How to Interpret the UFJ Merger Drama

TSURU Kotaro
Senior Fellow, RIETI

Over the past month and half, UFJ Holdings, Inc. and its controversial plan to merge with Mitsubishi Tokyo Financial Group (MTFG) have certainly grabbed the spotlight. The unusual takeover battle has stirred much and curiosity and given Japanese people yet another reason to get excited in the midst of one of the hottest summers in years, on top of all the excitement brought by the Athens Olympic Games.

The drama began on July 16 when UFJ and MTFG suddenly unveiled a plan to merge, a move that provoked legal action by Sumitomo Trust and Banking Co., another major bank that had earlier agreed to buy UFJ's trust unit. On the very day of the announcement, Sumitomo Trust filed for a court injunction to suspend the merger talks between UFJ and MTFG. On July 27, the Tokyo District Court granted a preliminary injunction preventing UFJ from including its trust unit, UFJ Trust Bank, in the talks with MFTG. This was followed by yet another twist on July 30, when Sumitomo Mitsui Financial Group (SMFG) suddenly offered to buy UFJ, making the outcome of the UFJ saga totally unpredictable. Then, on August 11, the Tokyo High Court overturned the lower court injunction. This ruling was finalized on August 30, when the Supreme Court rejected an appeal by Sumitomo Trust. With this court ruling, MTFG and UFJ have taken a major stride toward a full merger, a package that includes UFJ Trust Bank. Despite all this, the Financial Services Agency has not ruled out the possibility of filing a criminal charge against UFJ, while SMFG's merger offer remains valid with the September 24 reply deadline for UFJ approaching. As such, it remains uncertain how the ongoing tug of war over UFJ will end.

Shareholders' interest must be always kept in mind

The unfolding of the UFJ merger drama is totally different from the conventional process by which "megabank" mergers have been carried out in the past. Generally speaking, mergers between big companies not only have impact on the industry, but also affect the interests of each party to the merger. Thus, negotiations normally take place behind closed doors among a few key persons (the top managers of both merging companies, along with - if the merger involves companies in a heavily regulated industry - government officials); the announcement of a merger plan comes only after things are settled. In such a backroom deals, the interest of those involved in merger talks naturally take top priority and the resulting deal takes on the character of a tacit agreement based on mutual trust among negotiators. Such, however, has not been the case for the UFJ merger, where the entire negotiation has played out before the eyes of the public because of the involvement of judicial authorities and the surprise takeover bid by SMFG.

What has been particularly noteworthy is the fact that SMFG's entry into the UFJ takeover contest has already had a substantive impact on the UFJ-MTFG integration process. In early August, SMFG submitted a merger proposal to UFJ, offering a capital injection of ¥500 billion or more and a plan for management integration "in the spirit of equals." This effectively forced UFJ to consider the SMFG offer because refusing to do so would run counter to its shareholders' interests and might result in shareholder representative suit. Meanwhile, MTFG, if it was to consider the interests of UFJ shareholders, had to present better terms, which is the reason behind MTFG's earlier-than-planned agreement and announcement on August 12 to offer a capital injection of up to ¥700 billion. This was quickly countered by SMFG on August 24 with the announcement of a new merger package, in which SMFG promised to offer up to ¥700 billion in capital and a one-for-one share swap, a scheme that would provide a 20 percent or greater premium to UFJ shareholders.

With SMFG's hat in the ring, the top managers of UFJ and MTFG have been unable to proceed with their merger plan based solely on their own logic. It has now become clear - though this is how things are supposed to be in the first place - that top managers must always consider shareholders' interests when negotiating a merger. In this context, the whole merger battle has been quite meaningful. By joining the fray, SMFG may be intending to raise the cost of the merger cost for its rival (MTFG) thereby securing a better competitive position vis-a-vis the new mega bank that would result from a UFJ-MTFG merger, even if it fails in its own takeover bid. At the same time, however, SMFG must be careful so as not to make the terms of its offer too good because its own shareholders will not tolerate such a sweetheart deal.

