Bank of Tokyo Mitsubishi UFJ: A big bank in big trouble

Updated : 01.07.2016 / Category Corporate Investigations


When the Nihon Keizai Shimbun (Nikkei) daily reported on June 8 that Bank of Tokyo Mitsubishi UFJ (BTMU) is set to relinquish its status as a primary dealer of Japanese government bonds, speculation swirled among market players that Japan's largest bank is trying to get even with the Bank of Japan for unexpectedly introducing negative interest rates in February as part of its fight against deflation.

There was good reason to suspect BTMU's motives. At a lecture meeting in Tokyo in April, BTMU Chairman Nobuyuki Hirano (who also is president and group CEO of Mitsubishi UFJ Financial Group) publicly expressed dissatisfaction with the Japanese central bank: "Because banks will be unable to pass on negative interest to customers, [negative interest rates] will reduce their net interest margins and sap their financial strength. The short-term effects are clearly negative."

Indeed, the impact from negative interest rates is considerable. BTMU forecasts its stand-alone net business income for the year ending in March 2017 will be ¥670 billion, a hefty 24.6 percent decline from the year ended in March 2016. MUFG's net profit is forecast to dip by 10.7 percent to ¥850 billion--a second consecutive decline.

At a press conference in May, Hirano said negative interest rates are expected to compress profits by "¥100 billion in total." This figure came from a ¥35 billion shortfall from narrowing interest spreads in such products as floating-interest-rate loans; a ¥30 billion reduction in commission fees due to waning appetite on the part of private investors to buy financial products; and loss of earnings from derivative and other transactions.

Some point finger at a high-ranking Finance Ministry official for leak
It was only a few years ago, however, that MUFG secretly sounded out the Finance Ministry about the possibility of giving up BTMU's primary dealer status. The ministry oversees the system of primary dealers, in which financial institutions directly buy newly issued bonds from the government and resell them to customers. Primary dealers run the risk of being left holding a hoard of unsold government bonds when the price of the bonds falls. Such bonds often end up in the book as appraisal losses. MUFG internally discussed the advisability of repeatedly buying and selling government bonds in the short term--which is not BTMU's main business--by using funds collected from depositors at a time when it faces the risk of losing money, according to a source at Mitsubishi UFJ Trust and Banking (MUTB).

Mitsubishi UFJ Morgan Stanley Securities Co. and Morgan Stanley MUFG Securities Co., which also are primary dealers, are under the MUFG umbrella. From the standpoint of separating the roles of financial institutions within the group, it is "logical" to let these two securities companies serve as primary dealers while the bank engages in trading government bonds in the market, an MUFG executive said.

In addition to the three MUFG firms, 17 institutions, including Mizuho Bank, Mitsui Sumitomo Banking and Nomura Securities Co., serve as primary dealers that are each required to buy 1 percent of newly issued government bonds. The Japanese government is set to auction more than ¥147 trillion in new bonds, including refinanced bonds, in fiscal 2016. Even if BTMU quits the primary dealer club, only ¥1.5 trillion in bonds will be affected. Furthermore, financial institutions without primary dealer status can directly buy these bonds. In fact, more than 200 financial institutions already do so.

"It is true that the bank pushed a plan to relinquish its status because of the prospect of sustaining losses if it held government bonds until they mature due to negative interest rates," said a BTMU insider perplexed by the intensive media coverage of and market response to BTMU's possible departure.

Amid the media frenzy, MUFG executives suspected a high-ranking Finance Ministry official leaked the information to the Nikkei, an influential business newspaper.

If negative interest rates stay in place, they could undermine Japan's fiscal discipline. In fact, transactions of government bonds in the market are gradually declining in volume, possibly threatening stable consumption of bonds in the long run. Furthermore, Prime Minister Shinzo Abe announced in early June that a scheduled hike in the consumption tax rate from 8 percent to 10 percent would be postponed again, this time from April 2017 to October 2019. To fill the expected revenue shortfall from this deferment, the government may resort to issuing more bonds, deteriorating the nation's financial health further. This aroused suspicions a Finance Ministry official might have tried to stir up the financial sector by leaking information in a bid to warn the Abe administration against increasing the nation's debt.

