MUFG forms JV with Morgan Stanley in Japan

Whichever way you spin it, it appears that Japan's premier commercial bank has taken its pound of flesh in return for the historic $9 billion capital injection into Morgan Stanley in November 2008 -- if, that is, the memorandum of understanding (MOU) signed on Thursday becomes reality.

The announcement of the planned merger between Morgan Stanley's operations in Japan and the securities unit of Mitsubishi UFJ Financial Group signals a coup for the Japanese bank, which over the past year has been growing with an emphasis on improving its return on equity (ROE). Among other things, it has made Union Bank of California and Mitsubishi UFJ Securities into 100% subsidiaries and in 2006 it formed a private banking joint venture with Merrill Lynch.

"But MUFG needs to improve its profitability, which is why it wants to absorb the high ROE of Morgan Stanley," says a rival banker

MUFG, along with the rest of the global banks, has seen its net income drop in the past year. In the first nine months of its current fiscal year to March 2009 (referred to as fiscal 2008) it posted a net loss of ¥42 billion ($429 million), compared to ¥636 billion gain for the fiscal 2007 as a whole. It also has a high expense ratio (63.2% in H1 FY2008) and a low return on asset (ROA) compared to its global peers.

Two of the five board members of the joint venture (which will be 60% held by MUFG) will come from Morgan Stanley: the chairman and the head of the institutional business. The latter will reportedly be from Morgan Stanley in perpetuity, according to one Morgan Stanley source. Morgan Stanley bankers see this appointment as a guarantee of their operational independence.

Still, the average Morgan Stanley banker may be unhappy about combining with Mitsubishi UFJ Securities, one of the weaker securities houses in Japan (third in all ECM and all DCM and fourth in all M&A for 2008, according to Dealogic). And he may be even more disgruntled on seeing Goldman Sachs, still independent thanks to the investment by Warren Buffett (and US taxpayers), continue to make its characteristic private-equity transactions, as it did last week with the investment into Universal Studios Japan.

One of the rumours doing the rounds in Tokyo is that the agreed JV was a condition for MUFG's investment late last year. Recall that Morgan Stanley's stock price was in freefall after the Lehman Brothers collapse. The original deal, whereby MUFG contributed $3 billion of equity, had to be renegotiated over a weekend to 100% convertible shares, on which MS pays $900 million in dividends annually. MUFG also has one banker on the MS board.  

However, a Morgan Stanley banker says the deal was entirely mutual. "It should be obvious that access to the local market (via the tie-up) will be beneficial to Morgan Stanley. We have the investment banking capacity and MUFG has the blue-chip corporate clients and the essential retail distribution." Morgan Stanley will also be able to help MUFG with its international distribution.