The regulatory authorities should prepare for possible post-merger problems

At least on surface, the FSA is merely an observer in UFJ merger drama rather than a stage director. Under the old "convoy system" of financial administration, arranging and inducing mergers between banks was one of the defining roles of financial regulators. At that time, government instructions were so intrusive and meticulous that people often said, "They (government officials) would tell you when to pick up or put down your chopsticks." The FSA may be staying on the sidelines of the UFJ struggle because it fears that critics will accuse it of trying to revive the old-fashioned methods of discretionary administration.

Indeed, if ensuring the stability of the financial system is the sole goal of financial administration, it would be fine as long as UFJ becomes part of any megabank, whether it is MTFG or SMFG. In reality, however, such a megabank merger would have a big influence on borrowers and depositors, and the impact may differ depending on who merges with whom and how it is done. Therefore, the regulatory authorities should monitor the progress of merger talks, rather than intervene, to anticipate and prepare for problems that may arise as result of the merger.

There are two points of concern with regard to the prospective MTFG-UFJ tie-up. First, if the merger, which began as a rescue of UFJ by MTFG, becomes more of a merger of equals due to the influence of SMFG, the post-merger personnel management and computer system integration may not go smoothly because of the greater likelihood of conflicts between the two corporate cultures and subsequent face-saving compromises, as was seen in the three-way merger that created Mizuho Financial Group. Should this happen, the ultimate costs incurred by bank customers will be substantial. To ensure smooth integration, MTFG must take the initiative (see "Bright Side and Dark Side of Mergers and Consolidations," Economics Review).

Second, the question remains as to how many of the unique strengths of UFJ can be retained after its integration with MTFG. It has been pointed out that a MTFG-UFJ combination - as compared to the SMFG-UFJ tie-up - would generate greater synergy in terms of service areas, as well as in operational and financial respects. This is because MTFG and UFJ complement each other in many ways. For instance, MTFG, whose customer base includes a large number of major corporations, has strengths in the Tokyo metropolitan area and in wholesale banking, whereas UFJ is strong in the Kinki and Chubu regions, and has solid credentials in retail banking aimed at individuals and small businesses. But it is not clear whether the integrated entity can combine these strengths. An empirical analysis of American banks has shown that small business lending by a merged bank tends to reflect the lending behavior of the acquirer bank (note 1). Other recent studies of European banks have found that small business borrowers from a target bank (i.e., the one that is acquired) are less likely to obtain loans from the merged bank (note 2), and that the stock market generally takes the announcement of a bank merger as a positive factor for borrowers from the acquiring bank and as a negative factor for borrowers from the target bank (note 3). Judging from these findings, should MTFG succeed in taking control, the integration process may go smoothly, but the merged bank may not retain UFJ's strengths in retail banking services for small businesses and individuals.

In sum, what has become apparent through the UFJ merger fight is that the top managers - not only top managers of banks, but those of any corporation considering a merger or consolidation - must be able to convince shareholders that a planned merger or consolidation will not only help the managers themselves survive, but also bring benefits greater than would be realized in a merger with another candidate - even if they proceed with merger/integration talks in the conventional manner, that is, making deals behind closed doors. However, as has been the case with MTFG, managers preparing a merger deal may find they cannot back out because their potential partner would then merge with a rival,putting them at a competitive disadvantage. Or they may risk being swallowed by a larger competitor. Under such circumstances, managers may try to strike a deal at all costs, turning a blind eye to unresolved problems. It is therefore important for regulatory authorities to anticipate problems that may arise from management integration and take the necessary preemptive measures in a timely manner.

September 7, 2004
Footnote(s)
  1. Peek, J. and E. Rosengren (1998), "Bank consolidation and small business lending: its not just bank size that matters," Journal of Banking and Finance 22, pp 799-820
  2. Sapienza, P. (2002), "The effect of banking mergers on loan contracts," Journal of Finance 57, pp 329-367
  3. Karceski, J., S. Ongena, and D. Smith (2004), "The impact of bank consolidation on commercial borrower welfare," mimeo

September 7, 2004