“ “Mega-Mergers’ Economic Reasons and Performances: Lessons from Japan”

1. ““Mega-Mergers’ Economic Reasons and Performances:Lessons from Japan” Kimie Harada, Chuo University Takatoshi Ito, Tokyo University

2. Purpose • Examines short- and long-term performance of consolidations of larger scale banks in Japan. • Japan experienced its banking crisis in late 1990s, a decade prior to global financial crisis in later 2000s. • Large scale bank consolidations took place after the global financial crisis in the U.S. and Europe. Results of those consolidations taken place recently are not determined yet. Sumy, Ukraine

3. Consolidation • Bank consolidations are not new. Waves of bank consolidations in 1980s in the U.S. and European countries • Journal of Banking and Finance put together special features concerning consolidations of financial services industry in 1999. • Berger, et.al.(1999) reviews over 250 literature of financial services industry consolidation. • Amel, et.al.(2004) considers indirect effects in analyzing consolidations. Sumy, Ukraine

4. Consolidation • The government indirectly helped and arranged those consolidations. • Some criticized as aiming at “too big to fail” because consolidations in late 2000s were hastily arranged and not based on business strategy. • Public funds were injected in those newly created big banks in the U.S. Sumy, Ukraine

5. Main results • Japanese banks suffered from dealing with massive amount of nonperforming loans and urged to restore their financial health. →consolidation • Banks which had low rating of market evaluations at the announcement of a merger resulted in poor results of balance sheet analysis. • A merger of weak banks did not create sound bank even after a decade. Sumy, Ukraine

6. Brief historyof crisis • Hyogo bank, a regional bank listed on the Osaka Stock Exchange, collapsed suddenly in 1995. It was the first failure of a listed bank. • There were 20 big banks and the monetary authorities proclaimed none of them would be allowed to fail. • One of the 20 big banks, Hokkaido Takushoku Bank, failed in November 1997. In the same month one of the big four securities companies, Yamaichi Securities failed. Sumy, Ukraine

7. Brief historyof crisis • Two large long-term credit banks failed and nationalized under a new law in 1998. • In 1997 and 1998, the financial health of Japanese banks was questioned and they were asked to pay premiums that Japanese banks paid relative to their U.S. and U.K. competitor banks on Eurodollar and Euroyen loans. Sumy, Ukraine

8. Brief history of a crisis • Nationalization of two banks started a panic and the Japanese banking crisis became a global concern. • Capital injection by the government in March 1998 and again in March 1999 calmed the market for the moment. • Banks pursued accounting profit, such as scrambling with foreign investors, reverse merger etc. ) and utilized accounting benefits of the Deferred Tax benefits. Sumy, Ukraine

9. Brief history of a crisis • Between 1998 and 2002, Japanese banks were pressured by the market and the regulator to fatten reserves for future losses and raise the capital ratio. • Several banks attempted various measures to boost the capital ratio—some real, some cosmetic—and merger was one of the choices. • Example: It had been unthinkable that a large bank in a corporate group (keiretsu) chose to merge with another bank in an different corporate group. Sumy, Ukraine

10. Brief history of a crisis • Along with mergers, some institutional changes also took place. Banks were allowed to have securities subsidiaries and vice versa. • In 1998, financial holding companies’ structure was allowed, and it became possible to have banks and securities firms under the same roof of a financial holding company. • Focus on their mergers and examine banks’ motivations for mergers, institutional details, and consequences of their mergers. Sumy, Ukraine

11. Related literature • Tachibanaki and Haneda (1999) directly examines mergers. • Indirectly remark on mergers: Ohashi et al. (2001) Matsuura and Takezawa (2000) Drake and Hall (2003) Hosono, Sakai and Tsuru (2006) in general mergers did not improve after mergers. Sumy, Ukraine

12. Institutional change • Primary motives for mergers are cost savings and revenue enhancements. • Group of Ten (2001) report, the most important forces encouraging mergers are improvement in information technology, financial deregulation, globalization of markets, and increased shareholder pressure for financial performance. • Literature investigated whether mergers enhanced efficiency by examining indicators of profitability and cost savings. Sumy, Ukraine

