Sumitomo Mitsui Financial Group (SMFG), Japan's second biggest bank by market value, is about to acquire Citi's wholesale and retail securities arms in Japan for $5.2 billion, according to several sources quoted on the wire services and in the Nikkei group of media organs on Tuesday and Wednesday.
Nikko Citigroup, the wholesale arm, is 49%-owned by Citigroup Global Markets (itself 100%-owned by Citigroup, USA) and 51%-owned by Nikko Citi Holdings. Nikko Cordial Securities, the retail brokerage, is 100%-owned by Nikko Citi Holdings.
The Japanese arm of the US bank was thrown open to Japanese bids as part of an effort by Citi to shed none-core assets and raise cash to offset its gigantic losses in 2008.
The result of the bidding is something of a surprise, according to Stephen Church, economist at Japaninvest in Tokyo. While Mitsubishi UFJ Financial Group (MUFG), SMFG and Mizuho were all involved in the bidding, "the expectation was that Mizuho would get Nikko, because of its historical links with Nikko," says Church.
Nikko was originally part of the Industrial Bank of Japan (IBJ), but was spun off in 1924. IBJ went on to be merged into Mizuho. Church believes MUFG was never a serious contender because of bad blood between the units dating back to when Nikko decided to merge with Travellers (later Citigroup) in the late 1990s -- despite MUFG having a moral claim on Nikko because of a rescue made in 1965. In addition, MUFG is busy on negotiations which could lead to a merger between its securities unit and Morgan Stanley Securities, Japan.
"Mizuho not paying top dollars and getting its due prize would seem to indicate that the ex-Fuji and ex-Dai-ichi Kangyo Bank commercial bankers have prevailed over the ex-IBJ investment bankers. Discretion is the better part of valour, as they say," says Church. Another factor could be the additional complication presented by the ongoing integration of Shinko Securities with Mizuho Securities.
The Mizuho group is the product of a merger between the Industrial Bank of Japan, Dai-Ichi Kangyo Bank and Fuji Bank. The launch of the combined operations in April 2002 was a disaster for the new conglomerate as it involved serious electronic malfunctions that caused millions of dollars to be mis-routed and took a month to fully fix. Partly as a result of integration issues, financial results have not been encouraging: the group estimated consolidated losses of ¥580 billion for fiscal 2008, compared to an earlier estimate of a ¥100 billion gain.
The other question, says Church, is how SMFG will be able to combine its existing alliances with Daiwa and Goldman Sachs with its new unit.
Daiwa Securities SMBC is a joint venture between Daiwa and SMFG, in which SMFG owns 40%. There is some speculation that Nikko Citigroup could be combined with Daiwa Securities SMBC, and that Nikko Cordial could be combined with Daiwa Securities (Daiwa's retail securities arm), although Church is sceptical.
"Japanese companies are less interested in the balance sheet aspect, and more in the company's 'DNA'. SMFG is a bank with Osaka roots and considered quite rough and ready, and opportunistic. Nikko Citigroup, in contrast, is considered gentlemanly, and strongly Tokyo-centric," says Church.
Goldman Sachs also has a long relationship with SMFG, although it's not clear how amicable it is. (One banker close to Goldman describes it as 'loose and none-exclusive.') SMFG invested $430 million in Goldman Sachs in 1986 in exchange for a 12.5% stake (long since sold). Federal Reserve rules, however, determined that SMFG could not increase its interest, exercise management rights, or expand to other countries.
Goldman had the chance to return the favour in 2003, when it purchased ¥150.3 billion of SMFG preferred stock with a 4.5% cash dividend. The preferred stock was convertible into common stock beginning two years after issuance, and on a mandatory basis at the end of 25 years. As part of the agreement (according to a Goldman press release at the time), SMFG would also provide substantial first loss protection. Some observers believe these terms were extremely tough for SMFG -- considering it had earlier given Goldman an important capital injection on easier terms. As a result, SMFG might be delighted to be able to route its international institutional business through Nikko Citigroup and its domestic institutional business through Daiwa SMBC Securities.
