财经观察 1386 --- Japans Banks: a Tasty Opportunity

Monday, October 20, 2008
Japan's Banks: a Tasty Opportunity
By LESLIE P. NORTON
The golden age for Japan's banks is nigh, as they shop for growth abroad.
フォームの終わり
THE CAVALRY THAT CAME to Morgan Stanley 's aid last week swept in from the east, in the form of a cash injection by Japan's Mitsubishi UFJ Financial . The move marked more than a boon for the ailing U.S. bank. It signaled a sharp change in direction for Japanese banking companies. All but given up for dead five years ago, Japan's banks have revived, and some finally are worth a look by U.S. investors.

The key to their comeback is cold, hard cash, of which they have a bundle, at least compared with many American and European banks. Mitsubishi UFJ (ticker: MTU) had no trouble ponying up $9 billion for 21% of Morgan Stanley (MS).

On a smaller scale, Nomura Holdings (ticker NMR) quickly forked over an estimated $1 billion to buy the Asian and European arms of bankrupt Lehman Brothers, and is eager to explore opportunities in the U.S. Throw in deals with western banks and investment companies done by Mizuho Financial (MFG) and Sumitomo Mitsui Financial (8316.Japan) this year, and it's clear a new dawn has come.

This should hearten investors in U.S. and European financials. After all, if the Japanese could turn around their banking sector, why can't others do the same?

The Japanese banking system was devastated when Japan's investment bubble burst in 1989. Stock prices and real-estate values spiraled lower, pulling collateral values down and triggering corporate defaults. The crisis hit home in 1997, when two big institutions failed. The government then started injecting capital into the banks, and pressed hard for consolidation. But just as the industry began to revive, the Internet bubble burst. The Bank of Japan cut interest rates to zero to avert deflation. It didn't work, and in 2003 came the failure of behemoth Resona Bank and the start of another round of government recapitalization.

That set off a stampede in Japanese bank shares, which doubled and even tripled until early '06. In all, Tokyo spent $440 billion to buy bad loans and recapitalize the banks, and is still recouping its money.

A sustained revival in Japan's economy isn't in the cards for this year, but lending and property prices are starting to recover, and banks are awash in capital.

Only a handful of Japanese megabanks exist today. Mitsubishi UFJ, the largest, with $1.82 trillion in assets, was formed by the merger of two big banks in 2005, themselves survivors of the first round of crisis-spurred consolidation. A predecessor bank was founded in 1880 by a former samurai. Mizuho, Japan's second largest, was formed by the 2000 merger of behemoths Dai-Ichi Kangyo Bank, Fuji Bank, and Industrial Bank of Japan; its name means "abundant rice." Sumitomo Mitsui, No. 3, dates to 1876. Then there's Resona, product of the merger of Daiwa and Asahi banks.

These banks are sitting on $4.77 trillion of assets, more than Japan's GDP of $4.38 trillion but still smaller than the nation's $5.4 trillion in deposits. Given that Japan's economy has grown less than 2% a year in recent years and is expected to fall into recession this year, getting a decent return at home seems nigh impossible. Mitsubishi's return on assets clocks in at 0.56% and Mizuho's at 0.33%, according to The Banker magazine. Compare that to 1.03% for HSBC Holdings, or 1.46% for JPMorgan Chase. Japan's institutions have tried to boost returns via consumer finance and fee income, but individuals are reluctant to buy equities. Shopping abroad for growth makes sense, particularly when asset prices are falling.

MITSUBISHI IS OPTIMISTIC, too. Says Chief Executive Nobuo Kuroyanagi: "We are now looking forward to working with Morgan Stanley to deliver the significant strategic benefits that we believe our alliance will bring."

The CEO has told investors Mitsubishi wants to become one of the five largest global financial institutions by market value by March 2010 and in the top 10 of the league table finance rankings in the major regions. Last week, it sported a market cap of $82 billion, still well behind JPMorgan, Bank of America (BAC) or Wells Fargo (WFC). No wonder. Mitsubishi's loan-to-deposit ratio is just 68%, and its return on assets is measly. That's why it recently bought the 35% of Union Bank of California it didn't own. UnionBanCal, a specialist in lending to smaller and medium-sized companies, largely dodged the subprime-mortgage problem, and is profitable.

Enter Morgan Stanley, which approached Mitsubishi even as it considered linkups with Wachovia or China's sovereign wealth fund. Morgan Stanley represented Mitsubishi in its 2005 merger with UFJ, and in the takeover of UnionBanCal. In the wake of Lehman's bankruptcy, Mitsubishi and Morgan announced a $9 billion pact, but as Morgan Stanley shares kept falling, the agreement looked doomed. Several days ago, Mitsubishi officials reportedly received assurances at the International Monetary Fund meetings in Washington, D.C., that their equity stake wouldn't be diluted by a Washington bailout. They also negotiated vastly more favorable terms that didn't include a direct stockholding. Mitsubishi will pay $7.8 billion for 10% preferred, convertible into 21% of the company at $25.25, and another $1.2 billion for 10% perpetual preferred, callable after three years at 110% of its face value. It will also name a Morgan director.

