20-F 1 d20f.htm ANNUAL REPORT Annual Report
Table of Contents

As filed with the Securities and Exchange Commission on September 19, 2008

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 20-F

 

¨ REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF

THE SECURITIES EXCHANGE ACT OF 1934

OR

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended March 31, 2008

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the transition period                      to                     

OR

¨ SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

Date of event requiring this shell company report

Commission file number 333-11072

 

KABUSHIKI KAISHA MITSUBISHI TOKYO UFJ GINKO

(Exact name of Registrant as specified in its charter)

THE BANK OF TOKYO-MITSUBISHI UFJ, LTD.

(Translation of Registrant’s name into English)

Japan

(Jurisdiction of incorporation or organization)

7-1, Marunouchi 2-chome

Chiyoda-ku, Tokyo 100-8388

Japan

(Address of principal executive offices)

Susumu Tsukahara, +81-3-3240-1111, +81-3-3240-5429, address is same as above

(Name, Telephone, Facsimile number and Address of Company Contact Person)

 

Securities registered or to be registered pursuant to Section 12(b) of the Act: None

Securities registered or to be registered pursuant to Section 12(g) of the Act: None

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

$1,934,700,000 aggregate principal amount of 8.40% Global Senior Subordinated Notes due April 15, 2010

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report:

At March 31, 2007, (1) 10,257,961,942 shares of common stock and (2) 357,700,000 shares of preferred stock were issued.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes   ¨    No   x

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

Yes   ¨    No   x

Note—Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:

Yes   x    No   ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  ¨    Accelerated filer  ¨    Non-accelerated filer  x

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

U.S. GAAP  x    

  

International Financial Reporting Standards as issued
by the International Accounting Standards Board  ¨

  

    Other  ¨

Indicate by check mark which financial statement item the registrant has elected to follow:

Item 17   ¨    Item 18   x

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes   ¨    No   x

 

 


Table of Contents

TABLE OF CONTENTS

 

           Page

Forward-Looking Statements

   3

Item 1.

   Identity of Directors, Senior Management and Advisors    4

Item 2.

   Offer Statistics and Expected Timetable    4

Item 3.

   Key Information    4

Item 4.

   Information on the Company    18

Item 4A.

   Unresolved Staff Comments    39

Item 5.

   Operating and Financial Review and Prospects    40

Item 6.

   Directors, Senior Management and Employees    93

Item 7.

   Major Shareholders and Related Party Transactions    102

Item 8.

   Financial Information    104

Item 9.

   The Offer and Listing    105

Item 10.

   Additional Information    105

Item 11.

   Quantitative and Qualitative Disclosures about Credit, Market and Other Risk    116

Item 12.

   Description of Securities Other than Equity Securities    126

Item 13.

   Defaults, Dividend Arrearages and Delinquencies    127

Item 14.

   Material Modifications of the Rights of Security Holders and Use of Proceeds    127

Item 15.

   Controls and Procedures    127

Item 16A.

   Audit Committee Financial Expert    128

Item 16B.

   Code of Ethics    128

Item 16C.

   Principal Accountant Fees and Services    129

Item 16D.

   Exemptions from the Listing Standards for Audit Committees    130

Item 16E.

   Purchases of Equity Securities by the Issuer and Affiliated Purchasers    130

Item 17.

   Financial Statements    131

Item 18.

   Financial Statements    131

Item 19.

   Exhibits    131

Selected Statistical Data

   A-1

Consolidated Financial Statements

   F-1

 

For purposes of this Annual Report, we have presented our consolidated financial statements in accordance with accounting principles generally accepted in the United States, or US GAAP, except for risk-adjusted capital ratios, business segment financial information and some other specifically identified information. Unless otherwise stated or the context otherwise requires, all amounts in our financial statements are expressed in Japanese yen.

 

When we refer in this Annual Report to “we,” “us,” “our” and “BTMU,” we generally mean The Bank of Tokyo-Mitsubishi UFJ, Ltd. and its consolidated subsidiaries, but from time to time as the context requires, we mean The Bank of Tokyo-Mitsubishi UFJ, Ltd. as an individual legal entity. Similarly, references to “UFJ Bank” are to UFJ Bank Limited as well as UFJ Bank Limited and its consolidated subsidiaries, as the context requires. References in this Annual Report to “yen” or “¥” are to Japanese yen and references to “US dollars,” “US dollar,” “dollars,” “US$” or “$” are to United States dollars. Our fiscal year ends on March 31 of each year. References to years not specified as being fiscal years are to calendar years.

 

We usually hold the ordinary general meeting of shareholders in June of each year in Chiyoda-ku, Tokyo.

 

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Forward-Looking Statements

 

We may from time to time make written or oral forward-looking statements. Written forward-looking statements may appear in documents filed with or submitted to the US Securities and Exchange Commission, or SEC, including this Annual Report, and other reports to shareholders and other communications.

 

The US Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking information to encourage companies to provide prospective information about themselves. We rely on this safe harbor in making these forward-looking statements.

 

Forward-looking statements appear in a number of places in this Annual Report and include statements regarding our intent, business plan, targets, belief or current expectations and/or the current belief or current expectations of our management with respect to our results of operations and financial condition, including, among other matters, our problem loans and loan losses. In many, but not all cases, we use words such as “anticipate,” “aim,” “believe,” “estimate,” “expect,” “intend,” “plan,” “probability,” “risk” and similar expressions, as they relate to us or our management, to identify forward-looking statements. These statements reflect our current views with respect to future events and are subject to risks, uncertainties and assumptions. Should one or more of these risks or uncertainties materialize or should underlying assumptions prove incorrect, actual results may vary materially from those which are anticipated, aimed, believed, estimated, expected, intended or planned, or otherwise stated.

 

Our forward-looking statements are not guarantees of future performance and involve risks and uncertainties. Actual results may differ from those in the forward-looking statements as a result of various factors. We identify in this Annual Report in “Item 3.D. Key Information—Risk Factors,” “Item 4.B. Information on the Company—Business Overview,” “Item 5. Operating and Financial Review and Prospects” and elsewhere, some, but not necessarily all, of the important factors that could cause these differences.

 

We do not intend to update our forward-looking statements. We are under no obligation, and disclaim any obligation, to update or alter our forward-looking statements, whether as a result of new information, future events or otherwise.

 

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PART I

 

Item 1.    Identity of Directors, Senior Management and Advisors.

 

Not applicable.

 

Item 2.    Offer Statistics and Expected Timetable.

 

Not applicable.

 

Item 3.    Key Information.

 

A.    Selected Financial Data

 

The selected statement of operations data and selected balance sheet data set forth below have been derived from our audited consolidated financial statements. On October 1, 2005, Mitsubishi Tokyo Financial Group, Inc., or MTFG, the parent company of The Bank of Tokyo-Mitsubishi, Ltd., or BTM, merged with UFJ Holdings, Inc., or UFJ Holdings, the parent company of UFJ Bank Limited, or UFJ Bank, with MTFG being the surviving entity. Upon consummation of the merger, MTFG changed its name to Mitsubishi UFJ Financial Group, Inc. The merger was accounted for under the purchase method of accounting, and the assets and liabilities of UFJ Holdings and its subsidiaries were recorded at fair value as of October 1, 2005. Therefore, although the merger of BTM with UFJ Bank occurred and BTM changed its name to The Bank of Tokyo-Mitsubishi UFJ, Ltd., or BTMU, on January 1, 2006, the results of operations of UFJ Bank and its subsidiaries have been included in our consolidated financial statements since October 1, 2005. Numbers as of and for the fiscal years ended March 31, 2004 and 2005 reflect the financial position and results of BTM and its subsidiaries only. Numbers as of March 31, 2006 reflect the financial position of BTMU while numbers for the fiscal year ended March 31, 2006 comprised the results of BTM and its subsidiaries for the six months ended September 30, 2005 and the results of BTMU from October 1, 2005 to March 31, 2006. Numbers as of and for the fiscal years ended March 31, 2007 and 2008 reflect the financial position and results of BTMU. See note 2 to our consolidated financial statements for more information.

