In a move that was either brilliantly timed or very lucky -- or more likely a bit of both -- the smallest of Japan's three megabanks by assets, Sumitomo Mitsui Financial Group (SMFG) yesterday raised ¥803 billion ($8.2 billion) from a sale of new shares, which could increase to ¥923 billion ($9.4 billion) if the greenshoe is exercised in full, just as the markets look set to turn down after a long rebound.
The deal represents the largest amount raised from an equity financing by any Japanese bank on record. According to Dealogic, it is almost 60% larger than the former follow-on record of $5.2 billion which was set in 2006, also by SMFG. In terms of all issuers, the SMFG follow-on comes in third on the all-time high list, behind two NTT deals in 1999 and 2000, which amounted to $14.9 billion and $11.4 billion respectively.
The pure equity format reflects investor concerns about the quality of capital at the country's banks, and the failure of hybrid capital to sufficiently absorb losses during periods of stress.
The deal was launched on May 28 and the books closed last Friday. The final price was set yesterday afternoon Japan time at ¥3,928 per share, a 3% discount to Monday's closing price of ¥4,050 and at the tight end of the 3%-5% range at which it was marketed.
According to one banker close to the deal, demand was reasonably strong. The international tranche, which comprised 50% of the deal, was 2.5-3 times subscribed. The domestic tranche was split 90-10 in favour of retail investors, saw the latter portion around 1.4 times subscribed and the institutional tranche 1.1 times subscribed.
The deal, which consisted entirely of new shares, will have a nasty impact on existing investors, as it will result in 30% dilution. "Along with other huge recent deals for Nomura and Toshiba, this deal was perfect for a rights issue, which unfortunately is not possible in Japan," noted the banker. He added that many existing investors did not compensate for the dilution by buying more shares.
The banker pointed out that even with the decline in the Nikkei 225 index over the past few days, the deal was priced well above the ¥3,720 level where the stock was trading when the offering was launched last month.
The deal benefited from the Nikkei's remarkable rally over the past month, which has been driven by investors hoping for a sustained economic recovery. The Nikkei has put on almost 1,000 points, or 8.36%, in the past four weeks. During the same period, SMFG's share price has also soared, reaching ¥4,480 yesterday from ¥3,670 on May 29. However, the Nikkei closed down 96 points on Monday (almost 1%) at 10,039.7 points, on the back of reports that Western governments would start trimming their fiscal stimulus plans.
Some media reports suggested on Monday that the stock slid because SMFG raised more money than the amount it had originally announced. However, that may have been due to confusion about the role of the greenshoe. Said one banker close to the deal: "The report is quite wrong, and the number of new shares to be issued has not changed since the original filing."
The deal is paradoxical in the sense that it's encouraging that it could be done at all, but troubling because of the large amount of money needed to be raised by the bank. Certainly, the funds raised will give the bank increased comfort following its ¥545 billion acquisition of retail brokerage Nikko Cordial Securities and parts of Nikko Citigroup's debt and equity underwriting business last month. In addition, the capital raising exercise helps compensate for the company's net earnings loss of ¥373 billon in the financial year ending March 2009.
According to the same banker quoted above, investors were especially concerned about the acquisition of Nikko Cordial Securities. Indeed, Yuri Yoshida of ratings agency Standard and Poor's in Tokyo, says that goodwill paid on the deal (the difference between the price and the then-net asset value of ¥393 billion) is taken straight out of tier-1 capital. NAV varies, meaning Yoshida is reluctant to give a precise value, but the goodwill would appear to be around ¥145 billion, or 18% of the total amount raised pre-greenshoe.
The banker also said that the deal posed no great problems in terms of underwriting (which was done on a 'soft' basis), despite its size. He did say that an oddity of the deal was the number of foreign and institutional long-only funds that continued to buy shares in the market during the first four days of last week, even though it was certain that they would get their full allocation, given the sheer size of the deal.
"It was as if they didn't understand how such a deal works. Some investors (who were waiting until Monday to buy) were getting nervous as they saw the price go up. However, the price came off on Friday and yesterday by almost 10% which gave them some relief," he told FinanceAsia.
There has been some debate about the extent to which SMFG's tier-1 capital has really been improved under the deal. Fitch Ratings estimates it has gone up to just under 9%, from 8.2% (as reported by SMFG) at the end of the past financial year (March 31, 2009). However, S&P analyst Yoshida told FinanceAsia that it's difficult to measure any improvement given that: "SMFG is using a different accounting method for the past financial year to what they were using in the previous financial year. Until they provide more detailed figures, as they must in July 2009, it will be very difficult to see if the adjustments they have made (such as reducing their risk assets by seven trillion) are appropriate or not," she said.
"Intuitively, it would seem strange that their tier 1 ratio for the last financial year should actually improve to 8.2% on the previous year's level of 6.94%, considering their almost ¥400 billion loss, and the deteriorating macro environment (which is bound to have pushed up their credit costs)," Yoshida added.
SMFG's capital level adjustments for the past financial year were made under Basel II rules known as the Advanced Internal Ratings Band Approach, which allow banks more discretion on how to weigh their risk assets. Under the non-advanced approach, the bank is advised to assume losses will amount to 35%-40%, but SMFG may have chosen a lower estimate. Fitch bank analyst Chikako Horiuchi counters that "the likelihood of these losses being below 35%-40% is high, because Japan banks emphasise high levels of collateral". In addition, she points out that the calculation was approved by the Japanese banking regulator, the Financial Services Agency.
Fitch reckons that a tier-1 capital ratio of close to 9% is quite respectable by global standards, since the money raised by SMFG does not have to be paid back. Western banks may appear to have very strong capital adequacy levels, but in fact, those levels will come down as they pay back their government creditors.
One Japanese asset manager told FinanceAsia that under the current regime, Japanese banks are receiving money from the Bank of Japan, which they are then lending to investors to buy their equity. "It's all quite circular," he noted. However, he believed that SMFG's decision to buy Nikko Cordial was "interesting" and showed a desire to try new ways of becoming profitable.
Surprisingly, the joint global co-ordinators did not include Nomura Securities, but did comprise Daiwa Securities SMBC (a joint venture between SMFG and Daiwa Group) and Goldman Sachs, which also has close informal ties with SMFG. Those two banks were also joint bookrunners, along with Barclays Bank, Citi and J.P. Morgan. On the domestic portion, Daiwa Securities SMBC, Nomura and Goldman were bookrunners.