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Andrew Liyana

MTU AT A GLANCE

P/E ► -13.0   EV/EBITDA ► 45.1 HIGH ROA ► 0.1% AVG ROE ► -8.2% AVG Debt to Equity ► 25.1 AVG Current Ratio ► 3.10 HIGH Interest Coverage Ratio ► 5.21 VERY HIGH

 

 

 

 

 

 

Mitsubishi UFJ Financial Group (NYSE:MTU) (also known as MUFG) became the world's largest bank holding company by total assets in 2005,^[1] controlling over Y190 trillion (USD 2 trillion) in assets as of the March 31, 2008.^[2] Despite having the most assets, the Japanese bank holding company is smaller in terms of Market capitalization than other large money-center banks, like Wells Fargo (WFC), J P Morgan Chase (JPM), and Bank of America (BAC). The market's lower valuation stems from Mitsubishi's historically low Return on Assets (ROA); for the 1H of 2008, MUFG has a ROA of 0.56% compared to 1.03% for HSBC Holdings (HBC) and 1.46% for J P Morgan Chase (JPM).^[3]

The Japanese bank runs a conservative book compared to industry peers, with a loan-to-capital ratio of 68%.^[3] While this has limited ROA/earnings, it has kept the bank from having capital issues as European and American competitors, such as Lehman Brothers (LEH), UBS AG (UBS), and Citigroup (C).^[4] The CEO sees the 2008 Financial Crisis has an opportunity to expand its global footprint by investing in troubled companies and markets^[3] and aims to be in the top 5 in terms of market capitalization by 2010.^[1] Mitsubishi uses bank deposits and short-term borrowings to originate Loans to corporations, governments, and individuals. MUFG also invests in Equities and bonds. 78% of the nearly Y100 billion loan portfolio is borrowed domestically, and similarly, Japanese financial assets form over half its Y39 billion investment portfolio.^[5] So while management aims at expanding globally, the health of the Japanese economy and financial market will impact earnings over the next few years.^[4]

While the company is Japanese, one is able to buy its ADR (NYSE: MTU).^[6] Not only does Mitsubishi's financial health and outlook affect the share price, but also the Yen/USD exchange rate. The company records earnings and assets in its local currency, so an appreciation of the Yen benefits the ADR price and increases the nominal value of dividends on its ADR shares, as it earns more in terms of US dollars.^[7]

Overview of Japanese Banking History

Following a boom in the 1980s, the Japanese economy came to a screeching halt in 1989. For the next 16 years, the economy had deflation, corporate defaults, and Interest Rates that hovered around 0%.^[3] The Asian Financial Crisis, along with the internet bubble-burst, led to large bank failures, including behemoth Resona Bank.^[3] The Japanese government injected close to $440 billion to recapitalize the battered industry^[3], and the country has observed low single digit increases in land prices during 2006 and 2007 for the first time in nearly two decades.^[8] A recovery in the domestic economy would help steepen the yield-curve, which benefits MUFG. The bank can lend long-term at higher rates and borrow short-term at lower rates; thus, capturing the difference in Spread.

Business Overview

Mitsubishi UFJ Financial Group, Inc. was formed by the merger of Mitsubishi Financial and UFJ Holding Inc. in October 1, 2005.^[1] The synergy made MUFG the largest bank in terms of total assets.^[1] The company since has expanded overseas growth by acquiring the remaining shares of the 6th largest bank in California in terms of deposits^[4], UnionBanCal (UB) in 2008, and buying a 21% stake in the investment bank, Morgan Stanley (MS), for $9 billion USD in October 2008.^[9] The company's expansion goals are not limited the United States. The company has stated its intentions to be the largest bank in Asia, the EU, and the Middle East.^[4]

MUFG makes money in two ways; interest based revenue and non-interest based revenue.

Interest Income

MUFG's spread is the difference in the cost of borrowing compared to the amount generated from lending money. Higher is better as it means more income for the same amount borrowed.^[10]

Mitsubishi holds deposits on behalf of customers and sells low-interest bonds. These accounts pay clients interest and/or provide services, such as checking and credit clearing, in exchange for using their money to lend to others or buy equity and fixed income instruments. The amount paid to clients in the form of interest payments or account services is MUFG's expense. The money gained from investing the money is its revenue. The difference, also known as Spread, is MUFG's income. Shown in the graph is MUFG's domestic spread over the past three years. Ideally, Mitsubishi expands the spread as that means it is generating more money given the same amount borrowed. Total company spreads on all funds was 1.22% in FY 2006, 1.38% in 2007, and 1.32% in 2008.^[5]

Net Interest income was Y2.279 trillion (or 24 billion) or 56.2% of income in FY 2008.^[5]

Non-Interest Income

Mitsubishi generates fee revenue through investment banking consulting, investment advisory, trust management, and securities business. Such offerings include providing businesses advice on potential mergers and acquisitions, expansion into overseas markets (especially Asia), and financing consulting.^[2] Displayed in the table, trust fees and fees on investment funds business accounted for the greatest portion on fees and commissions in 2008.