 

Except for risk-adjusted capital ratios, which are calculated in accordance with Japanese banking regulations based on information derived from our consolidated financial statements prepared in accordance with Japanese GAAP, and the average balance information, the selected financial data set forth below are derived from our consolidated financial statements prepared in accordance with US GAAP.

 

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You should read the selected financial data set forth below in conjunction with “Item 5. Operating and Financial Review and Prospects” and our consolidated financial statements and other financial data included elsewhere in this Annual Report on Form 20-F. These data are qualified in their entirety by reference to all of that information.

 

    Fiscal years ended March 31,  
    2004     2005     2006     2007     2008  
    (in millions, except per share data and number of shares)  

Statement of operations data:

         

Interest income

  ¥ 1,116,300     ¥ 1,194,507     ¥ 2,249,309     ¥ 3,444,360     ¥ 3,693,822  

Interest expense

    337,544       388,098       728,762       1,279,212       1,579,299  
                                       

Net interest income

    778,756       806,409       1,520,547       2,165,148       2,114,523  

Provision (credit) for credit losses

    (142,617 )     123,945       163,416       341,570       407,238  
                                       

Net interest income after provision (credit) for credit losses

    921,373       682,464       1,357,131       1,823,578       1,707,285  

Non-interest income

    973,689       795,682       556,849       1,220,453       1,213,585  

Non-interest expense

    1,028,304       954,258       1,616,828       2,172,027       2,886,882  
                                       

Income from continuing operations before income tax expense and cumulative effect of a change in accounting principle

    866,758       523,888       297,152       872,004       33,988  

Income tax expense

    331,103       237,296       68,921       410,299       490,309  
                                       

Income (loss) from continuing operations before cumulative effect of a change in accounting principle

    535,655       286,592       228,231       461,705       (456,321 )

Income (loss) from discontinued operations—net

    1,946       1,493       8,973       (817 )     (1,746 )

Cumulative effect of a change in accounting principle, net of tax(1)

          (977 )     (8,425 )            
                                       

Net income (loss)

  ¥ 537,601     ¥ 287,108     ¥ 228,779     ¥ 460,888     ¥ (458,067 )
                                       

Net income (loss) available to a common shareholder

  ¥ 527,528     ¥ 280,392     ¥ 221,780     ¥ 449,925     ¥ (464,348 )
                                       

Amounts per share:

         

Basic earnings (loss) per common share—income (loss) from continuing operations available to a common shareholder before cumulative effect of a change in accounting principle

  ¥ 104.72     ¥ 55.76     ¥ 30.64     ¥ 44.89     ¥ (45.10 )

Basic earnings (loss) per common share—net income (loss) available to a common shareholder

    105.10       55.87       30.72       44.81       (45.27 )

Diluted earnings (loss) per common share—income (loss) from continuing operations available to a common shareholder before cumulative effect of a change in accounting principle

    104.43       55.50       27.01       44.21       (45.10 )

Diluted earnings (loss) per common share—net income (loss) available to a common shareholder

    104.81       55.61       27.07       44.13       (45.27 )

Number of shares used to calculate basic earnings (loss) per common share (in thousands)

    5,019,470       5,019,470       7,219,739       10,041,800       10,257,962  

Number of shares used to calculate diluted earnings (loss) per common share (in thousands)

    5,019,470       5,019,470       8,119,446 (2)     10,289,317 (2)     10,257,962  

Cash dividends per share declared during the fiscal year:

         

—Common share

  ¥ 7.73     ¥ 34.71     ¥ 157.21     ¥ 43.52     ¥ 44.19  
  $ 0.07     $ 0.32     $ 1.33     $ 0.37     $ 0.39  

—Preferred share (Class 1)

  ¥ 123.75     ¥ 82.50     ¥ 41.25              
  $ 1.07     $ 0.78     $ 0.38              

—Preferred share (Class 2)

              ¥ 36.42     ¥ 60.00     ¥ 60.00  
              $ 0.31     $ 0.51     $ 0.52  

—Preferred share (Class 3)

                    ¥ 23.85     ¥ 15.90  
                    $ 0.21     $ 0.14  

—Preferred share (Class 4)

                    ¥ 18.60        
                    $ 0.16        

—Preferred share (Class 5)

                    ¥ 19.40        
                    $ 0.17        
    At March 31,  
    2004     2005     2006     2007     2008  
    (in millions)  

Balance sheet data:

         

Total assets

  ¥ 85,058,552     ¥ 92,050,299     ¥ 158,825,706     ¥ 153,605,242     ¥ 152,079,231  

Loans, net of allowance for credit losses

    39,113,565       42,686,305       84,923,276       85,130,539       88,729,093  

Total liabilities

    82,286,419       88,883,714       150,556,223       144,919,111       145,413,533  

Deposits

    58,369,249       60,224,192       114,062,281       113,386,103       115,402,156  

Long-term debt

    5,086,993       5,196,388       11,925,838       12,263,205       11,651,570  

Total shareholder’s equity

    2,772,133       3,166,585       8,269,483       8,686,131       6,665,698  

Common stock

    749,873       749,873       871,973       871,973       871,973  

 

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     Fiscal years ended March 31,  
     2004     2005     2006     2007     2008  
     (in millions, except percentages)  
     (unaudited)     (unaudited)     (unaudited)     (unaudited)     (unaudited)  

Other financial data:

          

Average balances:

          

Interest-earning assets

   ¥ 72,394,249     ¥ 82,220,483     ¥ 112,023,359     ¥ 140,731,722     ¥ 141,312,806  

Interest-bearing liabilities

     67,026,490       75,632,995       98,073,940       119,077,306       122,819,930  

Total assets

     83,474,334       92,584,867       132,835,133       154,208,262       155,527,958  

Total shareholder’s equity

     2,398,816       2,769,260       5,485,014       8,481,891       8,061,817  
     (unaudited)     (unaudited)     (unaudited)     (unaudited)     (unaudited)  

Return on equity and assets:

          

Net income (loss) available to a common shareholder as a percentage of total average assets

     0.63 %     0.30 %     0.17 %     0.29 %     (0.30) %

Net income (loss) available to a common shareholder as a percentage of total average shareholder’s equity

     21.99 %     10.13 %     4.04 %     5.30 %     (5.76) %

Dividends per common share as a percentage of basic earnings per common share

     7.35 %     62.13 %     511.75 %     97.12 %     (3)

Total average shareholder’s equity as a percentage of total average assets

     2.87 %     2.99 %     4.13 %     5.50 %     5.18 %

Net interest income as a percentage of total average interest-earning assets

     1.08 %     0.98 %     1.36 %     1.54 %     1.50 %

Credit quality data:

