A Marriage Made In Japan: Morgan Stanley & Mitsubishi UFJ

Amid the hoopola over a pile-in to equities last week, two pieces of news went relatively unnoticed. Japanese "megabank" Mitsubishi UFJ laid off 1,000 domestic employees, and almost in the same breath, agreed to merge its Japanese investment banking business with Morgan Stanley's operations there.

You'll remember that late last year Mitsubishi UFJ saved Morgan Stanley from the fringes of bankruptcy when it purchased a 21 percent stake in the then-struggling U.S. investment bank (holding company) for $9 billion.

The deal seems to have worked out well for the Japanese bank. While it's had to mark down its own earnings some 80 percent, Morgan Stanley is set to turn an even bigger profit at the end of this quarter; the stock price is already three times higher than it was the weekend it was crossing the t's on the deal with Mitsubishi.

Japan's $14.7 trillion nest egg
Last week's announcement suggests that Mitsubishi had greater plans in mind for its partnership with Morgan Stanley than merely being its largest shareholder. Indeed, one rumor in Tokyo is that the Japanese-operations merger was a prerequisite for the 21 percent equity purchase.

While there's little evidence to support that claim, you can bet that Mitsubishi has always planned on being more than a passive investor. After all, Morgan Stanley has two things that Mitsubishi badly wants: pedigree and profitability. Indeed, Mitsubishi said about last week's tie-up: "We hope the deal with Morgan Stanley will put us closer to turning a profit."

In return, Morgan Stanley gets size. Despite its growing earnings and the big uptick in Morgan Stanley's share price, its market capitalization of $25 billion is still less than half the size of $58 billion Mitsubishi. It now presents a real threat to its larger rival there too, Goldman Sachs, which has a long-time relationship with Japanese bank Sumitomo. With households there sitting on $14.7 trillion in cash, the rewards for running a successful one-stop-shop in Japan are huge.

Indeed, many now see Morgan Stanley and Goldman Sachs as the only significant long-term players in Japan. Nomura, which guaranteed the bonuses of Lehman Brothers employees when it bought the remains of that bank last year, probably overpaid wildly and caused more harm than good, says one investment banker in London, who wished to remain anaonymous. Citigroup is looking to offload its private stake in Nikko Cordial. And rumor also has it that Merrill Lynch will fold its Japanese operations and rebrand its significantly-downsized presence as Bank of America Japan, according to Gavin Parry, head of trading at Japanese and Asian trading specialist Helmsman Global Trading in Hong Kong.

Where's The Kobe?
The biggest question, of course, is whether the Mitsubishi-Morgan Stanley deal is a harbinger of greater ties to come. It's not difficult to present a compelling case for a global Mitsubishi-Morgan.

While U.S. banking regulations go from air-tight to practically suffocating in the wake of the credit crisis, transferring the kind of risk that leads to outsize returns offshore -- to, say, Tokyo -- may make a lot of sense. Equally, with the increasing significance of Asia as a source of earnings growth, a big presence in the region will only become more essential.

A combined Morgan Stanley and Mitsubishi UFJ would give both banks the firepower to dwarf their regional competitors -- perhaps even forcing them into similar transactions. And it reduces the odds than a large Chinese bank could snap up the lion's share of investment banking profits in the region.

When it comes to global banking, a combination of size and cashflow is a compelling reason to bite the bullet and say your vows.