"The Finance Ministry was left out in the cold at the G-7 Ise-Shima summit meeting in May, as exemplified by the Prime Minister's Office unilaterally distributing a document saying the current state of the global economy is similar to that just before the collapse of Lehman Brothers," an MUFG executive said. "Seeking to relinquish primary dealer status was not us retaliating against the BOJ, but the Finance Ministry seeking revenge against the Prime Minister's Office through the leak."

Risk of resource bubble bursting pulling rug out from under MUFG
Negative interest rates are a domestic woe sucking the financial vitality of BTMU and MUFG, but low global prices for resources are a major concern for their business overseas. While Mizuho Financial Group and Sumitomo Mitsui Financial Group had provided ¥6 trillion and ¥5.8 trillion, respectively, in credit to resource-related projects as of the end of March, MUFG's credit line reached ¥10.4 trillion. MUFG is the world's largest lender to such projects, surpassing the four major U.S. banks, such as JPMorgan Chase & Co. and Wells Fargo & Co., according to an SMFG source.

With the burst of the commodities bubble, however, the financial standing of MUFG's loan recipients has deteriorated. This has heightened concerns these loans could become irrecoverable. If fact, MUFG's nonperforming loans in this sector sky-rocketed to ¥122 billion in March 2016 from ¥3 billion in the previous business year. If ¥679 billion in credit deemed to have been provided to troubled enterprises is included, the sum is ¥801 billion. In a nutshell, 8 percent of resource-related credit the financial group provided has turned "sour."

Resource-related companies are divided into five groups: "Integrated" enterprises such as oil majors and state-run oil companies; "upstream" companies dealing with exploration, drilling and production; "midstream" entities having pipelines and storage depots; "downstream" companies refining and selling oil and other resources; and "others," including mining.

Upstream and mining companies are vulnerable to low resource prices. MUFG has provided ¥4.2 trillion in credit to companies in these two groups. "Even if that entire sum were to become irrecoverable, MUFG could easily withstand this because its total capital amounted to ¥17.94 trillion as of the end of March, and its Tier 1 capital, including ordinary shares, totaled over ¥13 trillion," an unruffled BTMU insider said. "Although we provided ¥10.4 trillion in credit, ¥4.2 trillion of that is an unused portion of committed lines of credit. There is no reason that we should be alarmed."

But, BTMU's financial health will worsen because such loans likely will hurt profits. In the financial year ending March 2016, the group booked ¥255.1 billion in credit costs, such as allowance for bad debts. Of this, ¥75 billion was for resource-related companies. Another ¥75 billion in such costs will likely be booked in the current business year.

At a press conference in May, Hirano was asked how the group would be affected by fluctuations in resource-related markets. Hirano replied by referring to West Texas Intermediate (WTI), a benchmark for crude oil pricing. "If the price increases by $5 per barrel, our credit cost will be reduced by ¥20 billion," he said. "If the price drops by $5 per barrel, it will increase by ¥30 billion." The WTI rate projected by MUFG for the business year ending in March 2017 is $35 per barrel, while the current price is around $50 per barrel. It is true that MUFG has some leeway, but nonetheless, resource markets still can pull the rug from underneath a bank.

Ballooning costs from strengthened U.S. regulations
U.S. regulations, which have been strengthened since the collapse of Lehman Brothers in 2008, are another headache for MUFG. The U.S. Federal Reserve Board demanded last year that financial institutions strengthen their cybersecurity measures, and will establish a number of enhanced prudential standards--for large U.S. holding banks and foreign bank organizations that have more than $50 billion in assets in the United States--over liquidity, risk management and capital on July 1. The new standards aim to prevent bank failures and ensure the stability of the U.S. financial system. Foreign banking institutions are required to set up an intermediate holding company in the United States, under which all their U.S. subsidiaries are placed.

To comply with the new regulations, MUFG reorganized its U.S. holding company, MUFG Americas Holding Corp., into an intermediate holding company in March. It plans to place five U.S. BTMU subsidiaries and also those of MUTB and Mitsubishi UFJ Securities Holdings under this company. However, this step is expensive. "[MUFG] is bracing itself for the huge cost of unifying the systems of those companies," an informed source said.

