A shopping spree may solve a dollar drought among Japanese banks. As Japanese corporations acquire assets abroad to escape a shrinking domestic economy, the country’s financial institutions are making loans abroad faster than they can amass matching deposits and other dependable sources of funding. That has helped send the cost of converting yen to dollars soaring, and worried regulators in Tokyo. Mergers and acquisitions targeting smaller U.S. banks would help reduce the mismatch.
The Japanese financial system is dominated by three “mega-banks”, Mitsubishi UFJ Financial Group, Sumitomo Mitsui Financial Group and Mizuho. Like the Japanese companies they serve, this trio and their smaller rivals are itching to get away from an ageing and sluggish home market, one where interest rates – a key driver of financial sector profits – are now in negative territory.
So they have branched out, financing projects, lending to multinationals, and helping domestic corporate clients pursue a string of big overseas purchases. MUFG’s Bank of Tokyo-Mitsubishi UFJ unit single-handedly lent Suntory $12.5 billion to buy U.S. bourbon maker Jim Beam two years ago. In September, Japan’s banks became the world’s top cross-border lenders for the first time, according to Bank of International Settlements data cited by Moody’s.
But growth in foreign-exchange deposits has not kept pace with the lending blitz. The shortfall is made up with less sticky sources of funding such as so-called repurchase agreements, borrowings from other banks and currency swaps. To make matters worse, a big chunk of deposit funding consists of accounts held by large companies, which can be flightier than those of retail customers.
Markets also suggest a funding squeeze is on, with the cost of switching yen for dollars soaring. Last month the cost of swapping five years of yen payments for dollars, as measured by cross-currency basis swaps, peaked at 105.6 basis points – the biggest reading in the dataset’s near-eight-year history, Thomson Reuters Eikon shows.
Japanese officials are understandably fretting. In December the Bank of Japan highlighted a considerable, albeit narrowing, “stability gap” between overseas assets and stable liabilities. The Bank of Japan – which doesn’t police banks, but does safeguard financial stability – urged banks to keep trying to secure stable non-yen funding and to get better at tackling potential market stresses.
In fairness, the banks realize that this is a problem, and have been trying to adapt. In the last two and half years Mizuho, for example, has grown non-yen deposits more than 70 percent faster than overseas loans. And there are yet more prosaic fixes available. One way to lock down funding, for example, would be to issue more longer-dated bonds in foreign currencies.
However, a bolder and more permanent solution would be to emulate those customers who have been running around the West with chequebooks in hand.
MUFG, which at $63 billion is Japan’s biggest bank by market capitalisation, is the prime candidate for expansion through takeovers. The group, which is also Morgan Stanley’s biggest shareholder, has already made a string of acquisitions and built subsidiary Union Bank into a U.S. institution sporting $115 billion of assets.
Leaders including MUFG Chief Executive Nobuyuki Hirano and Takashi Oyamada, president of core banking unit BTMU, talk openly about their appetite for further M&A, and MUFG wants Union Bank, which as of September 2014 ranked 13th by deposits, to become one of America’s 10 largest lenders by size and earnings. That makes sense: the parent company is already well known to Washington regulators, and could cut costs by folding other lenders into Union Bank.
Others could strike deals, too. Mizuho, for example, has been more circumspect, but does say it is open to “inorganic growth” in areas including banking, securities, and asset management, provided deals make strategic sense and are reasonably priced.
There are plenty of potential targets to choose from in America’s fragmented banking sector. On the smaller side, for example, the S&P Composite 1500 banks index includes 79 banks with a market value of less than $5 billion. Snapping up Zions Bancorp, the largest of this group, would add about $60 billion of assets. With the biggest U.S. lenders effectively prohibited from bulking up at home, that gives Japanese banks and other predators room to move.
Investors know this, of course. That’s why these smaller lenders trade at an average of about 1.4 times book value, Eikon data shows. So they will not look like bargains in Japan, where none of the six biggest banks trades above 0.5 times book value. But the dilution for a few small purchases may be a price worth paying to make sure their funding matches their global ambitions.