"Goldman is viewed in Japan as being somewhat grasping, and the 2003 deal is considered typical of its attitude," comments Church. The business volume generated by SMFG is considerable. According to Dealogic, it has amounted to over $8 billion in ECM and $20.3 billion in DCM in the past 10 years. In mergers and acquisitions, Goldman has benefitted from working on $16 billion of SMFG-related deals.
Church believes that the essential drivers of the SMFG acquisition of the Nikko units were not solely commercial, but part of a long-standing governmental attempt to consolidate the Japanese banking industry into three mega-banks organised on German lines -- insurance, assurance, a trust business, and a commercial bank. This would enable them to compete against encroaching foreign banks, and also mount their own bids abroad.
"The ministry of finance and IBJ (the leading long-term credit bank formed in 1952) started work on planning the restructuring of the Japanese financial sector and the result was the "Allfinanz Reform", starting in 1985 and running until 2015. Under Allfinanz everything -- asset management, assurance, insurance, securities, trust banking -- was to be bundled into the megabanks universalised on the German model and very few major independents were anticipated to survive," Church writes in a recent report.
A Tokyo-based consultant who prefers to remain anonymous confirms that recent weeks have seen a great deal of vertical integration, but not much horizontal integration. "Banks are not merging with each other, they are picking up additional units," he points out. (The exception is Shinsei Bank, which recently announced it was contemplating a merger with Aozora Bank). SMFG announced yesterday that it is also buying Japan's second-biggest non-bank lender Orix for ¥30 billion.
The same consultant does not believe that these consolidations are going to result in a lot more profit for the Japanese financial sector. "The pie in Japan is getting smaller. The mega-banks are still basically focused on Japan and adding on a foreign presence. I think this strategy is dangerous, because the domestic securities market is shrinking," he says.
According to a Nikkei newspaper report, 14 major brokerages have so far reported net losses for financial 2008, which ended in March, because of a drop in commissions from the trading of stocks and investment trusts. The report notes that the daily average trading value of the Nikkei is down 31% on the previous year, and much of that business is being absorbed by online brokers such kabu.com, which is far cheaper than the traditional face-to-face form of brokering. Kabu.com made a profit in financial 2008.
Nikko Citigroup and Nikko Cordial have not escaped the contagion. For the first nine months of financial 2008, Nikko Cordial announced operating income down 58% on the same period last year, at ¥20.8 billion. It made a net loss of ¥0.8 billion for the period. Nikko Citigroup announced an operating loss of ¥20.68 billion (net loss of ¥14.5 billion) for the first nine months of financial 2008, compared to an operating loss of ¥11.44 billion on-year.
The market is also highly fragmented. According to the confidential report of one foreign investment bank examining the period between 2003 and March 2008, Mizuho Securities has 3.9% of the securities market in Japan, while Daiwa SMBC has under 8%. Goldman has 6.5%, the top figure among the foreign banks. Nikko Citi is an attractive target, with 13% of the combined institutional and retail market. Nomura is top, with 25.1% of the combined market.
The other interesting point in all this is where it leaves Nomura, as the only pure investment bank in the world. The anonymous consultant believes Nomura has internationalised to a far greater extent than the commercial banks -- and that it might even at some point transplant its headquarters to London to access markets worldwide.
"Nomura knows it can't rely on its domestic operations any more. Indeed, in the fourth quarter of financial 2008, Nomura's retail portion made a loss for the first time in many years. However, it feels it can leverage its links in Japan to sell its retail base investment products relating to China and India. It has its eye on teasing out some of that $15 trillion in household savings," says the consultant. Despite this, the consultant believes even Nomura will at some point need to buy or be acquired by a commercial bank, for the unmatched volume of their financing ability.
