Ratings groups have weighed in on the possible mega-merger between two large Japanese banks.

One of Japan’s largest lenders, UFJ Holdings Inc., is seeking merger discussions with the country’s second-largest bank, Mitsubishi Tokyo Financial Group Inc.

Dominion Bond Rating Service reports that MTFG has noted that it intends to immediately give serious consideration to the UFJ request.

If a deal goes ahead, DBRS calculates that a total merger of these two entities would create the world’s largest banking group with total assets of US$1.7 trillion, surpassing Citigroup Inc..

“If a formal announcement is made and a merger eventually proceeds to fruition, the credit impact is viewed favourably for UFJ, which has lower DBRS ratings than is the case with MTFG. Essentially, this potential transaction would help UFJ, the weakest of the big four Japanese banks,” DBRS comments.

“MTFG has financial resources that could help accelerate UFJ’s recovery from its poor asset quality position, although this would also weaken MTFG’s asset quality. Strategically, UFJ’s large retail banking operation would balance well with MTFG’s large corporate business,” DBRS says. “Other considerations for MTFG ratings would include the structure, pricing, business integration plans, and expected synergies from the potential merger.”

Nana Otsuki, a Standard & Poor’s credit analyst, said, “If the reports turn out to be accurate and the consolidation goes ahead, it could adversely affect the ratings on MTFG banks and positively affect ratings on UFJ banks.”

In a release, S&P says that concerns over UFJ’s capital have grown this year. The fear is that its capital may be eroded due to disposals of large amounts of the group’s bad loans during fiscal 2004. “Consolidation with MTFG, which has stronger capitalization, should provide advantages to UFJ. 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,” S&P says.

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