The two plan to work on deals together in banking and money management, though the exact details won't be announced until June. But here's one example. If Morgan advises one company that wants to buy another and needs financing, it could bring in Bank of Tokyo Mitsubishi, the largest bank under the Mitsubishi banner, and UnionBanCal as lead arrangers for the financing. "Now Morgan Stanley has a large balance sheet to play with and can do everything in-house," says one investment banker familiar with the deal. And Mitsubishi can introduce Morgan Stanley to its numerous Fortune 500 clients.

Says Camille Carlstrom, the banking analyst at Putnam Investments: "It makes strategic sense for them. It opens up the potential for greater investment banking opportunities for [Mitsubishi] with a smart global partner and complementary skillsets."

One person who knows Mitsubishi speculates the two deals give it east- and west-coast "beachheads" that allow it to "roll up deposits" in the U.S. JPMorgan thinks possible takeover targets include Zions Bancorp (ZION) of Salt Lake City and Dallas-based Comerica (CMA). But take your pick; big regionals are going for a song. National City (NCC) or IndyMac, anyone?

Mitsubishi shares are down 27% this year, outperforming the Nikkei 225 stock average, despite worries about rising credit costs. Nobody expects the bank to meet its full-year earnings forecast of $6 billion, though the Morgan Stanley dividend will help. But next year is a different story.

Deutsche Bank thinks the integration of Bank of Tokyo and UFJ could add $1.86 billion to the bottom line each year. Rama Krishna, managing principal at Pzena Investment Management, says Mitsubishi "is trading at an extremely attractive level" compared with its less-healthy western counterparts. As credit conditions revive, normalized returns on equity will zoom to 12% to 15% from under 10% last year, suggesting Mitsubishi ought to trade for "at least twice today's level," says Krishna.

Mitsubishi already gets 17% of earnings from outside Japan. The Morgan Stanley deal could boost that to 30%, without accounting for possible taxes, since an annual dividend will be $900 million. David Trone, an analyst at Fox-Pitt Kelton, thinks Morgan Stanley's return on equity could clock in at 17%, much higher than Mitsubishi's own returns. Anton Schutz of Burnham Capital, a Morgan Stanley shareholder, figures Morgan, which traded at $19 last week and at $45 not so long ago, will still earn $4 a share next year.

As for Nomura, chief executive Kenichi Watanabe is grabbing Lehman's people but not its assets and liabilities. (Nomura is paying $225 million for the Asian arm, and guaranteeing the $1 billion bonus pool for Europe.) Now the real work begins: Hanging on to Lehman's people and adding 5,500 new employees to Nomura's roster of 18,000. Most are better-paid, and unused to Nomura's culture, which includes the singular Japanese custom of rotating managers through wildly disparate jobs.

Nomura's historic ROE is in the single digits, lower than its peers', although the company thinks it can generate 10+%. "They've swung to the other end of the spectrum in taking considerably less risk than their peers globally," says Sarah Ketterer, CEO of Los Angeles-based Causeway Capital, who estimates Nomura is ponying up $1 billion for the Lehman operations. "It gives them the benefit of having some surplus capital."

The $1 billion is a fraction of Nomura's market value of $25 billion, though earning a return on its Lehman investment could take a while. Much depends on Japan, where Nomura manages a third of individual-investor assets. When that market turns decisively, Nomura is sitting in the catbird seat.

More deals lie ahead. Earlier this year, Mizuho invested $1.2 billion in a Merrill Lynch (MER) recapitalization. Sumitomo Mitsui Financial put nearly $1 billion in Barclays (BARC.UK). Sumitomo has a long history with Goldman Sachs, investing $500 million in Goldman in 1986, a stake it sold at a large profit in 2002. Goldman returned the favor in 2003, investing $1.3 billion in Nomura, and still owns preferred convertible into nearly 4% of the bank. Sumitomo has said it would consider future requests for capital.

Japan's non-life insurers are also venturing overseas. This year, Tokio Marine Holdings (8766.Japan) agreed to buy Philadelphia Consolidated for about $4.7 billion. Given the hunt for topline growth, there are opportunities to be taken in Europe, too, where financial firms are badly hammered.

The Bottom Line
After industry-wide consolidation, Japan's remaining banks are awash in capital. In coming years, earnings could really take off for companies like Mitsubishi, Nomaru and Mizuho.

The real golden age for Japanese banks won't come until Japan's revival gains traction. Then deflation will reverse, and the Bank of Japan can "normalize" interest rates. That will steepen the yield curve, letting banks make a spread on their deposits, and enticing individuals to bring their money home to Japan's market.

The outlook this year is bad. Japan's banks are expected to miss their earnings forecasts for the year ending March. And valuations of European and U.S. banks have plunged, rendering Japanese shares less cheap. Still, these transactions make Japanese bank returns look more promising for the first time in a long while.

Bank-share valuations are down to 1998-'99 levels. But land prices are up since that crisis, corporate balance sheets are much healthier, and credit costs are lower. "These are the cheapest of all Japanese stocks," says Rama Krishna of Pzena. "They're a good place to hide." And, eventually, to profit.