DBRS Upgrades BTMU to A (high); Trend Negative in Line with Sovereign

DBRS Ratings Limited (DBRS) has today upgraded the Long-Term Deposits & Senior Debt rating of The Bank of Tokyo-Mitsubishi UFJ, Ltd. (BTMU or the Bank) to A (high) from “A”. Concurrently, the Short-Term Instruments rating was upgraded to R-1 (middle), from R-1 (low) and the Intrinsic Assessment (IA) from A (low) to A. The IA is based upon the financial strength of the consolidated Mitsubishi UFJ Financial Group (MUFG or the Group). See the full list of ratings at the end of the press release.

The ratings upgrade reflects the Group’s resilient domestic franchise, as well as the growing overseas operations, which have helped to offset the challenges faced by MUFG in the low-growth, low-interest rate domestic market. In addition, the Group benefits from good asset quality, solid capital levels and a stable funding base. Although DBRS expects the Group to face some earnings pressure from the current challenges in the domestic and global environment, DBRS views the Group as well positioned relative to global peers.

The Bank’s IA is combined with a support assessment of SA2, which results in a one notch uplift to the final Issuer Rating and Long-Term Deposits and Senior Debt ratings for systemic support. The SA2 reflects the systemic importance of MUFG to the financial system in Japan, and the generally supportive regulatory framework. DBRS’s A (high) sovereign debt rating has a Negative trend and, given the uplift incorporated in the Bank’s ratings for systemic support, this leads to a Negative trend on the Bank’s ratings.

Further positive rating pressure is unlikely in the medium term given the recent upgrade and the Negative trend on the sovereign rating. Negative rating pressure could result from a downgrade of the sovereign, or a significant increase in the Group’s risk profile related to its overseas activities.

MUFG has a strong franchise in Japan, where the Group has an approximate 20% share of domestic deposits as of end-March 2015 (based on statistics provided by the Bank of Japan as of end March 2015), which underpins the Group’s ratings. The Group has a strong presence domestically in commercial banking, retail and consumer finance, asset administration and asset management, capital markets and securities. DBRS also views positively the diversification provided by the Group’s stable operations in the US (MUFG Americas Holdings Corporation, rated “A”, Stable trend, by DBRS), the growing operations in Asia and the Group’s global strategic alliance with Morgan Stanley. Overall, overseas assets comprised 40% of total assets at end-March 2015, compared to 31% at end-March 2012.

MUFG has reported solid earnings over recent years, as strong non-interest income and overseas earnings growth, along with low credit costs have more than offset the ongoing weak domestic loan demand and low interest rate environment in Japan. DBRS expects earnings to come under some pressure as the Group absorbs the impact of negative interest rates in Japan, lower growth rates in China, stress in the energy loan portfolio, and a return to a more normal level of loan impairments. However, DBRS expects the Group to remain well placed relative to global peers.

In DBRS’s opinion, MUFG has a generally conservative risk profile supported by a cyclically low level of bankruptcies in Japan. Total impaired loans as a percentage of gross loans were 1.01% at end-December 2015. Credit quality also appears to be strong in the Group’s other major markets, with MUFG Americas Holdings (MUAH) reporting a non-performing asset (NPA) to gross loans and other real estate owned (OREO) ratio of 0.92% in 1H15, and Bank of Ayudhya ‘Krungsri’ reporting a Non-Performing Loan (NPL) ratio of 2.47% at end-2015. DBRS also notes that the Group’s lending exposure to sectors and geographies which are currently under increased stress, such as energy, China and Russia, appears manageable. At end-1H15, 100% of MUFG’s exposure to non-Japanese corporates in China (approximately 38% of the Group’s Chinese lending exposure) and Russia (78% of the Group’s Russian exposure) was classed as normal or performing. Similarly, 94.7% of the Group’s JPY 5.5 trillion credit exposure to oil and gas oil and gas companies and projects engaged in exploration, field development and production, was classified as normal or performing at end-1H15. DBRS will, however, continue to monitor these exposures given the respective stresses evident within each market.

MUFG’s funding position is underpinned by a very strong retail deposit base in Japan, leading to a loan-to-deposit (LTD) ratio for the Group of 72% at end-December 2015. With MUFG reporting an overseas LTD ratio of 115% at end-9M15, the Group’s overseas operations rely on a larger proportion of market funding. DBRS will continue to monitor how the growth of MUFG’s overseas operations is funded, though DBRS expects the overseas funding profile to remain manageable. A consequence of the surplus of domestic deposits and lack of demand for credit in Japan has been that MUFG, as with other Japanese banks, holds a very large portfolio of domestic government bonds (JGBs). At end-December 2015, the portfolio was JPY 26.5 trillion, or equivalent to 183% of Tier 1 capital. The JGB holdings, which had a duration of 3.5 years at end-December 2015, are a source of liquidity, but could lead to earnings volatility due to interest rate risk exposure, and also contribute to a concentration in exposure to the Japanese sovereign.

DBRS views MUFG as having built up a solid capital position. At end-September 2015, the Group reported a fully-loaded Basel 3 Common Equity Tier 1 (CET1) ratio of 12.0%. DBRS also expects the Group to be well positioned to meet future Total Loss Absorbing Capacity (TLAC) requirements, although the domestic regulations are still to be finalised. MUFG, however, like its mega-bank peers, has a meaningful exposure to Japanese equities, which leads to some volatility in the P&L and capital ratios due to unrealised gains and losses. Although the ratio of domestic listed equities to Tier 1 and CET1 has decreased in recent years, unrealised gains remain significant, and represented 200 bps of CET1 at end-September 2015. DBRS does, however, note the implementation of the Japanese Corporate Governance Code in June 2015, which requires companies holding shares of other listed companies as cross-shareholding to disclose the reason for these holdings. MUFG has stated its intention to reduce the ratio of domestic listed equities to Tier 1, which stood at 19% at end-December 2015, to approximately 10% over the next five years.

Notes:
All figures are in JPY unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (December 2015). Other methodologies used include the DBRS Criteria: Support Assessment for Banks and Banking Organisations (December 2015), DBRS Criteria: Guarantees and Other Forms of Explicit Support (February 2016), and DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (February 2016). These can be found can be found at: http://www.dbrs.com/about/methodologies

The sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance

For further information on DBRS historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Lead Analyst: Elisabeth Rudman
Rating Committee Chair: William Schwartz
Initial Rating Date: 30 November 1982
Most Recent Rating Update: 20 February 2015

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