MUFG is also being weighed down by increasing labor costs arising from dealing with the tightened regulations. UBS, a major Swiss bank, has hired a former U.S. investment banker and former chief risk officer at JPMorgan Chase. UBS had to offer "enormous remuneration," according to a well-informed U.S. source. Unless its U.S. operations expand in scope, MUFG's profit may shrink due to these heavy costs.

The rising cost of buying dollars since last autumn, which was accelerated by the Fed's rate hike in December last year, also is a nagging problem for MUFG executives. The group's average outstanding loans in the United States between October 2015 and March 2016 was ¥18.4 trillion, while the corresponding figure for deposits during this period was ¥16 trillion. As the group's lending greatly exceeded its deposits, it must cover this shortage by buying dollars on foreign exchange markets. Speculation is rife in the financial sector that the cost of procuring the U.S. currency will incrementally increase due to market expectations of a higher U.S. interest rate, the BOJ's negative interest rates and lower market liquidity of the dollar due to strengthened regulations by U.S. authorities.

Little prospect for growth in domestic market
MUFG is trying to boost its presence in two main overseas markets--the United States and Asia. In December 2013, it acquired the Bank of Ayudhya, a major Thai commercial bank, and made it a subsidiary. In January 2016, the Bank of Ayudhya opened 151 branches in Cambodia and announced the acquisition of a 100 percent stake in Hattha Kaksekar Ltd., a Cambodian small-lot retailer licensed to accept deposits. In April, MUFG bought a 20 percent stake in Security Bank, the seventh-largest commercial bank in the Philippines, for $792 million (about ¥83 billion), making it an equity method affiliate of BTMU.

But dark clouds are already appearing over the MUFG strategy to harvest the fruits of Asian economic growth. A drop in its provision of loans in the region is an ominous sign at a time when the group is already being hit by the slowing Chinese economy and accompanying trade contraction in the region. 

While MUFG's average outstanding deposits are increasing (¥6.5 trillion in the latter half of the business year ending March 2015, ¥6.8 trillion in the first half of the 2016 business year and ¥7.1 trillion in the latter half), lending is decreasing. Lending for the corresponding periods were ¥13.8 trillion, ¥13.2 trillion and ¥12.4 trillion, respectively. MUFG is considering entering the expanding Indonesian market. Indonesia has the largest population among members of the Association of Southeast Asian Nations (ASEAN), but it applies strict regulations on foreign capital. India allows foreign investors to hold a stake up to 74 percent in some domestic companies, but the business environment there remains far from ideal.

In its settlement of accounts for the financial year ending in March, BTMU reported an alarmingly low interest rate spread (lending rate minus deposit rate) of less than 1 percent. Due to its cost-cutting efforts, BTMU slightly improved its net interest margin from minus 0.06 percent in the previous business year to minus 0.04 percent.

BTMU registered ¥701.3 billion in gross financial margin for the last business year, a 1.5 percent drop year-on-year, and trailing Sumitomo Mitsui Banking Corporation's ¥787.6 billion. Even if the figure is combined with that of MUTB, it only reaches ¥785.9 billion, a 1.1 percent decrease from the previous year. Earnings from fees and commissions involving investment trusts and sales of insurance products--which have heretofore yielded considerable gains--slipped 8.6 percent to ¥288.2 billion from the previous year's ¥315 billion.

Retail business-related subsidiaries, which MUFG hoped would rev up domestic earnings, are performing tepidly. Although Acom Co. Ltd., a consumer financing firm, increased operating profit by about 10 percent to ¥15.5 billion, Mitsubishi UFJ Nicos Co. Ltd., its core company for credit card operations, reported an operating deficit of ¥18.1 billion due to expenses stemming from its overcharged interest to borrowers. Its net loss reached ¥40.9 billion.

Buds of growth are scarce in MUFG's domestic operations. The only hope for growth was in overseas operations, including those in the United States. If MUFG's business abroad hits a snag, the group will have nowhere else to turn.

Possibly alarmed by the group's business prospects, Hirano announced 3,500 domestic career-track jobs will be cut over the next 10 years. They will be downgraded to posts that require no job relocation and have their pay cut. MUFG might be accused of being "sekoi," a word meaning tight-fisted or petty that was showered on former Tokyo Governor Yoichi Masuzoe, who recently resigned over his inappropriate use of political funds.


This is a translation of an article from the July 2016 issue of Sentaku. The original article can be found here.