13. Institutional change • In the Japanese banking sector, many bank mergers took place when banks’ balance sheets were damaged due to increasing nonperforming loans (NPLs) after the burst of the bubble economy in 1990. • Most banks were found to be under capitalized. The number of failed banks was more than that of merged banks. • NPLs and under-capitalization might have encouraged relatively fragile banks to agree to merger proposals from relatively healthier banks. Sumy, Ukraine

14. Mizuho Financial Group • Three large banks, Dai-Ichi Kangyo Bank (DKB Asset size; 52.53 trillion yen), Fuji Bank (Asset size; 46.38), and Industrial Bank of Japan (IBJ Asset size; 42.09 trillion yen), announced a merger in August 1999. • The merger was completed in September 2001 as Mizuho Holdings. • Unusually, compared with Non-Japanese bank mergers, the three banks were amalgamated on an equal basis and the share exchange ratio was an equal 1:1:1. Sumy, Ukraine

15. Mizuho Financial Group Sumy, Ukraine

16. Mitsubishi UFJ FG • Mitsubishi UFJ Financial Group (MUFG) is the most recent financial group which has two different holding companies as the roots, former Mitsubishi Tokyo Financial Group (MTFG) and UFJ Holdings. • Unlike in the case of Mizuho Financial group, MUFG has been built on many mergers. • The first merger was on April 1st 1996, announced on March 28th 1995. BTM. Sumy, Ukraine

17. Mitsubishi UFJ FG • MTFG was relatively the healthiest bank among Japanese mega banks. On the other hand, UFJ Holdings faced extreme difficulties. • Sanwa Bank (Asset size; 47.59 trillion yen) and Tokai Bank (30.36 trillion yen) merged and UFJ Holdings was established in April 2001 and these two banks merged to form UFJ Bank in January. • The merger was announced in June 2000 but it was not completed until June 2002. needed two years. Sumy, Ukraine

18. Mitsubishi UFJ FG • These two big financial groups merged and became MUFG in October 2005. The core banks of the group, Bank of Tokyo-Mitsubishi (81.11trillion yen) and UFJ Bank (68.18 trillion yen) merged the following year, January 2006. • They are now Bank of Tokyo-Mitsubishi UFJ Bank. • This large financial group plan was approved when UFJ Holdings accepted an offer to merge with MTFG in July 2004. The UFJ Holdings was the weakest among the then four major banking groups and faced an emergency situation. Sumy, Ukraine

19. Mitsubishi UFJ FG • Three large Sumy, Ukraine

20. Sumitomo Mitsui FG • Sumitomo Mitsui Banking Corporation (SMBC) resulted from a merger between Sakura Bank and Sumitomo Bank, which had roots in the old Zaibatsu in April 2001. • This was a straightforward merger of two competing banks with similar nationwide branch networks. • Sakura Bank, one of the preceding banks of SMBC, was created in 1990 when Mitsui Bank and Taiyo Kobe Bank merged. The bank operated as Taiyo Kobe Mitsui Bank until 1992 and renamed to Sakura Bank. Sumy, Ukraine

21. Sumitomo Mitsui FG • The group experienced a mysterious merger. When SMBC (Asset size; 102.83 trillion yen) established SMFG they agreed to merge with one of its wholly owned subsidiaries, Wakashio Bank in March 2003. • Under the merger, SMBC was legally dissolved, leaving Wakashio Bank as the surviving bank. However, Wakashio Bank was renamed SMBC after the merger. • This “reverse merger” was said to aim at eliminating unrealized losses of equities in assets by adding paper profits that were born by the merger. Sumy, Ukraine

22. Sumitomo Mitsui FG Sumy, Ukraine

23. Sumitomo Mitsui FG • The disclosed unrealized losses of SMBC (original SMBC) were about 672 billion yen before the merger. But, this amount of losses was completely disposed by the merger. • SMBC capitalized at 1058 billion yen which was acquired by the subsidiary with 81 billion yen. The capital of the new SMBC (former Wakashio Bank) is 560 billion yen on paper. This is why the merger is called the “reverse” merger. Sumy, Ukraine