          

Allowance for credit losses

   ¥ 649,339     ¥ 567,651     ¥ 912,997     ¥ 993,527     ¥ 1,050,738  

Allowance for credit losses as a percentage of loans

     1.63 %     1.31 %     1.06 %     1.15 %     1.17 %

Nonaccrual and restructured loans, and accruing loans contractually past due 90 days or more

   ¥ 1,229,157     ¥ 1,005,049     ¥ 1,850,892     ¥ 1,531,753     ¥ 1,573,801  

Nonaccrual and restructured loans, and accruing loans contractually past due 90 days or more as a percentage of loans

     3.09 %     2.32 %     2.16 %     1.78 %     1.75 %

Allowance for credit losses as a percentage of nonaccrual and restructured loans, and accruing loans contractually past due 90 days or more

     52.83 %     56.48 %     49.33 %     64.86 %     66.76 %

Net loan charge-offs

   ¥ 247,429     ¥ 209,446     ¥ 107,756     ¥ 265,246     ¥ 344,047  
     (unaudited)     (unaudited)     (unaudited)     (unaudited)     (unaudited)  

Net loan charge-offs as a percentage of average loans

     0.61 %     0.49 %     0.17 %     0.31 %     0.39 %

Average interest rate spread

     1.04 %     0.94 %     1.27 %     1.38 %     1.32 %

Risk-adjusted capital ratio calculated under Japanese GAAP(4)

     11.97 %     11.83 %     12.48 %     12.77 %(5)     11.20 %

 

Notes:

(1)   Effective April 1, 2004, we adopted Financial Accounting Standards Board Interpretation, or FIN, No. 46 (revised December 2003), “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51.” Effective March 31, 2006, we adopted FIN No. 47, “Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143.”
(2)   Includes the common shares potentially issuable by conversion of the Class 3, Class 4, and Class 5 Preferred Stock.
(3)   Percentages of basic loss per common share have not been presented because such information is not meaningful.
(4)   Risk-adjusted capital ratios have been calculated in accordance with Japanese banking regulations, based on information derived from our consolidated financial statements prepared in accordance with Japanese GAAP.
(5)   Risk-adjusted capital ratio at March 31, 2007 has been restated from 12.83% to 12.77%.

 

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Exchange Rate Information

 

The tables below set forth, for each period indicated, the noon buying rate in New York City for cable transfers in Japanese yen as certified for customs purposes by the Federal Reserve Bank of New York, expressed in Japanese yen per US$1.00. On September 17, 2008, the noon buying rate was US$1.00 equals ¥104.71 and the inverse noon buying rate was ¥100 equals US$0.96.

 

     Year 2008
     March    April    May    June    July    August    September(1)

High

   103.99    104.56    105.52    108.29    108.19    110.48    108.85

Low

   96.88    100.87    103.01    104.41    104.64    107.59    104.71

 

(1)   Period from September 1, 2008 to September 17, 2008

 

     Fiscal years ended March 31,
     2004    2005    2006    2007    2008

Average (of month-end rates)

   ¥ 112.75    ¥ 107.28    ¥ 113.67    ¥ 116.55    ¥ 113.61

 

B.    Capitalization and Indebtedness

 

Not applicable.

 

C.    Reasons for the Offer and Use of Proceeds

 

Not applicable.

 

D.    Risk Factors

 

Investing in our securities involves a high degree of risk. You should carefully consider the risks described below as well as all the other information in this Annual Report, including our consolidated financial statements and related notes, “Item 5. Operating and Financial Review and Prospects,” “Item 11. Quantitative and Qualitative Disclosures about Credit, Market and Other Risk” and “Selected Statistical Data.”

 

Our business, operating results and financial condition could be materially and adversely affected by any of the factors discussed below. The trading price of our securities could decline due to any of these factors. This Annual Report also contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including the risks faced by us described below and elsewhere in this Annual Report. See “Forward-Looking Statements.”

 

Risks Related to Our Business

 

We have experienced and may continue to experience difficulty integrating our IT system and other aspects of our operations with those of the UFJ Bank and, as a result, may have difficulty achieving the benefits expected from the integration.

 

Since our merger with UFJ Bank, which was completed in January 2006, we have been implementing a business integration plan that is complex, time-consuming and costly. Achieving the targeted revenue synergies and cost savings is dependent on the successful implementation of the integration plan. We may not succeed in addressing the risks or other problems encountered in the ongoing integration process. In particular, as part of our integration process, we are currently undertaking a significant project to fully integrate the IT systems of the two banks. We commenced the integration of the two systems into a new common IT system in the first half of calendar year 2008 and has since encountered some system problems. These and other problems in the ongoing integration process may cause us to incur significant costs, preventing us from achieving the previously announced cost reduction targets as scheduled. Those problems could also severely damage our reputation. In addition, previously

 

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expected revenue synergies may not materialize in the expected time period if we fail to address any problems that arise in the ongoing integration process. If we are unable to resolve smoothly any problems that arise in the ongoing integration process, our business, results of operations, financial condition and stock price may be materially and adversely affected.

 

If the goodwill recorded in connection with our recent acquisitions, including the merger with UFJ Bank, becomes impaired, we may be required to record impairment charges, which may adversely affect our financial results and the price of our securities.

 

In accordance with US GAAP, we have accounted for our recent acquisitions, including the merger with UFJ Bank and the acquisition of additional shares in kabu.com Securities Co., Ltd., using the purchase method of accounting. We recorded the excess of the purchase price over the fair value of the assets and liabilities of the acquired companies as goodwill. US GAAP requires us to test goodwill for impairment at least annually, or more frequently if events or changes in circumstances indicate that goodwill may be impaired. Goodwill is tested by initially estimating fair value and then comparing it against the carrying amount. If the carrying amount of a reporting unit exceeds its estimated fair value, we are required to record an impairment loss. The amount of impairment and the remaining amount of goodwill, if any, is determined by comparing the fair value of the reporting unit as of the test date against the fair value of the assets and liabilities of that reporting unit as of the same date.

 

The recent global financial market instability negatively affected the fair value of our reporting units for purposes of our periodic testing of goodwill for impairment. As a result we recorded a significant amount of impairment of goodwill in the fiscal year ended March 31, 2008. As of March 31, 2008, we recorded goodwill of ¥970.4 billion. The amount of goodwill is expected to increase if we acquire additional shares of common stock of UnionBanCal Corporation, or UNBC, through our tender offer that is scheduled to expire on September 26, 2008, unless extended, and the planned subsequent merger. We may be required to record additional impairment charges relating to goodwill in future periods if the fair value of any of our reporting units declines below its assets and liabilities. Any additional impairment charges will negatively affect our financial results, and the price of our securities could be adversely affected. For a detailed discussion of the goodwill recorded and our periodic testing of goodwill for impairment, see “Item 5. Operating and Financial Review and Prospects—Critical Accounting Estimates—Accounting for Goodwill and Intangible Assets” and “Item 5. Operating and Financial Review and Prospects—B. Liquidity and Capital Resources—Financial Condition—Goodwill.”

 

We may suffer additional credit-related losses in the future due to problem loans.

