“Mega-Mergers' Economic Reasons and Performances: Lessons From

“Mega-Mergers’ Economic Reasons and Performances: Lessons from Japan” Kimie Harada ∗ Takatoshi Ito ** This version; May 1, 2012 ∗ Professor, Department of Commerce, Chuo University, Higashi-nakano 742-1, Hachioji-shi, Tokyo 192-0393 Japan: Email: [email protected]. ** Professor, Graduate School of Economics, The University of Tokyo, 7-3-1, Hongo, Bunkyo-ku, Tokyo, 113-0033, Japan: Email: [email protected]. “Mega-Mergers’ Economic Reasons and Performances: Lessons from Japan” Kimie Harada Takatoshi Ito Abstract This study examines short- and long-term performances of consolidations of larger scale banks. 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 and some of those consolidations were criticized as aiming at “too big to fail”. With a decade experience, this paper shows that banks which had low rating of market evaluations at the announcement of a merger resulted in poor results of balance sheet analysis. This could be lessons from Japan with the global banking sector now consolidated than ever. Keywords: bank merger, financial holding companies and event study JEL Classification: G19, G21. 1 1. Introduction This study examines short- and long-term performances 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. There were waves of bank consolidations in 1980s in the U.S. and European countries so that bank consolidations themselves are not new and already analyzed in many papers. Journal of Banking and Finance put together special features concerning consolidations of financial services industry in 1999. In it, Berger, et.al.(1999) reviews over 250 literature of financial services industry consolidation. The main purpose of Berger, et.al.(1999) is to evaluate the causes, consequences and future implications of financial services industry. Amel, et.al.(2004) considers indirect effects of other factors such as country, industry and time period analyzed in analyzing consolidations. Striking difference between consolidations in 1980s and those in 2000s is that the government indirectly helped and arranged those consolidations. Some of those consolidations were 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. As explained later, a decade earlier to global financial crisis, Japanese banks suffered from dealing with massive amount of nonperforming loans and urged to restore their financial health. The way they took was consolidations. The purpose of this paper is to introduce the surroundings, economic situation, individual bank’s background and motivation of a consolidation and indicates some lessons from Japanese banking sector to the U.S. and European banks. 2 In 1995 Hyogo bank, a regional bank listed on the Osaka Stock Exchange, collapsed suddenly. It was the first failure of a listed bank. At that time, there were 20 big banks and the monetary authorities proclaimed none of them would be allowed to fail. The promise was to assure that financial vulnerability in Japan would not spill over to other major financial centers. However, two years later, 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. In the following year, two large long-term credit banks failed and nationalized under a new law. 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. In 1998, two of the major banks, the Long-term Credit Bank of Japan (LTCB) and the Nippon Credit Bank (NCB) were taken over by the government. Nationalization of these banks started a panic and the Japanese banking crisis became a global concern (The list of major bank failures is in Appendix Table 1). Capital injection by the government in March 1998 and again in March 1999 calmed the market for the moment. At the same time, some banks scrambled to raise capital by inviting investors (Goldman Sachs into Sumitomo Bank as an example1)and some banks were merged by smaller banks to raise accounting capital (Sumitomo Mitsui Bank was merged by Wakashio Bank2). Both of these ways for raising capital utilized accounting benefits of the Deferred Tax benefits. 1 Goldman sacks bought 12,621,804 shares for approximately $1.259 billion. The after-tax profit accruing to Sumitomo Bank from this transaction was estimated at approximately $600 million (Source: Sumitomo Mitsui B.C. back news). 2 This merger case is discussed in next subchapter. 3 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. It had been unthinkable that a large bank in a corporate group (keiretsu) chose to merge with another bank in an different corporate group. As examples of this type of merger, Sumitomo Bank (major bank of Sumitomo group) merged with Sakura Bank (major bank of Mitsui group), and Fuji Bank, Daiichi-Kangyo Bank, and Industrial Bank of Japan decided to make a three-way merger. There are currently only three mega banking groups (Sumitomo Mitsui Financial Group, Mitsubishi UFJ Financial Group, and Mizuho Financial Group). The remaining banks include two independent trust banks (Sumitomo Trust Bank and Mitsui Trust Bank) and one smaller banking group, Resona Holdings. 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. Three mega banking groups emerged in Japan after 2000, however, each group had different strategies and chose a different legal structure for the group. In this paper, therefore we will focus on their mergers and examine banks’ motivations for mergers, institutional details, and consequences of the mergers. The rest of the paper is organized as follows. We review related literature and describe structure of financial holding companies in section 2. Performance of these financial holding companies is measured by stock price movements and financial statements. It is difficult to do pre- and post- analysis, because a merger tends to involve not only merging two or three balance sheets and exchanging old stocks for 4 new stocks, but also reorganizing subsidiaries and securities firms in the financial group. For examining market participants’ reaction to bank mergers, the event study approach is employed. For analyzing balance sheets of banks which have different structure, we created evaluation methodology on an equal footing with different organizations. Event study of stock price is in section 3 and financial statements pre- and post- merger analyses are in section 4. We discuss the implications of the results in section 5 and conclude with section 6. 2. History: Institutions and Accounting 2.1 Literature review of the Japanese banking sector Before the 1990s, few studies examined mergers in the Japanese banking sector because bank mergers were rare and almost all of the mergers were not voluntary, but rescue mergers arranged by the Ministry of Finance. In recent years however, the number of papers examining bank failures and bank mergers increased. Tachibanaki and Haneda (1999) examine indicators such as stock price, productivity, profitability, and fund-raising costs for five merger cases of city banks between 1967 and 1996. They found less evidence of gains from a merger than expected. There is no other literature that directly examines mergers by city banks before the 1990s. Papers of an early date which indirectly remark on mergers are Tachibanaki and Haneda (1999), Ohashi et al. (2001), Matsuura and Takezawa (2000), and Drake and Hall (2003).3 Matsuura and Takezawa (2000) estimate production function with merger dummy variables between 1988 and 1997. The main purpose of their paper was to distinguish unhealthy banks from seemingly healthy banks and a 3 Ohashi et al. (2001) is a translated version of a summary regarding Japanese consolidation from the Group of Ten (2001) report. In the report, mega-mergers after 2001 are not covered. 5 dummy variable was used as a control variable for mergers. In their paper, mergers did not have a strong impact on production. Drake and Hall (2003) applied the nonparametric frontier approach to analyze efficiency in the Japanese banking sector with 149 banks for 1998. Based on the cross-section analysis, Drake and Hall (2003) suggest that it would be very difficult to predict the outcome of mergers because larger banks had the least x-efficiency gains and had no economies of scale either. Tachibanaki et al. (1997) examine only trust banks with the focus on examining portfolio selection and efficiency gains in the management of trust banks. Recently Okada (2007) examined mergers in the Japanese banking sector with various market indicators and found that merged banks became less efficient compared with the pre-merger period. Okada (2007)’s results imply that the motivation of mega-mergers was to take advantage of the “too-big-to-fail” policy. Hosono, Sakai and Tsuru (2006) cover bank mergers during the period of 1990 to 2004 and investigate motivations and consequences of mergers.

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