Ichiro Suzuki
On February 22, Japan’s Nikkei Index rose to a fresh all time high at last, rewriting the mark that stood since the end of 1989. On the other hand, the TOPIX, which has always been considered as better gauge of the Japan market, still traded 10% below its peak in the late 1980s. Two indices’ relationship resembles the one between the Dow Jones Industrial Average and the S&P500. Like the Dow, the Nikkei index is based on prices of its components. Some companies with high share prices have greater influences on the index than others. Stock splits that reduce share price affect the Nikkei negatively. The TOPIX is essentially based on market capitalization as is the case with the S&P500. In recent months, aggressive buying of some high-priced names brought up the Nikkei, to let it conquer the 1989 high.
There is another factor behind the lag that the TOPIX has been suffering. At the height of the infamous Japan Bubble, banks and other financial institutions led the market as lenders to real estate developers and house buyers. Banks’ value became bloated not only by real estate lending but also by mutual share holdings with other Japanese industries. Shares of real estate developers were high fliers in the 1980s, and stakes in these companies that banks carried on their balance sheets drove their share prices, too. Heavy financial regulations at that time allowed banks lots of rents, also contributing to their soaring profits. This is how Japanese banks came to dominate the top ten list of the world’s largest corporations by equity market capitalization. At the height of the boom in the late 1980s, share of the financials sector rose above 40% in the Tokyo market.
The way banks made a meteoric rise, of course, was a double-edged sword. As a real estate bubble popped at the outset of the 1990s, some of the loans to developers turned sour, to become non-performing loans that would afflict them for years. Even worse, value of the companies whose shares were carried on bank balance sheets plummeted, adversely affecting banks’ share prices. Hit by such a double whammy, banks’ share prices were brought down sharply in the next quarter century. How severely they were hit is not easy to fathom from the movements of their share prices, because they went through a number of mergers by the turn of the 21st century. Nomura Securities, Japan’s largest investment bank renamed as Nomura Holdings since then, has never merged with anyone, traded at 850 on the day the Nikkei hit a fresh all time high, as opposed to 5,990 at the height of the company’s might in the 1980s. Over a decade ago Nomura witnessed its low at less than half the February 22 share price.
The Industrial Bank of Japan was the largest corporation on earth by equity market capitalization in the late 1980s, reigning Japan’s financials industry for decades. The burst of the bubble drove the bank into a quagmire of chronic non-performing loans problem. By the turn of the 21st century, IBJ merged with two other banks that were also two of the world’s ten largest corporations at one point, to form Mizuho Financial Group. A combination of once three of the world’s largest corporations doesn’t even make Japan’s top ten list. Its equity market capitalization at $50 billion is less than a tenth of $570 billion of J.P. Morgan Chase, the world’s largest bank today. Mizuho represents a case of spectacular value destruction, and shows why Japanese banks in general are trading only at half of their book value.
Mitsubishi UFJ Financial Group, formed after several mergers, is currently Japan’s largest bank and is one of the ten largest Japanese corporations. However, about a half its market capitalization, $125 billion, is ascribed to its 20% stake in Morgan Stanley. In late 2008, in a deepening banking crisis, Mitsubishi UFJ bought the stake, as a passive investor, of the Wall Street bank amid its desperate search for fresh capital injection. Japanese banks were not brought down by subprime mortgages and exotic financial products created out of them. They simply missed a chance to participate in the boom, coming off years of severe NPL problems. Excluding the stake in Morgan Stanley, the market does not value Mitsubishi UFJ’s operations very generously. (Morgan Stanley has been reportedly wanting to buy back the 20% owned by Mitsubishi UFJ. They appear to think “Thank you for helping us back then, but we’ve let you make enough money through your investment in us.”) The bank is doing well for a Japanese institution, but at the same time presenting a case of failure to create value for shareholders. Warren Buffet famously said “Only when the tide goes out, do you discover who’s swimming naked”. This remark can be perfectly applied to Japanese banks. They once boasted of themselves as some of the smartest and most powerful institutions in the world of business. The bubble’s burst has ruthlessly exposed their lack of competence. Where the TOPIX stands today in relation to the Nikkei is a brutal display of the banks’ competence. The financials sector has fallen to only 10% of the Japan market today, way down from over 40% in the late 1980s.
From a different perspective, however, Japanese banks may not be doing too badly. The 2007-09 Global Financial Crisis brutalized European banks denying their business models, and their balance sheets suffered severe damages. Tightened capital requirements after the crisis weigh on them heavily, creating acute capital shortages. Prior to the GFC, Chinese banks crowded the list of the world’s largest banks. Since then, they are suffering the same ordeal that Japanese banks did upon a burst of the bubble. It probably takes a long time for Chinese banks to come back. Since the crisis U.S. banks have set themselves apart from the rest of the world. If they are taken as exceptions, standings of well-capitalized Japanese banks that came off the GFC unscathed look all right.
About the author: Mr. Suzuki is a retired investment banker based in Tokyo, Japan.