 

When we loan money or commit to loan money, we incur credit risk, or the risk of losses if our borrowers do not repay their loans. We may incur credit losses or have to provide for additional allowance for credit losses if:

 

   

large borrowers become insolvent or must be restructured;

 

   

domestic or global economic conditions, either generally or in particular industries in which large borrowers operate, deteriorate;

 

   

the value of the collateral we hold, such as real estate or securities, declines; or

 

   

we are adversely affected by other factors to an extent that is worse than anticipated.

 

If actual loan losses are higher than currently expected, the current allowances for credit losses will be insufficient. Our allowance for credit losses in our loan portfolio is based on evaluations, assumptions and estimates about customers, the value of collateral we hold and the economy as a whole. Our loan losses could prove to be materially different from the estimates and could materially exceed these allowances. In addition, the

 

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standards for establishing allowances change, causing us to change some of the evaluations, assumptions and estimates used in determining the allowances. As a result, we may need to provide for additional allowances for credit losses.

 

Credit losses may also increase if we elect, or are forced by economic or other considerations, to sell or write off our problem loans at a larger discount, in a larger amount or in a different time or manner than we may otherwise want. We may not be able to realize the value of the collateral we hold or enforce our rights against defaulting customers because of the difficulty of foreclosing on collateral in Japan, the illiquidity of and depressed values in the Japanese real estate market, and other reasons.

 

In addition, we may provide additional loans, equity capital or other forms of support to troubled borrowers in order to facilitate their restructuring and revitalization efforts. We may forbear from exercising some or all of our rights as a creditor against them, and we may forgive loans to them in conjunction with their debt restructuring. These practices may substantially increase our exposure to troubled borrowers and increase our losses. An increase in loan losses would adversely affect our results of operations, weaken our financial condition and erode our capital base.

 

We may be adversely affected if economic conditions in Japan or elsewhere worsen.

 

Our performance is affected by general economic conditions of the countries in which we operate, particularly Japan where we primarily conduct our business. General economic conditions that could affect us include interest rates, inflation, investor sentiment, the availability and cost of credit, the liquidity of the global financial markets, the level and volatility of debt and equity capital markets, and raw material prices. Any of these economic conditions, currently existing or occurring in the future, may adversely affect our financial condition and results of operations. For a discussion of the current economic environment in Japan and certain other countries, see “Item 5. Operating and Financial Review and Prospects—Business Environment.”

 

If the Japanese stock market declines in the future, we may incur losses on our securities portfolio and our capital ratios will be adversely affected.

 

We hold large amounts of marketable equity securities of which a significant portion are securities of Japanese issuers. The market values of these securities are inherently volatile. We have experienced impairment losses on our marketable equity securities in the fiscal year ended March 31, 2008 as a result of a decline in Japanese stock prices, and we may incur additional losses on our securities portfolio if the Japanese stock market further declines in the future. Material declines in the Japanese stock market may also materially adversely affect our capital ratios. For a detailed discussion of our holdings of marketable equity securities and the effect of market declines on our capital ratios, see “Item 5. Operating and Financial Review and Prospects—B. Liquidity and Capital Resources—Capital Adequacy” and “Selected Statistical Data—Investment Portfolio.”

 

Our results of operations may be negatively affected by the recent global financial instability triggered by disruptions in the residential mortgage market in the United States.

 

The recent credit market instability initially triggered by disruptions in the residential mortgage market in the United States resulting from concerns with increased defaults of higher risk mortgages to lower income households may adversely affect our loan and investment portfolios, which includes securitization products such as asset-backed securities. For example, some of our investment securities may need to be marked at a significantly lower price because a market price for those securities is depressed or not properly quoted. We may also be affected by credit market deterioration caused by defaults on these higher risk residential mortgages. Specifically, the availability of credit may become limited, causing some of our counterparties to default, or some of our credit derivative transactions to be negatively affected. For example, Lehman Brothers Holdings Inc. filed a petition under Chapter 11 of the US Bankruptcy Code on September 15, 2008, as a result of which we expect an adverse impact of approximately ¥20 to ¥30 billion on our income from continuing operations before income tax expense for the fiscal year ending March 31, 2009. Moreover, the negative developments in the US credit markets may cause significant fluctuations in stock markets globally and foreign currency exchange rates, which in turn may affect our results of operation. If credit market conditions continue to deteriorate, our capital funding structure may need to be adjusted, our funding costs may increase, or our credit-related losses may increase, all of which could have a material impact on our financial results and financial condition.

 

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The valuation of certain financial instruments relies on quoted market prices that may fluctuate significantly.

 

A substantial portion of the assets on our balance sheet comprises financial instruments that we carry at fair value. Generally, in order to establish the fair value of these instruments, we rely on quoted market prices. If the value of a financial instrument carried at fair value declines, a corresponding write-down may be recognized in our income statement. As the global financial markets became unstable following concerns of increased defaults of higher risk mortgages in the United States, there have been increasing circumstances where quoted market prices for securities became significantly depressed or were not properly quoted. Significant fluctuations in the market or disfunctionalities in the market could have a significant adverse effect on the fair value of the financial instruments that we hold.

 

Our business may be adversely affected by negative developments with respect to other financial institutions, both directly and through the effect they may have on the overall banking environment and on their borrowers.

 

Some domestic and foreign financial institutions, including banks, non-bank lending and credit institutions, securities companies and insurance companies, have experienced declining asset quality and capital adequacy and other financial problems. This may lead to severe liquidity and solvency problems, which have in the past resulted in the liquidation, government control or restructuring of affected institutions. For example, the recent deterioration of the asset-backed securitization products market and residential mortgage market in the United States resulted in Lehman Brothers Holdings Inc. filing a petition under Chapter 11 of the US Bankruptcy Code. Other banks, securities companies, insurance companies and other financial institutions, especially US institutions, continue to be under significant pressure due to declining asset quality as a result of recent deterioration of the global financial markets. These developments are expected to adversely affect our financial results for the fiscal year ending March 31, 2009. Other financial difficulties relating to financial institutions could adversely affect us because:

 

   

we have extended loans, some of which may need to be classified as nonaccrual and restructured loans, to banks, securities companies, insurance companies and other financial institutions that are not our consolidated subsidiaries;

 

   

we are a shareholder of some other banks and financial institutions that are not our consolidated subsidiaries;

 

   

we may be requested to participate in providing assistance to support distressed financial institutions that are not our consolidated subsidiaries;

 

   

the government may elect to provide regulatory, tax, funding or other benefits to those financial institutions to strengthen their capital, facilitate their sale or otherwise, which in turn may increase their competitiveness against us;

 

   

deposit insurance premiums could rise if deposit insurance funds prove to be inadequate;

 

   

bankruptcies or government support or control of financial institutions could generally undermine confidence in financial institutions or adversely affect the overall banking environment;

 

   

negative media coverage of the financial industry, regardless of its accuracy and applicability to us, could affect customer or investor sentiment, harm our reputation and have a materially adverse effect on our business or the price of our securities;

 

   

new regulations may be adopted to prevent future difficulties of financial institutions, which could increase our short term costs; and

 

   

we could be perceived to be facing the same issues as other financial institutions that hold assets with no market liquidity or with significantly depressed values as a result of the significantly negative views about the financial services industry in general.

 

Changes in interest rate policy, particularly unexpected or sudden increases in interest rates, could adversely affect the value of our bond and financial derivative portfolios, problem loans and results of operations.

