Why Japanese Banks Lack Deal Mojo

The Wall Street Journal – Nov 7, 2016 – If you can’t build it, buy it. Unfortunately, that’s not an option for Japan’s mega banks.

Struggling to make profits grow in their domestic lending businesses, Japan’s banks have languished. Add to their pain negative interest rates and meaty cost structures, and the future is visibly bleak. Yet, not much has been done about it. Bank stocks are down 27% this year.

Elsewhere in Japan’s financial sector, notably among insurance companies, foreign acquisitions have been substantial of late. Japanese insurers have scooped up over $30 billion of insurance assets across the globe over the last two years. The rationale is simple: trade low growth and negative rates in Japan, for higher growth and rates in the U.S. and elsewhere.

Yet banks, in the same environment, have hovered on the sidelines. They have bought small chunks of loan books from the likes of Royal Bank of Scotland and small stakes in commercial lenders in Asia and the U.S. But the transformative deals and strategies their insurance siblings have pursued haven’t materialized.

There are substantial obstacles, of course. With amped-up regulatory enforcement, the efficiencies of capital and cost aren’t like they once used to be. Japanese banks also sit on more corporate equity holdings through legacy cross-shareholdings than most global banks, and these are subject to higher regulatory capital and more generally, riskier. And their equity isn’t strong currency: Japanese banks trade at a price that is on average half of their book value.

And, an overhang of past capital-intensive acquisitions continues to linger. Japan’s biggest lender, Mitsubishi UFG, for instance, forayed deep into the U.S. banking market. It has a lending joint-venture with Morgan Stanley and presence on the West Coast through Union Bank and a slew of regional bank acquisitions. It has risen to one of the top lenders by total loans in its U.S. wholesale and retail lending business.

Increased volumes aren’t enough to offset the MUFG’s net interest margin compression. Including foreign exchange effects, net income from the U.S. business fell 7% between fiscal years 2015 and 2016 as total assets rose by 14%. Accessing U.S. dollar funding is also becoming more of an issue as short-term interbank borrowing costs rise on the back of new regulations. Japanese banks are forced largely to use yen-based deposits to fund the gap between foreign lending and deposits.

Japanese banks’ desperately need a focused overhaul — from greater efficiency in how they use their balance sheet to stabilizing earnings and generate more than just the basic interest income, like fees and commissions—effectively more noninterest income. With M&A on the sidelines, the only option Japan’s large banks have is building it.

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