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Morningstar | Mizuho Raising Exposure to Profitable Leasing Business; IBJ Deal Suggests Possible Future M&A

Mizuho Financial Group plans to raise its stake in IBJ Leasing (8425 JP) from 3.8% to 20%, according to the Nikkei. IBJ Leasing would issue new shares to Mizuho and use the proceeds to invest in Marubeni (8002 JP) subsidiary MG Leasing, making MG Leasing a 50-50 joint venture of IBJ and Marubeni. The news affects Mizuho in two ways.

Financially, a 20% stake in IBJ Leasing as an equity-method affiliate would boost Mizuho’s annual net profit by around 0.5%--material but not enough to change our fair value estimate of JPY 199.

Strategically, we think the move suggests increased probability of future M&A among the Mizuho-related leasing firms and potentially more exposure to the leasing sector for Mizuho. Mizuho currently has less exposure to leasing than its megabank rivals Mitsubishi UFJ Financial Group (MUFG) and Sumitomo Mitsui Financial Group (SMFG).

SMFG owns half of Sumitomo Mitsui Finance & Leasing (SMFL), the largest pure leasing firm in Japan with market share of around 14%, and beneficially owns two thirds of Dublin-based SMBC Aviation Capital, one of the top five aircraft lessors globally. (Half of the former and one third of the latter are held by trading firm Sumitomo Corp.). MUFG owns 23% of both Mitsubishi UFJ Lease (market share of 13%) and Hitachi Capital (market share of 9%, plus substantial European business) and has said in the past that the two may merge in future.

In contrast, Mizuho holds only 9% of Fuyo General Lease (market share of 7%) and 4% each of IBJ and Tokyo Century (market shares of 5% and 10%, respectively), which were affiliated with Mizuho’s three predecessor banks but have stayed independent of one another in the absence of a large bank stake. The tie-up between IBJ and Marubeni touches Fuyo in particular, as Marubeni is a longtime shareholder in Fuyo and enjoys substantial business links with it. According to the Nikkei, Mizuho is also approaching Tokyo Century about collaboration.

Tokyo Century has been the most successful of the three Mizuho-related leasing firms in terms of generating consistently high ROE and growing assets. Trading firm Itochu is its largest shareholder, and Tokyo Century regards itself as more of an Itochu-related company than an Mizuho one.

The leasing business is generally a more profitable business than the banking business is in Japan at present. Industrywide, the average ROA is around 0.9%, three times that of banks, while ROE of around 8% compares with around 6% on average for banks. For the megabanks, which are internationally active and subject to Basel III, having exposure to leasing via minority equity-method stakes is attractive because they can benefit from earnings without the full capital charges that would come with consolidation. This is the reason SMFG recently lowered its stake in SMFL from 60% to 50%, selling 10% to Sumitomo Corp. The returns on aircraft leasing and railcar leasing overseas have been particularly attractive, although we expect returns in these areas to come down over time as more players devote capital to them.

In Japan, we estimate that the size of assets addressed by leasing firms is about JPY 28 trillion, or 6% the size of the country’s bank loans. It is about JPY 13 trillion in terms of pure leases without also including installment sales and loans made by leasing firms. Lease rates are based on a spread over Japanese government bond yields, so over the medium term they should be sensitive to the three- to five-year sector of the curve (compared with bank loan rates that are typically linked to shorter-term rates). At present the average yield on leasing companies’ assets remains above 3%, compared with only 1% on bank loans, though leasing companies need to pay around 0.6% more than banks for their non-deposit funding. At a result, we estimate that the total domestic revenue pie for leasing firms is about JPY 1 trillion, or 15% the size of the domestic banking sector’s combined net interest income. With an average gap between asset yields and funding costs of around 2.5%, pretax profit after expenses comes to around 1.3%, resulting in the industrywide after-tax ROA of around 0.9%.

The leasing firms often claim that M&A does not really increase value because many customers get quotes from several different firms as a matter of practice, so competitors can gain share when two firms merge. However, the example of Tokyo Century, formed in 2009 from the merger of former Dai-Ichi Bank affiliate Century Leasing and former Kangyo Bank affiliate Tokyo Leasing, shows that the right fit can boost returns significantly, not mainly because of cost-cutting but because of new cross-selling opportunities. After the merger, Tokyo Century’s ROA rose from around 0.6% on a pro-forma basis to around 1.4% currently.