 

We hold a significant amount of Japanese government bonds and foreign bonds, including US Treasury bonds. We also hold a large financial derivative portfolio, consisting primarily of interest-rate futures, swaps and

 

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options, for our asset liability management. An increase in relevant interest rates, particularly if such increase is unexpected or sudden, may negatively affect the value of our bond portfolio and reduce the so called “spread,” which is the difference between the rate of interest earned and the rate of interest paid. In addition, an increase in relevant interest rates may increase losses on our derivative portfolio and increase our problem loans as some of our borrowers may not be able to meet the increased interest payment requirements, thereby adversely affecting our results of operations and financial condition. For a detailed discussion of our bond portfolio, see “Selected Statistical Data—Investment Portfolio.”

 

Our trading and investment activities as well as our international operations expose us to interest rate, exchange rate and other risks.

 

We undertake extensive trading and investment activities involving a variety of financial instruments, including derivatives. We also have significant business operations abroad, including operations of UNBC, in the United States and elsewhere. Our income from these activities as well as our foreign assets and liabilities resulting from our international operations are subject to volatility caused by, among other things, changes in interest rates, foreign currency exchange rates and equity and debt prices. For example:

 

   

increases in interest rates may have an adverse effect on the value of our fixed income securities portfolio, as discussed in “—Changes in interest rate policy, particularly unexpected or sudden increases in interest rates, could adversely affect the value of our bond and financial derivatives portfolios, problem loans and results of operations” above; and

 

   

fluctuations in foreign currency exchange rates against the Japanese yen may adversely affect our financial condition, including our capital ratios, to the extent that our foreign currency denominated assets and liabilities are not matched in the same currency or appropriately hedged, and will create foreign currency translation gains or losses, as described in “Item 5. Operating and Financial Review and Prospects—A. Operating Results—Effect of the Change in Exchange Rates on Foreign Currency Translation.”

 

In addition, downgrades of the credit ratings of some of the securities in our portfolio could negatively affect our results of operations. Our trading and investment activities in financial instruments may also be adversely affected by regulatory measures taken by government agencies, such as the SEC measures taken recently to limit certain types of shortselling in securities. Our results of operations and financial condition are exposed to the risks of loss associated with these activities. For a discussion of our investment portfolio and related risks see “Item 5. Operating and Financial Review and Prospects—B. Liquidity and Capital Resources—Financial Condition—Investment Portfolio” and “Item 11. Quantitative and Qualitative Disclosures about Credit, Market and Other Risk.”

 

We may not be able to maintain our capital ratios above minimum required levels, which could result in the suspension of some or all of our operations.

 

We started calculating our risk-weighted capital ratios based on a new framework relating to regulatory capital requirements based on the Basel II framework established by the Basel Committee on Banking Supervision as of March 31, 2007. We are required to maintain risk-weighted capital ratios above the levels specified in the capital adequacy guidelines of the Financial Services Agency of Japan. The capital ratios are calculated in accordance with Japanese banking regulations based on information derived from the relevant entity’s financial statements prepared in accordance with Japanese GAAP. Our subsidiaries in California, UNBC and Union Bank of California, N.A., or UBOC, are subject to similar US capital adequacy guidelines. We or our subsidiary banks may be unable to continue to satisfy the capital adequacy requirements because of:

 

   

increases in credit risk assets and expected losses we or our subsidiary banks may incur due to fluctuations in our or our subsidiary banks’ loan and securities portfolios as a result of deteriorations in the credit of our borrowers and the issuers of equity and debt securities;

 

   

increases in credit costs we or our subsidiary banks may incur as we or our subsidiary banks dispose of problem loans or as a result of deteriorations in the credit of our borrowers;

 

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declines in the value of our or our subsidiary banks’ securities portfolio;

 

   

changes in the capital ratio requirements or in the guidelines regarding the calculation of banks’ capital ratios;

 

   

a reduction in the value of our or our subsidiary banks’ deferred tax assets;

 

   

adverse changes in foreign currency exchange rates; and

 

   

other adverse developments discussed in these risk factors.

 

Our capital ratios may also be adversely affected if we or our subsidiary banks fail to refinance our subordinated debt obligations with equally subordinated debt. As of March 31, 2008, subordinated debt accounted for approximately 31.2% of our total regulatory capital, as calculated under Japanese GAAP. The failure to refinance these subordinated debt obligations with equally subordinated debt may reduce our total regulatory capital and, as a result, negatively affect our capital ratios.

 

If our capital ratios fall below required levels, the Financial Services Agency could require us to take a variety of corrective actions, including withdrawal from all international operations or suspension of all or part of our business operations. For a discussion of our capital ratios and the related regulatory guidelines, see “Item 4.B. Information on the Company—Business Overview—Supervision and Regulation—Japan—Capital Adequacy” and “Item 5. Operating and Financial Review and Prospects—B. Liquidity and Capital Resources—Capital Adequacy.”

 

We may have difficulty achieving the benefits expected from the recently completed and planned mergers and other business combinations.

 

In line with our ongoing strategic effort to create a leading comprehensive financial group that offers a broad range of financial products and services, we have recently completed and are planning to complete mergers and other business combinations, including transactions with some of our subsidiaries and equity-method investees. For example, on August 29, 2008, we commenced a tender offer to acquire all of the shares of UNBC’s common stock not owned by us. We also review opportunities to pursue new acquisitions or business combinations regularly.

 

If a planned merger or business combination fails, we may be subject to various material risks. For example, our growth strategies in Japan and globally may not be implemented as planned. In addition, the price of our securities may decline to the extent that the current market price reflects a market assumption that any pending transaction will be completed. Furthermore, our costs related to any planned transaction, including legal, accounting and certain financial adviser fees, must be paid even if the transaction is not completed. Our reputation may also be harmed due to our failure to complete an announced transaction. Even after a transaction is completed, there are various risks that could adversely affect our ability to achieve our business objectives, including:

 

   

The growth opportunities and other expected benefits of these business combinations or acquisitions may not be realized in the expected time period and unanticipated problems could arise in the integration process, including unanticipated expenses related to the integration process as well as delays or other difficulties in coordinating, consolidating and integrating personnel, information and management systems, and customer products and services;

 

   

We may be unable to cross-sell our products and services as effectively as anticipated and we may lose customers and business as some of the operations are reorganized, consolidated with other businesses and, in some cases, rebranded;

 

   

We may have difficulty in coordinating the operations of our subsidiaries and affiliates as planned due to legal restrictions, internal conflict or market resistance;

 

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The diversion of management and key employees’ attention may detract from our ability to increase revenues and minimize costs; and

 

   

We may encounter difficulties in penetrating certain markets due to adverse reactions to our newly acquired ownership in, or closer affiliation with, other financial institutions or businesses.

 

Any of the foregoing and other risks may adversely affect our business, results of operations, financial condition and stock price. For a more detailed discussion of recently completed and planned mergers and other business combinations involving our subsidiaries and affiliates, see “Item 4.B. Information on the Company—Business Overview” and “Item 5. Operating and Financial Review and Prospects—Recent Developments.”

 

Any adverse changes in UNBC’s business could significantly affect our results of operations.