Combined Income and Expenses

Net interest income (interest income - interest expense) decreased Y50.1 billion to Y2,279.7 billion (USD 24 billion) for FY 2008 from 2007.^[5] The increase in interest-earning assets were offset by higher interest paid. During FY 2008, the company shifted Y5 trillion from domestic loans to non-Japanese customers in Asia, the United States, and Europe. Non-interest income in 2008 gained from an appreciating Yen, but were more than offset by a decline in overall fees and commissions; the real estate segment and credit card business saw fees decrease Y41.9 billion.^[5]

The largest drag on non-interest income was from net investment securities losses. While in FY 2007, MUFG earned Y238.3 billion in investment securities gains, the bank lost Y1,373.1 billion in FY 2008. The company marked down debt securities, due to impairment losses, and equity securities resulting from a decline in Japanese stock prices. Non-interest expense jumped to Y3,659.7 billion in 2008 from Y2,784.2 billion in 2007 due to a Y893.7 billion impairment of goodwill. As a holding company, MUFG decided to write down its subsidiary values to what it thought was fair value. The impairment was due mainly to the the 2008 global financial market instability.^[5]

An overview of MUFG's income and expenses. The 2008 Financial Crisis led to asset write-downs, which led to a net income loss for FY 2008.^[5]

Investment & Loan Portfolio

MTU borrows money through checking and interest bearing accounts and makes loans in primarily the Japanese market; however, the portion of international loans is increasing.^[5]

Mitsubishi takes deposits and borrows at low Interest Rates in order to make loans and investments. As of March 31, 2008, MUFG had Y99,002 billion outstanding loans, a 3.9% increase over the previous year. It loans primarily to domestic manufacturing and consumer segments, but has increasingly moved towards loaning to foreign commercial and industrial clients. Domestic loans formed 81.2% of all loans in 2007, but 78.5% in 2008.

In addition to using borrowings to make loans, Mitsubishi will purchase Debt and Equity assets. The company had Y38,729.3 billion in outstanding available-for-sale securities in 2008, which is down from Y45,679.8 billion a year earlier.^[5] The decrease is from the sale of Japanese Government bonds, and also, from losses in unrealized gains. Essentially, the assets it held depreciated about Y2,200 billion between March 31, 2007 and March 31, 2008. Falling global asset prices, especially Japanese securities, drives market value lower. The largest decrease (~Y2 trillion) was in marketable equity securities (stocks).^[5]

In addition to loans, MUFG buys stocks, treasuries, and corporate bonds. In FY 2008, the equity portion of MUFG's portfolio depreciated. Declining financial asset values hurt MUFG's investment portfolio (especially Japanese markets).^[5]

Key Trends and Forces

2008 Financial Crisis

Like most banks, Mitsubishi is suffering from the global credit crunch. It raises the cost-of-borrowing, increases defaults, has led to poor investment performance, and forced MUFG to write-down Y893.7 billion in Goodwill during 2008.^[5][8] However, unlike financial competitors, such as American International Group (AIG), Lehman Brothers (LEH), and Merrill Lynch (MER), Mitsubishi is well-capitalized and views the 2008 financial crisis as advantageous for expanding its operations overseas.^[3] Its total risk-adjusted capital is 11.19%; the minimum requirement is 8.00%.^[11] In October 2008, MUFG announced that it would acquire the remaining outstanding shares of UnionBanCal (UB), the 6th largest bank in California in terms of deposits^[4], and take a 21% stake in Morgan Stanley (MS).^[9] In exchange for infusing $9 billion in capital, MUFG will received $7.8 billion in MS preferred shares that convert to common shares at a share price of $25.25. In addition, MUFG received $1.2 billion in non-convertible preferred stock. The preferred shares pay 10% annually, which gives MUFG a $900 million annual dividend.^[9]

International Expansion

In addition to purchasing stakes in American investment and commercial banks, MUFG also hopes to capture business in Europe and the Middle East. Between 2005 and 2007, MUFG increased foreign deposits by 11% and foreign loans by 22%.^[4] It also had double digit growth in its international Commercial Investment Banking and Forex divisions.^[4] Management sees the economic downturn as a way to enter markets in order to increase its customer-base and cross-selling of products.^[4] Strategic acquisitions mixed with a recovery in Investment banking and credit markets would benefit MUFG's earnings.

Yen/USD Relationship

Yen/USD relationship. A strengthening Yen supports a higher ADR share price, but increases defaults by foreign borrowers, who did not hedge their currency risk.^[7]

The value of the Yen compared to the US dollar impacts the value of ADR shares of MUFG and its business operations. Mitsubishi's stock is listed on the NYSE. An increase in the value of the Yen translates to higher share price and dividend payments in the ADR shares all else constant. An appreciating Yen can purchase more US dollars. However, on the flipside, a strengthening Yen adversely impacts parts of MUFG's business. Not all foreign borrowers hedge currency, so if they took a loan out in term of Yen dollars, and the Japanese currency appreciates, this increases the payment burden on the borrower. The pressure increases borrower defaults.^[7] Further, if MUFG does not hedge its foreign loans, currency movements impact earnings. During FY 2008, the amount of impairment losses resulting from the Yen appreciating was Y863.2 billion.^[5] The unwinding of the carry-trade has resulted in a strong Japanese currency during 2008. Investors, especially hedge funds borrowed low interest Yen and purchased securities in other countries that offered higher potential returns. With the collapsing financial markets, these investors have been scrambling to "unwind" the trade and buy back the Yen they were short.^[12]

