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Morningstar | Higher-Than-Expected MUFG Profit Comes From Reversals of Credit Costs While Core Business Struggles

Mitsubishi UFJ Financial Group posted better-than-expected profit at the bottom line for the July-September quarter owing to JPY 93 billion in write-backs of reserves for losses on loans to borrowers now judged to be less of a risk, but excluding one-time factors, it was another difficult quarter for MUFG. Strong returns from equity method affiliate Morgan Stanley, which contributed 20% of total profit during the period, and growth at Thai subsidiary Bank of Ayudhya could not compensate for the shrinking trend in the core domestic banking business.

Net revenue dropped 6.4% year on year, a faster rate of decline than the previous quarter’s 6.1%, as net interest income slid 4.2% and net fees were down 4.9% year on year. With operating expenses up slightly, preprovision operating profit fell 20% year on year, compared with an 18% fall in the previous quarter. MUFG raised its overly conservative full-year guidance to net profit of JPY 950 billion from JPY 850 billion, but the new guidance still only implies a return on equity of 3.7% in the second fiscal half, given that MUFG already earned more than JPY 650 billion in the first two quarters.

The group declared an interim dividend of JPY 11 per share, up from JPY 9 in last year’s first half, although even with the boost, MUFG’s dividend yield of 3.3% is still below the 3.8% and 3.9% yields of Japan’s other two megabanks. Instead, MUFG has been an active repurchaser of its shares. It most recently announced plans to buy back up to JPY 100 billion in the second fiscal half, which when combined with the JPY 50 billion repurchased in the first half would put the group on pace to maintain the average of the past four years (1.7% of shares outstanding annually) in the current fiscal year. Combined with the 3.3% dividend yield, this represents a total shareholder return yield of around 5%. We maintain our no-moat rating and JPY 797 fair value estimate, which is 0.64 times book value and 20% above the current price.

By segment, preprovision operating profit declined 11% year on year in retail and commercial banking despite another solid quarter at consumer finance subsidiary Acom (2.5% of MUFG’s total profit), owing in part to weak sales of investment products to individuals, given the uncertain market environment.

Preprovision operating profit in Japanese corporate and investment banking was down 16%, reflecting a strong period a year ago, but flat quarter on quarter thanks to rising net interest income on foreign-currency-denominated loans as U.S. interest rates rose. Preprovision operating profit in global corporate and investment banking rose 11% year on year for similar reasons, although the net interest margin at MUFG’s holding company in the U.S., Mitsubishi UFJ Americas Holdings, surprisingly eased slightly to 2.28% from 2.32% in the previous quarter despite higher U.S. interest rates. The difference between the overseas lending yield and overseas deposit cost at Mitsubishi UFJ Bank and Mitsubishi UFJ Trust Bank did rise with higher U.S. interest rates, however, to 1.31% from 1.30% in the prior quarter and 1.10% a year earlier.

Preprovision operating profit at global commercial banking rose 11% year on year due to loan growth and event-driven finance deals both in the Americas and in the Asia and Oceania region. Preprovision operating profit in asset management and investor services grew 21% year on year as assets under management expanded both inside and outside Japan. On Oct. 30, MUFG announced a deal to to buy Commonwealth Bank of Australia's international asset-management business, Colonial First State Global Asset Management, which we expect will lift the revenue contribution of the AM/IS segment to 7% from 5% currently when it closes in mid-2019. The contribution of the AM/IS segment to preprovision operating profit, currently around 8%, should similarly rise to around 10%.

Outside the customer segments, preprovision operating profit in the global markets segment, which corresponds to MUFG’s own treasury operations, fell 71% year on year as MUFG booked JPY 24 billion in net losses on debt securities during the quarter as it managed its large bond portfolio amid the volatile market conditions.