 

UNBC contributes to a significant portion of our net income. Any adverse change in the business or operations of UNBC could significantly affect our results of operations. Factors that could negatively affect UNBC’s results include adverse economic conditions in California, including the downturn in the real estate and housing industries in California, substantial competition in the California banking market, uncertainty over the US economy due to deteriorating credit markets in the United States, the threat of terrorist attacks, fluctuating oil prices and rising interest rates, negative trends in debt ratings and additional costs and other adverse consequences which may arise from enterprise-wide compliance or failure to comply with applicable laws and regulations such as the US Bank Secrecy Act and related amendments under the USA PATRIOT Act. We will be more significantly impacted by any adverse developments at UNBC if we are able to successfully acquire the shares for which we have launched a tender offer and complete the planned second-step merger after the tender offer.

 

We are exposed to new or increased risks as we expand the range of our products and services and the geographic scope of our business.

 

As we expand the range of our products and services beyond our traditional banking business and as the sophistication of financial products and management systems grows, we will be exposed to new and increasingly complex risks. We may have only limited experience with the risks related to the expanded range of these products and services. As a result, we may not be able to foresee certain risks, and new products and services we introduce may not gain acceptance among customers. Moreover, some of the activities that we are expected to engage in, such as derivatives and foreign currency trading, present substantial risks. As we expand the geographic scope of our business, we will also be exposed to risks that are unique to particular jurisdictions or markets. Our risk management systems may prove to be inadequate and may not work in all cases or to the degree required. As a result, we are subject to substantial market, credit and other risks in relation to the expanding scope of our products, services and trading activities or expanding our business beyond our traditional markets, which could result in us incurring substantial losses. In addition, our efforts to offer new services and products or penetrate new markets may not succeed if product or market opportunities develop more slowly than expected or if the profitability of opportunities is undermined by competitive pressures. For a detailed discussion of our risk management systems, see “Item 11. Quantitative and Qualitative Disclosures about Credit, Market and Other Risk.”

 

Changes in the business environment for consumer finance companies in Japan have adversely affected our recent financial results, and may further adversely affect our future financial results.

 

We have a large loan portfolio to the consumer lending industry as well as large shareholdings of consumer finance companies. The Japanese government has been implementing regulatory reforms affecting the consumer lending industry in recent years. In December 2006, the Diet passed legislation to reduce the maximum permissible interest rate under the Law Concerning Acceptance of Investment, Cash, Deposit and Interest Rate, etc., which is currently 29.2% per annum, to 20% per annum. Such reduction in the maximum permissible interest rate will be implemented before mid-2010. Under the reforms, all interest rates will be subject to the lower limits (15-20% per annum) imposed by the Interest Rate Restriction Law, which will compel, or has already compelled, lending institutions to lower the interest rates they charge borrowers.

 

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Currently, consumer finance companies that satisfy certain conditions are able to charge interest rates exceeding the limits stipulated by the Interest Rate Restriction Law so long as the payment is made voluntarily by the borrowers and the lender complies with various notice and other requirements. Accordingly, our consumer finance subsidiaries and equity method investees offer loans at interest rates above the Interest Rate Restriction Law. As a result of recent decisions by the Supreme Court of Japan, consumer finance companies experienced a significant increase in borrowers’ claims for reimbursement of previously collected interest payments in excess of the limits stipulated by the Interest Rate Restriction Law. New regulations that are scheduled to be effective before mid-2010 may also have a negative impact on the business of consumer finance companies as those new regulations are expected to require, among other things, consumer finance companies to review the repayment capability of borrowers before lending, thereby limiting the amount of borrowing available to individual borrowers.

 

These and other related developments have adversely affected, and may further adversely affect, the operations and financial condition of our subsidiaries and borrowers which are engaged in consumer lending, which in turn may affect the value of our related shareholdings and loan portfolio. For example, there was a significant increase in the allowance for repayment of excess interest at our consumer finance subsidiaries in the fiscal year ended March 31, 2007. Additionally, we recorded a provision for credit losses in the fiscal year ended March 31, 2008 relating to domestic consumer loans mainly due to a change in regulation applicable to the consumer finance industry, which results in some of our consumer borrowers encountering difficulties in refinancing their existing loans as loan approval standards were tightened. Such developments may have indirect negative financial consequences for us, such as a change in our tax circumstances or an increase in our valuation allowance for deferred tax assets as a result of a decline in the estimated future taxable income of our consumer finance subsidiaries and may negatively affect market perception of our consumer lending operations, thereby adversely affecting the future financial results.

 

We have recently been subject to several regulatory actions for noncompliance with legal requirements. These regulatory matters and any future regulatory matters or regulatory changes could have a negative impact on our business and results of operations.

 

We conduct our business subject to ongoing regulation and associated regulatory compliance risks, including the effects of changes in laws, regulations, policies, voluntary codes of practice and interpretations in Japan and other markets in which we operate. Our compliance risk management systems and programs may not be fully effective in preventing all violations of laws, regulations and rules.

 

The Financial Services Agency of Japan and regulatory authorities in the United States and elsewhere also have the authority to conduct, at any time, inspections to review banks’ accounts, including ours. Some of our other financial services businesses, such as our securities business, are also subject to regulations set by, and inspections conducted by, various self-regulatory organizations, such as the National Securities Dealers Association in the United States. In recent years, we have been subject to several regulatory actions by, among others, the Financial Services Agency of Japan, the Securities and Exchange Surveillance Commission of Japan and various US banking regulators.

 

Our failure or inability to comply fully with applicable laws and regulations could lead to fines, public reprimands, damage to reputation, enforced suspension of operations or, in extreme cases, withdrawal of authorization to operate, adversely affecting our business and results of operations. Regulatory matters may also negatively affect our ability to obtain regulatory approvals for future strategic initiatives. Furthermore, failure to take necessary corrective actions, or discovery of violation of laws in the process of further review of any of the matters mentioned above or in the process of implementing any corrective measures, could result in further regulatory action.

 

In addition, future developments or changes in laws, regulations, policies, voluntary codes of practice, fiscal or other policies and their effects are unpredictable and beyond our control. For example, new regulations to be enacted before mid-2010 are expected to require, among other things, consumer finance companies in Japan to review the repayment capabilities of borrowers before lending, thereby limiting the amount of borrowing available to individual borrowers, which in turn may negatively affect our future financial results.

 

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In addition, if a new accounting system or methodology becomes applicable to us as a result of changes to applicable banking or securities law requirements, market or investor expectations or otherwise, we may be required to incur significant additional costs, which may materially adversely affect our financial condition and results of operations.

 

Our business may be adversely affected by competitive pressures, which have partly increased due to regulatory changes and recent market changes in the financial industry domestically and globally.

 

In recent years, the Japanese financial system has been increasingly deregulated and barriers to competition have been reduced. The privatization of the Japanese postal savings system and the establishment of Japan Post Bank Co., Ltd. in October 2007, as well as the planned privatization of certain governmental financial institutions in October 2008, could also substantially increase competition within the financial services industry. In addition, there has been significant consolidation and convergence among financial institutions domestically and globally, and this trend may continue in the future and further increase competition in the market. A number of large commercial banks and other broad-based financial services firms have merged or formed strategic alliances with other financial institutions both in Japan and overseas. If we are unable to compete effectively in this more competitive and deregulated business environment, our business, results of operations and financial condition will be adversely affected. For a more detailed discussion of our competition in Japan, see “Item 4.B. Information on the Company—Business Overview—Competition—Japan.”

 

Our information systems and other aspects of our business and operations are exposed to various system, political and social risks.