Japanese Economy

While MUFG aims at expanding its international operations, 83% of 2008 income was generated domestically.^[5] In addition, the company holds primarily Japanese equities and agency bonds in its investment portfolio.^[5] As a result, fluctuations in the Tokyo Stock Exchange and the health of the Japanese economy impact MUFG's earnings. The Japanese economy went bust in 1989 and had almost two decades of deflation and a low interest rate environment.^[8] Several banks failed and the government infused $440 billion of capital into the banking industry in 2003.^[3] Land prices rebounded in 2006 and 2007 after sliding for 16 years.^[8] Improving economic conditions supports a steepening of the Yield Curve, which increases MUFG's operating profits. A steeper yield curve means Mitsubishi can borrow more cheaply in the short-term and lend at higher rates for the long-term. Also, by holding about Y6,000 billion in Japanese marketable securities, MUFG's capital is affected by movements in the Tokyo Stock Exchange.

Competition

Competitive Landscape

The past two decades of dismal growth in Japan, mixed with Asian Financial Crisis and the Internet bubble burst led to the collapse of 3 major Japanese banks over the past ten years. It also resulted in the Japanese government infusing capital into the system and pressing for consolidation.^[3] Today, Japan has 5 major "city banks" (aka money-center banks that have global operations), 110 regional banks, and 15 local banks.^[13] MUFG also has competes with 63 foreign commercial banks and 20 trust banks in Japan. Mitsubishi is the largest of the city banks in terms of assets with Y190 trillion (USD 2 trillion) in total assets.^[2] Other city banks include Nomura Holdings Inc ADR (NMR), Mitsui (MITSY), and Mizuho Financial Group (MFG).

Mitsubishi also competes in the international market for deposits and financial services with large money-center banks like Citigroup (C), UBS AG (UBS), and Credit Suisse Group (CS).

Being relatively well-capitalized compared to foreign competitors, Japanese banks have been looking to snap up deals overseas. Mitsubishi purchased stakes in UnionBanCal (UB) and Morgan Stanley (MS), while Nomura Holdings Inc ADR (NMR) took over Lehman Brothers (LEH) operations in Europe and Asia.^[3]

Banking Efficiency

Mitsubishi's revenue stream has been more tailored to retail banking than investment banking. As such, its returns on assets and cost/income ratio have been lower than competitors. Management aims to expand the investment banking side of its business as evident in its capital infusion into Merrill Lynch (MER).

References

1. ↑ ^{1.0 1.1 1.2 1.3} Zacks Research (MTU), Author Ann H. Heffron
2. ↑ ^{2.0 2.1 2.2} (MTU) Form 10-K, FY 2008, Item 4, Section B, Page 21-26
3. ↑ ^{3.0 3.1 3.2 3.3 3.4 3.5 3.6 3.7 3.8 3.9} Barron's Online, "Japan's Banks: a Tasty Opportunity", By: Leslie P. Norton, October 20, 2008
4. ↑ ^{4.0 4.1 4.2 4.3 4.4 4.5 4.6 4.7} Mitsubishi UFJ Financial Group's Investor Presentation "Overseas Business Strategy" July 1, 2008
5. ↑ ^{5.00 5.01 5.02 5.03 5.04 5.05 5.06 5.07 5.08 5.09 5.10 5.11 5.12 5.13 5.14 5.15} (MTU) Form 10-K, FY 2008, Item 5. Operating and Financial Review and Prospects, Pages 42-97
6. ↑ Yahoo! Stock Quote (MTU)
7. ↑ ^{7.0 7.1 7.2} (MTU) Form 10-K, FY 2008, Item 3, Section D, Pages 7-18
8. ↑ ^{8.0 8.1 8.2 8.3} (MTU) Form 10-K, FY 2008, "Economic Environment in Japan", Page 49-51
9. ↑ ^{9.0 9.1 9.2} SeekingAlpha "Mitsbubishi UFJ Overcomes Jitters to Take 21% Stake in Morgan" By Jason Simpkins, October 14, 2008
10. ↑ Mitsubishi UFJ Financial Group - Summary of 1st Quarter Results of FY Ending March 2009 - August 5, 2008
11. ↑ (MTU) Form 10-K, FY 2008, "Mitsubishi UFJ Financial Group Ratios", Pages 90-91
12. ↑ BullionVault.com "Yen Carry Trade Unwinds", October 16, 2008
13. ↑ (MTU) Form 10-K, FY 2008, Competition Pages 26-35
14. ↑ IBS Publishing "Bank Efficiency: Measure for Measure" Feb. 07, Issue 16.5, Author Ian Buchanan
15. ↑ National Information Center "Top 50 BHCs"