Recently, Merrill Lynch (NYSE: MER) announced its intention to purchase a $2.9 billion stake in Resona Holdings, Inc., Japan's fourth-largest bank, equivalent to about 9% of its common share capital. That's the largest investment ever by a foreign institution in a Japanese bank, eclipsing the $1.3 billion spent by Goldman Sachs (NYSE: GS) in 2003 on its stake in Sumitomo Mitsui Financial Group.
This move got me thinking about Mitsubishi UFJ Financial Group (NYSE: MTU), by far the more liquid of the two Japanese banks with U.S. market listings (its average daily volume over the past three months is around 1.7 million shares as compared to a bit over 59,000 shares for rival Mizuho Financial Group (NYSE: MFG)).
Two issues are of primary concern: Have the Japanese banks really cleaned up the mess of the past 15 years, and more broadly is Japan itself ready for another season in the sun? The financial sector is generally a good proxy for a country's overall fortunes, or lack thereof.
A Long Winter of Discontent
Few kind words have been said about Japanese banks since they led that country's slide into a decade-long funk starting in 1992.
Much of that funk was tied to the shoddy lending practices, inefficient management and opaque operations of the storied institutions that sat at the heart of Japan's "clubby" keiretsu-based economy for many years. The keiretsu were closely-held economic groups, each with a bank at the center, and the bluest of keiretsu blue-bloods was Mitsubishi.
These banks moved ponderously under the administrative guidance of bureaucrats at the Ministry of Finance (MOF). While the banks' loan portfolios turned sour following the bursting of the real-estate bubble in the early1990s and capital adequacy dwindled below BIS (Basel Accord) minimum requirements, the banks and their MOF lords dithered for most of the 1990s before finally starting to make real attempts to solve the underlying problems.
Many Mergers Later...
During this painfully-long swoon, the three major sectors of general-commercial banks (city banks in the old parlance), trust banks and long-term credit banks underwent a massive consolidation, resulting in the four megabanks - Mitsubishi UFJ, Mizuho, Sumitomo Mitsui and Resona. Achieving real efficiencies through mergers is difficult in any environment, but Japan's is particularly biased. Cultural sensitivities preclude the payroll slashing and branch closures that are characteristic of U.S. bank mergers, particularly given that the old keiretsu cultural identification of each bank was strong and jealously guarded.
That said, Mitsubishi UFJ's recent numbers don't seem all that bad. The crucial measure of non-performing loans to total loans was 2.14% for fiscal year 2006 as compared to 3.6% two years earlier. Tier 1 capital adequacy - another longstanding bane for Japanese banks - at 7.62% is comfortably above the 4% minimum BIS requirement. The ADS currently trades at a value investor-friendly price to book ratio of 1.4, quite a bit less than the 2.6 Morningstar industry average and less still than the 4.6 for the S&P 500 (all data as of May 4, 2007). The stock is about 20% off where it was at the beginning of 2006.
By comparison the MSCI Japan iShare (NYSE: EWJ) exchange-traded fund is up by around 5% for the same time period. MTU is not one of the more widely held foreign financial banks by U.S. institutional investors, though it is the 11th largest holding in the portfolio of mutual fund Dodge & Cox International (DODFX) at 1.98% of total assets.
Given the apparent progress in sprucing up its balance sheet and its low current valuation, Mitsubishi UFJ could be a nice thing to have in a Japan-rising scenario. That is plausible in the near term, but in the longer term there are some negative fundamentals to consider for the country including a very old and declining population.
We don't see new candidates stepping up to assume the global-leadership mantle from the previous generation of Toyota, Sony and the like. Old habits die hard in Japan, its backyard market of Asia is going through its own evolution, largely irrespective of Japan, and all of this tells me there are probably better spots in which to fish for value.
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