Two major rating agencies are split on the possible credit implications of a proposed Japanese bank mega-merger.

On Friday, Moody’s Investors Service placed the long-term credit ratings of Bank of Tokyo-Mitsubishi Ltd., Mitsubishi Trust and Banking Corporation, UFJ Bank Ltd., and UFJ Trust Bank Ltd., on review for possible upgrade.

The move came after the two holding companies, Mitsubishi Tokyo Financial Group and UFJ Holdings Inc., announced Wednesday they would start working toward a merger that would create the world’s biggest banking group.

Moody’s notes that the two financial groups are planning to reach a basic merger agreement by the end of the month, with a view to integrating their holding companies by the first half of 2005. The deal would create the world’s largest financial group, with total assets of JPY190 trillion.

Meanwhile, Standard & Poor’s Ratings Services also placed UFJ on CreditWatch with positive implications (suggesting a possible upgrade). But it also placed the ratings on Bank of Tokyo-Mitsubishi Ltd., and its various subsidiaries on CreditWatch with negative implications. It says that the CreditWatch placements apply to all long-term, senior unsecured bond, subordinated bond, and preferred securities ratings on the banks and their financing vehicles.

S&P reported Wednesday that concerns have mounted this year over UFJ’s capital, which may be eroded through disposals of large amounts of the group’s bad loans. “Consolidation with MTFG, which has stronger capitalization, should provide advantages to UFJ,” it says. “MTFG should also benefit from gaining a larger slice of the small and midsize enterprise and retail markets, and a strengthened business franchise in
the Kansai and Tokai areas.”

“ However, MTFG will face challenges in disposing of the large bad loans still burdening UFJ,” S&P warns. “In addition, there are concerns over the two financial services groups’ ability to progress the consolidation and subsequently complete restructuring.”

Nana Otsuki, a Standard & Poor’s credit analyst, says the CreditWatch listings will be resolved after assessing the details of the consolidation conditions. “While downgrades of BTM and Mitsubishi Trust could be by one notch, upgrades of the UFJ Banks could be by one or two notches,” said Otsuki.

Notwithstanding its action on the long-term credit ratings, Moody’s also noted that the bank financial strength ratings of BTM and MTBC have been placed on review for possible downgrade, while the bank financial strength ratings of UFJBK and UFJTB have been affirmed at current levels, and Moody’s also affirmed the four banks’ ratings for short-term deposits.

Moody’s says that its review of the long-term ratings will consider the appropriate deposit rating for such a major financial institution operating in a strongly protective regulatory environment, and the long-term prospects for enhancing the combined banks’ franchise and earnings potential over time.

“Moody’s will examine the short-term financial pressure possibly arising from UFJBK’s accelerated plans to reduce its non-performing assets, the resulting re-capitalization requirements of UFJ Holdings Inc. and its possible impact on Mitsubishi Tokyo Financial Group’ operating banks,” it says. “Moody’s also noted that the review will take an extended period of time and complexity and scale of such an extensive integration may carry significant execution risks.”