At last, a price

FINANCE & ECONOMICS
Japan's banking mega-merger

Feb 24th 2005 TOKYO
From The Economist print edition

That was the easy part

EVER since they announced their merger plan last July, shareholders in Japan's second-biggest bank, Mitsubishi Tokyo Financial Group (MTFG), and the fourth-biggest, UFJ, have hounded executives with a single question: what's the price? On February 18th, investors at last got an answer, as well as some replies to other pertinent inquiries about the putative benefits of the banks' merger. If this goes ahead as planned on October 1st, it will create an institution with assets of ¥188 trillion ($1.8 trillion), more than any other bank in the world. The price looks certain to be high enough to ensure the deal goes ahead. The combined bank's profitability, however, looks likely to be disappointing.

Under the agreement, every 100 UFJ shares will be worth 62 MTFG shares. That puts a value of ¥3 trillion or so on the junior partner, slightly more than investors had expected, and should put paid to any lingering chance that Sumitomo Mitsui Financial Group (SMFG), which made a rival offer for UFJ last August, will be able to block the deal. UFJ's managers, who signed an agreement with MTFG before settling on a price, have rebuffed SMFG's advances, with the help of the courts. Although SMFG has not yet formally withdrawn its own, more generous, offer, it may now turn its mind to a different big merger. It has been talking to Daiwa Securities, Japan's second-biggest broker.

UFJ had to do a deal with somebody. It was far behind Japan's other three big banks (MTFG, SMFG and Mizuho, currently the largest) in cleaning up bad loans, which were over 9% of its loan assets at the end of September. A year ago, regulators exposed a brazen attempt by UFJ staff to mislead them about the health of the bank's borrowers. The only way UFJ could expect to meet its bad-loan targets legitimately was to team up with a stronger partner. In September, MTFG injected ¥700 billion into UFJ in anticipation of the takeover, helping UFJ to write off some duff loans.

As far as UFJ's managers are concerned, a deal with MTFG has something else to be said for it: not too many job cuts. Both UFJ and SMFG are active in consumer banking and small-business lending, and boast strong branch networks around Osaka and Nagoya. By joining forces with MTFG, which is based in Tokyo and whose business is weighted more towards corporate clients, UFJ's bosses have chosen a partner with fewer overlaps.

In their latest plans, MTFG and UFJ do promise some savings. After the merger they will trim 6,000 jobs from their combined total of 78,000 and will close 300 retail and corporate branches (including 30 outside Japan) out of just over 1,400. These and other changes, they say, will cut costs by ¥240 billion a year within four years. Yet Takeo Hoshi, an economist at the University of California at San Diego, and Anil Kashyap, of the University of Chicago's business school, have looked at UFJ's previous job cuts, after it was created through a merger of three banks in 2001. They found that it made only cosmetic reductions. It shed 3,600 full-time jobs at its core banking units and headquarters, but added just as many at its subsidiaries. The holding company's part-time headcount rose too.

Managers at MTFG and UFJ, meanwhile, reckon that their bulk and complementary businesses will allow them to boost revenues at home and abroad. They say they will make net profits of ¥1.1 trillion in the year ending in March 2009, for a return on equity (ROE) of 17%, roughly double the current number. By issuing more credit cards and other consumer loans, selling lots of investment trusts and annuities, and cashing in on higher interest rates as the economy improves, they hope to triple their operating profits from retail banking, whose share of the total is supposed to rise from 15% to 35%.

The banks still expect to earn half their operating profits from corporate lending. Their forecasts look optimistic here too. They predict a 40% increase in loans to small and medium-sized firms, for example, as demand for credit finally recovers. But there is no sign of a recovery yet: lending in Japan is still shrinking, although less quickly than before. Three-fifths of all loans earn less than 2% interest, and the share is rising.

“They still are mostly trying to make money from basic borrowing and lending and the loan spreads are microscopic,” says Mr Kashyap. “It is highly unlikely that this formula will get them close to their ROE target.” Japan's banks are more stable these days, but they are still a long way from making serious money.

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