: The remaining position in the securities portfolio are U.S. and European government bonds, mortgage-backed securities and U.S. investment grade bonds ETFs, all of which have minimum redemption risk. We may consider a wide range of alternatives in the course of restructuring of the portfolio based on an assumption that U.S. interest rates will change in the next fiscal year and the year after. As yen interest rates eventually begin to increase at some stage, we'll start to increase our JGB and yen-denominated corporate bond positions. In that case, we may need to replace our portfolio and therefore we've decided the disposition of the securities portfolio at this time. Net revenue from market-related business for the next fiscal year is planned to be -5 billion yen, but we'll strive to improve the net revenue from that bottom level in the next fiscal year and the year after by conducting these operations.

Q15: You mentioned that you are aiming for an upswing in net earnings and an increase in dividend. Rather, I think you should take a fresh start after securing financial strength by using the upswing in earnings for rebalancing and restructuring your securities portfolio over the next few years. What are your thoughts on this?

A15: We'd like to have a range of management alternatives and execute them with some degree of flexibility. I think your suggestion (prioritize securing financial strength) would be one of the options, but at this moment I'd like to focus on resuming a dividend at an early timing.