 

As a major financial institution, our information systems and other aspects of our business and operations are exposed to various system, political and social risks beyond our control. Incidents such as disruptions of the Internet and other information networks due to major virus outbreaks, major terrorist activity, serious political instability and major health epidemics, have the potential to directly affect our business and operations by disrupting our operational infrastructure or internal systems. Such incidents may also negatively impact the economic conditions, political regimes and social infrastructure of countries and regions in which we operate, and possibly the global economy as a whole. Our risk management policies and procedures may be insufficient to address these and other large-scale unanticipated risks.

 

In particular, the capacity and reliability of our electronic information technology systems are critical to our day-to-day operations and a failure or disruption of these systems would adversely affect our capacity to conduct our business. In addition to our own internal information systems, we also provide our customers with access to our services and products through the Internet and ATMs. These systems as well as our hardware and software are subject to malfunction or incapacitation due to human error, accidents, power loss, sabotage, hacking, computer viruses and similar events, as well as the loss of support services from third parties such as telephone and Internet service providers.

 

Additionally, as with other Japanese companies, our offices and other facilities are subject to the risk of earthquakes and other natural disasters. Our redundancy and backup measures may not be sufficient to avoid a material disruption in our operations, and our contingency plans may not address all eventualities that may occur in the event of a material disruption.

 

These various factors, the threat of such risks or related countermeasures, or a failure to address such risks, may materially and adversely affect our business, operating results and financial condition.

 

We may be subject to liability and regulatory action if we are unable to protect personal and other confidential information.

 

There have been many cases where personal information and records in the possession of corporations and institutions were leaked or improperly accessed. In the event that personal information in our possession about

 

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our customers or employees is leaked or improperly accessed and subsequently misused, we may be subject to liability and regulatory action. As an institution in possession of personal information, we are required to treat personal and other confidential information as required by the Personal Information Protection Act of Japan. We may have to provide compensation for economic loss and emotional distress arising out of a failure to protect such information in accordance with the Personal Information Protection Act. In addition, such incidents could create a negative public perception of our operations, systems or brand, which may in turn decrease customer and market confidence and materially and adversely affect our business, operating results and financial condition.

 

A downgrade of our credit ratings could have a negative effect on our business.

 

A downgrade of our credit ratings by one or more of the credit rating agencies could have a negative effect on our treasury operations and other aspects of our business. In the event of a downgrade of our credit ratings, our treasury business unit may have to accept less favorable terms in our transactions with counterparties, including capital raising activities, or may be unable to enter into some transactions. This could have a negative impact on the profitability of our treasury and other operations and adversely affect our results of operations and financial condition.

 

Damage to our reputation could harm our business.

 

We are one of the largest and most influential financial institutions in Japan by virtue of our market share and the size of our operations and customer base. Our reputation is critical in maintaining our relationships with clients, investors, regulators and the general public. Our reputation could be damaged by numerous causes, including, among others, system troubles, employee misconduct, failure to properly address potential conflicts of interest, litigation, compliance failures, the activities of customers and counterparties over which we have limited or no control, and exacting scrutiny from regulatory authorities and customers regarding our trade practices and potential abuses of our dominant bargaining position in our dealings with customers. If we are unable to prevent or properly address these causes, we could lose existing or prospective customers and investors, in which case our business, financial condition and results of operations could be materially and adversely affected.

 

We are exposed to substantial credit and market risks in Asia, Latin America and other regions.

 

We are active in Asia, Latin America and other regions through a network of branches and subsidiaries and are thus exposed to a variety of credit and market risks associated with countries in these regions. A decline in the value of Asian, Latin American or other relevant currencies could adversely affect the creditworthiness of some of our borrowers in those regions. For example, the loans we have made to Asian, Latin American and other overseas borrowers and banks are often denominated in yen, US dollars or other foreign currencies. These borrowers often do not hedge the loans to protect against fluctuations in the values of local currencies. A devaluation of the local currency would make it more difficult for a borrower earning income in that currency to pay its debts to us and other foreign lenders. In addition, some countries in which we operate may attempt to support the value of their currencies by raising domestic interest rates. If this happens, the borrowers in these countries would have to devote more of their resources to repaying their domestic obligations, which may adversely affect their ability to repay their debts to us and other foreign lenders. The limited credit availability resulting from these and related conditions may adversely affect economic conditions in some countries. This could cause a further deterioration of the credit quality of borrowers and banks in those countries and cause us to incur further losses.

 

In addition, we are active in other regions that expose us to risks similar to the risks described above and also risks specific to those regions, which may cause us to incur losses or suffer other adverse effects.

 

We may incur significant additional costs for implementing effective internal controls.

 

In order to operate as a global financial institution, it is essential for us to have effective internal controls, corporate compliance functions, and accounting systems to manage our assets and operations. Moreover, under the U.S. Sarbanes-Oxley Act of 2002, which applies by reason of our status as an SEC reporting company, we

 

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are required to establish internal control over our financial reporting and our management is required to assess the effectiveness of our internal control over financial reporting and disclose whether such internal control is effective beginning from the fiscal year ending March 31,2008. Under the Japanese Financial Instruments and Exchange Law that took full effect in September 2007, Mitsubishi UFJ Financial Group, Inc., or MUFG, as a listed company in Japan, is required to file an internal control report with an annual securities report in Japan, beginning from the fiscal year ending March 31, 2009. Accordingly, we, as an important subsidiary of MUFG, must establish, maintain and operate our internal control system in accordance with MUFG policy.

 

Designing and implementing an effective system of internal control capable of monitoring and managing our business and operations requires significant management and human resources and considerable costs. If we identify any material weakness in our internal control system, we may incur significant additional costs for remediating such weakness. In addition, if we adopt a new accounting system, we may be required to incur significant additional costs, which may materially adversely affect our financial condition and results of operations.

 

Transactions with counterparties in countries designated by the US Department of State as state sponsors of terrorism may lead some potential customers and investors in the US and other countries to avoid doing business with us or investing in our securities.

 

We engage in operations with entities in or affiliated with Iran and Syria, including transactions with entities owned or controlled by the Iranian or Syrian governments, and we have a representative office in Iran. The US Department of State has designated Iran and Syria as “state sponsors of terrorism,” and US law generally prohibits US persons from doing business with such countries. Our activities with counterparties in or affiliated with Iran, Syria and other countries designated as state sponsors of terrorism are conducted in compliance in all material respects with both applicable Japanese and US regulations.

 

Our operations with entities in Iran consist primarily of loans to Iranian financial institutions in the form of financing for petroleum projects and trade financing for general commercial purposes, as well as letters of credit and foreign exchange services. Our operations relating to Syria are primarily foreign exchange services. We do not believe our operations relating to Iran and Syria are material to our business, financial condition and results of operations, as the loans outstanding to borrowers in or affiliated with Iran and Syria as of March 31, 2008 were approximately $410 million and $0.2 million, respectively, which together represented less than 0.1% of our total assets as of March 31, 2008. In addition, we receive deposits or hold assets on behalf of several individuals resident in Japan who are citizens of countries designated as state sponsor of terrorism.

 

We are aware of initiatives by US governmental entities and US institutional investors, such as pension funds, to adopt or consider adopting laws, regulations or policies prohibiting transactions with or investment in, or requiring divestment from, entities doing business with Iran and other countries identified as state sponsors of terrorism. It is possible that such initiatives may result in our being unable to gain or retain entities subject to such prohibitions as customers. In addition, depending on socio-political developments our reputation may suffer due to our association with these countries. The above circumstances could have a significant adverse effect on our business and financial condition.

