30 January 2008

Japan's banks poised to target western rivals

The recent plight of US banks, reeling from the turmoil in the subprime mortgage market, has been greeted by Japan's financial institutions with a mixture of anxiety and glee. While the impact of the credit problems on the US economy and markets is a concern, for Japanese financial institutions the sharp fall in US bank valuations and their pressing need for capital presents an exceptionally well-timed opportunity to invest and extend their footprint in overseas markets.

"Now it is our turn to do in the US, what [US banks] did in Japan in the 1990s," says the chief investment officer of one of Japan's largest insurance companies, referring to large US investments in distressed Japanese assets, including the outright purchases of three banks. "We will invest in something but we are waiting for prices to come down further," says an executive at a large investment bank.

But such statements may ring hollow, given the conspicuous lack of M&A activity by Japanese banks. So far, the only Japanese bank that has taken any action is Mizuho, which is investing about $1.3bn in Merrill Lynch as part of the US investment bank's $4bn recapitalisation. Others, including Mitsubishi UFJ Financial Group (MUFG), Japan's largest bank; Norinchukin Bank, the agricultural bank, which is considered one of the savviest Japanese financial institutions; and Sumitomo Mitsui Financial Group (SMFG), are all believed to be discussing opportunities.

Nobuo Kuroyanagi, president of MUFG, said this month the banking group would consider investing in a US or European bank if the opportunity arose. Kitayama Teisuke, SMFG president, says: "We are fully prepared to consider an acquisition if it suits our strategic objectives."

This kind of talk highlights the pressure building on Japanese banks to take advantage of investment opportunities in the west. With a shrinking domestic market, expanding their overseas businesses is one of the few paths to growth left for Japanese banks.

Japan is a mature market, in which companies have been shifting from indirect financing through the banks to direct financing in the capital markets. Furthermore, after a banking crisis that scared companies from taking on debt, followed by a rapid improvement in corporate earnings, "[private sector] loan demand is anaemic and firms are basically self-financing," says John Richards, head of research at Royal Bank of Scotland in Tokyo. In the past decade, lending by private sector banks in Japan declined by 27 per cent to Y391,286bn ($3.65bn) at the end of last year.

Although banks have tried to offset the impact of falling loan demand by expanding fee-generating businesses, such as sales of investment trusts, and diversifying into other areas, such as consumer finance, these moves are unlikely to be sufficient to make up for the downturn in their traditional revenue stream from lending.

"It's difficult to picture a scenario of growth [for banks] in Japan, where even consolidation [of the large banks] has been completed. So, they have to go overseas," says Katsuhito Sasajima, banking analyst at JPMorgan in Tokyo.

Fortunately, after more than a decade of working their way back to financial health, Japan's large banks are well-capitalised, with a tier-one capital adequacy ratio of about 6 to 7 per cent. "The structural liquidity, which has been a problem up to now, has turned out to be a blessing," says Brett Hemsley, banking analyst at HSBC in Tokyo.

However, Japanese banks are still constrained by management indecisiveness in expanding overseas. Mizuho's stake in Merrill, for example, is only 2-3 per cent, prompting analysts and industry officials to question whether it will provide the Japanese bank with any business advantage.

But some believe it could give Mizuho access to Merrill's franchise and network. "You don't need massive mutual ownership to make a relationship meaningful," says Mr Hemsley at HSBC. Mizuho has at least taken a few tentative steps forward. MUFG and SMFG have appeared indecisive.

MUFG has a 65 per cent stake in Union Bank of California, a retail bank, which generates more than half of the Japanese bank's overseas revenues. However, "there are no synergies" with the Japanese parent, says Mr Sasajima at JPMorgan. So far, MUFG has failed to match its overseas ambitions with action.

Meanwhile, analysts claim Japanese banks are missing an entire generation of managers who understand international markets because they have spent so long focusing on recovery. "The problem of human capital is worse than that of [financial] capital," says Mr Sasajima. Japanese banks may be flush with capital but that may not be enough for them to take advantage of the opportunities that abound.

© Graham Bishop