24. Sumitomo Mitsui FG Sumy, Ukraine

25. Event Study • Mergers among Japanese banks were motivated under its financial crisis. • General motivations for mergers are cost reductions, synergy effects and obtaining scale merits such as economies of scale and economies of scope (G10 report). • We examine the impact of announcements concerning mergers by applying a event study methodology in order to see how abnormal returns of merged banks responded to merger-related events. Sumy, Ukraine

26. Event Study • By examining abnormal returns, it is discussed how the market judged a merger. • An example: when abnormal returns of a relatively weak bank increased and those of relatively healthy bank did not change, this would be the case of so-called a “relief merger”, healthy bank bailed out the other ailing bank plagued by NPLs. • →No concrete results. Sumy, Ukraine

27. BIS Ratios and Credit Ratings • The probability of default of mega banks became higher than their pre-merger period (Harada and Ito (2011)) • BIS ratio became higher, healthier, after its financial crisis, and mergers (Table 5). Public money was injected and criteria of BIS capital was amended, so BIS ratios is less credible. • Credit ratings were downgraded (Table 6). Sumy, Ukraine

28. BIS ratios and Credit Ratings Sumy, Ukraine

29. BIS ratios and Credit Ratings Sumy, Ukraine

30. Financial Statement Analysis • A better measure of evaluating bank’s soundness would be financial statement data. • Indicators after 2000 are calculated here (due to the injection of public money in 1998 and 1999) • Figures 15-18 are basic data. Asset size of mega banks was similar when they were born then gap was created towards 2011. • MTUFJ bank looks sounder than others. Sumy, Ukraine

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33. Figures 19-25 • Figures 19 to 25 show earning indicators. • Ordinary revenue (Figure 19) and ordinary income (Figure 20) of Mitsubishi Tokyo UFJ bank is the highest. Ordinary income shows profitability from core business of banks as it is calculated by subtracting other income from ordinary income. • Ordinary revenue and ordinary income of two Mizuho banks show no sign of improvement. Sumy, Ukraine

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40. Figures 26 and 27 • Gross profit (Figure 26) is well known indicator。 • It is obvious that gross profit of Mitsubishi Tokyo UFJ is stable and higher than other banks. Gross profit of Sumitomo Mitsui bank fluctuates partly due to reverse merger in 2003. • Movements in Figure 27 show gains on bond trading. There is little difference among banks. Sumy, Ukraine

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43. Figures 28-30 • Figures 28 to 30 show earning indicators. • Cost of Mizuho Corporate bank dropped that of other banks increased after their mergers. The hike of Mitsubishi Tokyo UFJ is partly due to merger of UFJ bank in 2006. It is surprising to know that cost of mega banks did not fall. • Ratio of salaries and allowances (Figure 29) and ratio of rental fees for land show slight downward trend but they have not drastically decreased. Sumy, Ukraine

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47. Figure 31 • Ratio of risk management loan sharply dropped from its peak to around 2% in 2005 and generally has been continuing to be flat. • Recent low amount of risk management loan ratio, however, is not reliable as true nonperforming loan outstanding because the criteria have been relaxed several times (Hoshi (2011)). • It is publicly believed that credit risk of Japanese banks is more than it appears. Sumy, Ukraine

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49. Conclusion • Japan experienced its own financial crisis about 10 years before the global financial crisis. • Some lessons can be learned by comparing the two crises (recent global financial crisis). • In the beginning of 1990, Japanese so-called bubble economy followed by serious financial crisis. Japanese banks started to merge after its financial crisis in order to survive. • A merger of weak banks did not create a healthier bank. Sumy, Ukraine

50. Conclusion • Serious potential cost of fiscal expansion. Public money was injected, the government support for some mergers. • Budget deficit is said to harm the health of the Japanese financial system more than the global financial crisis itself. • Credit risk of Japanese banks are increasing. It is important to reduce the cost of the future financial crises. Sumy, Ukraine