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Dilution, dilution, dilution
Commentary: Investors brace for Japanese banks' share issuance
By Lisa Twaronite, MarketWatch
Last Update: 12:01 AM ET Nov 25, 2009
TOKYO (MarketWatch) -- Investors in Japanese megabanks are waiting for yet another shoe to drop.
Banks here are gearing up to issue more shares ahead of more stringent international guidelines on how much core Tier 1 capital they must hold. Mitsubishi UFJ Financial Group MTU, Japan's largest bank, is planning to issue a whopping 1 trillion yen ($11.2 billion) in new shares -- the biggest-ever share sale by a Japanese financial institution.
Investors are wondering if Sumitomo Mitsui Financial Group Inc. SMFJ.Y might be next.
The Basel Committee on Banking Supervision is expected to raise the level at which financial institutions are required to maintain their core Tier 1 capital as early as 2012. Core Tier 1 capital includes the sum of common shares and internal reserves -- but not preferred securities or preferred shares. That means the three megabanks can't count a sizable chunk of the billions of dollars they've raised since the global financial crisis began.
Preparation for the expected core capital requirements comes just as things were beginning to look a little better for Japan's three megabanks, albeit against a darkening economic backdrop. Mitsubishi UFJ, Mizuho Financial Group Inc. MFG, and Sumitomo Mitsui all fell into the red for the first time in five years in the fiscal year which ended in March 2009, but all three posted net profits in the April-September fiscal half.
However, Japanese banks are competing in an increasingly difficult climate, as the country's economic recovery remains fragile, deflationary pressures persist and lenders are forced to write off more bad loans.
Although the megabanks' Tier 1 capital ratios improved further in the first half of the fiscal year through March 2010, they still have high levels of preferred stocks and preferred securities, Fitch Ratings said Tuesday.
"Their 'core' Tier 1 capital ratios could fall to a very modest level, depending on the final decision as to how narrowly 'core' capital is defined. Weakening loan quality is likely to exert an additional burden on the banks' already somewhat weak core capitalization," Fitch said.
Plotting its next move
Banks here have all too much experience in the bad-loan department. Bad loans at Japan's major banks officially peaked at 43.2 trillion yen in March 2002, according to official government estimates. But most private analysts said that figure vastly understated the scale of the problem -- some put the total over 200 trillion yen, which would have been close to 30% of total lending.
Japanese policymakers are worried that higher core capital requirements would lead to banks restricting lending, which would threaten corporate capital investment and stall the economic recovery.
Sumitomo Mitsui Financial Group, Japan's third-largest bank, raised its core Tier 1 capital ratio to around 5% with an 860 billion yen increase in June, and is "believed to be plotting its next move," according to a report Tuesday in Japanese business daily Nikkei.
Its president, Teisuke Kitayama, told The Wall Street Journal in an interview just last month that his bank would focus on boosting retained earnings for the foreseeable future.
"It is our intention to avoid further dilution of our common stock," he told the newspaper. "We'd like to make every effort to further strengthen [our capital base], but the first priority is to increase the retained earnings."
Mizuho's situation is a bit trickier because of a 2003 fundraising effort. The lender issued about 910 billion yen worth of preferred shares to its client firms, which became convertible into common stock in July 2008.
However, as the bank's share price remains below the conversion price, only about a third of the shares had been converted by the end of September -- after Mizuho raised about 550 billion yen by issuing more shares in July.
"We're filled with shame to think of the clients that supported us when we were on the brink in 2003," a Nikkei report last week quoted an unidentified Mizuho executive as saying.
Priced-in
Mitsubishi UFJ Financial Group reported a week ago that its fiscal first-half net income surged 52%, helped by higher income from lending and gains in its stock portfolio. Read more on MUFG earnings.
But its shares subsequently plunged to a six-week low in the following session because it also confirmed the massive capital-raising share sale, which had been widely presaged in local media reports. The latest stock issuance will follow its 400 billion yen capital increase last December.
To be sure, even if Sumitomo Mitsui and Mizuho were to issue more shares, at least investors would likely see it coming, meaning many are already factoring it in. Even after Mitsubishi UFJ confirmed its upcoming massive issuance, the bank still has its fans.
"Because every 100 billion yen means 0.1% for Tier 1 and core capital, the amount raised adds 1.0% to the tally. In our view, the announcement confirms the anticipated dilution, which we believe is within expectations and thus should be priced-in," Macquarie Securities' analysts Ismael Pili, Makarim Salman and Ryosuke Tanaka wrote after Mitsubishi UFJ announced its share issuance.
They maintained their outperform rating on the lender.
In other words, the shoes may be dropping -- but some investors will wear them, as long as they fit.
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