 

Risks Related to Owning Our Subordinated Debt Securities

 

The indenture will not limit our ability to incur additional debt, including senior debt.

 

The indenture relating to our 8.40% global senior subordinated notes due 2010 does not limit or restrict the amount of other indebtedness, including senior indebtedness, that we or our subsidiaries may incur in the future.

 

The subordination provisions in our subordinated debt securities could hinder your ability to receive payment.

 

Under some circumstances, your right to receive payment on our 8.40% global senior subordinated notes due 2010 will be subordinated and subject in right of payment in full to the prior payment of all our senior

 

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indebtedness. We expect from time to time to incur additional indebtedness and other obligations that will constitute senior indebtedness, and the indenture relating to our 8.40% global senior subordinated notes due 2010 does not contain any provisions restricting our ability to incur senior indebtedness.

 

Item 4. Information on the Company

 

A.    History and Development of the Company

 

The Bank of Tokyo-Mitsubishi UFJ, or BTMU, is a major commercial banking organization in Japan that provides a broad range of domestic and international banking services from its offices in Japan and around the world. Our registered head office is located at 7-1, Marunouchi 2-chome, Chiyoda-ku, Tokyo 100-8388, Japan, and our telephone number is 81-3-3240-1111. BTMU is a joint stock company (kabushiki kaisha) incorporated in Japan under the Company Law of Japan (Law No. 86 of 2005, also known as the Companies Act or the Corporation Act).

 

BTMU was formed through the merger, on January 1, 2006, of Bank of Tokyo-Mitsubishi and UFJ Bank Limited, after their respective parent companies, Mitsubishi Tokyo Financial Group, Inc. and UFJ Holdings, Inc., had merged to form Mitsubishi UFJ Financial Group, Inc. on October 1, 2005.

 

Bank of Tokyo-Mitsubishi was formed through the merger, on April 1, 1996, of The Mitsubishi Bank, Limited and The Bank of Tokyo, Ltd.

 

The origins of Mitsubishi Bank can be traced to the Mitsubishi Exchange Office, a money exchange house established in 1880 by Yataro Iwasaki, the founder of the Mitsubishi industrial, commercial and financial group. In 1895, the Mitsubishi Exchange Office was succeeded by the Banking Division of the Mitsubishi Goshi Kaisha, the holding company of the “Mitsubishi group” of companies. Mitsubishi Bank had been a principal bank to many of the Mitsubishi group companies but broadened its relationships to cover a wide range of Japanese industries, small and medium-sized companies and individuals.

 

Bank of Tokyo was established in 1946 as a successor to The Yokohama Specie Bank, Ltd., a special foreign exchange bank established in 1880. When the government of Japan promulgated the Foreign Exchange Bank Law in 1954, Bank of Tokyo became the only bank licensed under that law. Because of its license, Bank of Tokyo received special consideration from the Ministry of Finance in establishing its offices abroad and in many other aspects relating to foreign exchange and international finance.

 

UFJ Bank was formed through the merger, on January 15, 2002, of The Sanwa Bank, Limited and The Tokai Bank, Limited.

 

Sanwa Bank was established in 1933 when the three Osaka-based banks, the Konoike Bank, the Yamaguchi Bank, and the Sanjyushi Bank merged. Sanwa Bank was known as a city bank having the longest history in Japan, since the foundation of Konoike Bank can be traced back to the Konoike Exchange Office established in 1656. The origin of Yamaguchi Bank was also a money exchange house, established in 1863. Sanjyushi Bank was founded by influential fiber wholesalers in 1878. The corporate philosophy of Sanwa Bank had been the creation of premier banking services especially for small and medium-sized companies and individuals.

 

Tokai Bank was established in 1941 when the three Nagoya-based banks, the Aichi Bank, the Ito Bank, and the Nagoya Bank merged. In 1896, Aichi Bank took over businesses of the Jyuichi Bank established by wholesalers in 1877 and the Hyakusanjyushi Bank established in 1878. Ito Bank and Nagoya Bank were established in 1881 and 1882, respectively. Tokai Bank had expanded the commercial banking business to contribute to economic growth mainly of the Chubu area in Japan, which is known for the manufacturing industry, especially automobiles.

 

For a discussion of the merger between Bank of Tokyo-Mitsubishi and UFJ Bank and other recent developments, see “Item 4.B. Business Overview” and “Item 5. Operating and Financial Review and Prospects—Recent Developments.”

 

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B.    Business Overview

 

We are a major Japanese commercial banking organization. We provide a broad range of domestic and international banking services in Japan and around the world. As of June 30, 2008, our network in Japan included 665 branches, 118 sub-branches, 1,885 branch ATMs and 26,572 convenience store-based, non-exclusive ATMs. We organize our operations based on customer and product segmentation, as follows:

 

   

retail banking;

 

   

corporate banking;

 

   

corporate and investment banking;

 

   

commercial banking; and

 

   

transaction banking;

 

   

global business;

 

   

global markets;

 

   

operations and systems; and

 

   

other, including trust and asset management, custody and eBusiness & IT initiatives.

 

For a detailed analysis of financial results by business segments, which is based mainly on our business organizations, see “Item 5. Operating and Financial Review and Prospects—A. Operating Results—Business Segment Analysis.” For a detailed analysis of financial results by geographic segment, see “Item 5. Operating and Financial Review and Prospects—A. Operating Results—Geographic Segment Analysis.”

 

BTMU conducts business activities in a variety of areas, including:

 

   

banking;

 

   

trust banking;

 

   

securities;

 

   

investment trusts;

 

   

credit cards and consumer finance;

 

   

leasing; and

 

   

international banking.

 

Retail Banking Business Unit

 

Our retail banking business unit offers a full range of banking products and services, including financial consulting services to individual customers in Japan through its branch offices and other direct distribution channels.

 

   

Deposits

 

The unit offers a full range of bank deposit products to its customers.

 

BTMU is implementing a wide variety of preferential interest rate measures which include a campaign designed to appeal to fixed term deposit needs of our customers who are nearing the attainment of their retirement bonus.

 

In January 2007, BTMU launched a membership club, the Quality Life Club, aimed chiefly at senior citizens of the baby-boom generation which provides a combination of financial and non-financial services. In addition to financial services such as consultation with experts on asset management, the club offers privileges such as high value-added services in areas of interest to senior citizens including travel and health.

 

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In May 2007, in a joint initiative with Walt Disney Japan, BTMU launched a new type of online banking service for individuals called “Disney Osaihu Plus” using the Internet and mobile phones. The Disney Osaihu Plus service aims to provide a solution for customers who are unfamiliar with banking services and find banking services difficult to understand, or find it hard to adapt to online banking. This service aims to be easy-to-use and to encourage customers to feel comfortable with online banking services.

 

   

Investment Trust

 

We offer a varied line-up of products allowing our customers to choose products according to their investment needs. In the fiscal year ended March 31, 2008, BTMU introduced a total of seven investment trusts. As of the end of March 2008, BTMU offered our clients a total of 94 investment trust products.

 

In April 2007, BTMU began offering the “Global Sovereign Open (monthly closing type)”, largest asset holding fund in Japan and one of our most popular investment products.

 

In July 2007, BTMU began offering the “Bond Fund Denominated in Currency of Emerging Countries (monthly closing type)”. BTMU also began offering the “World High-Interest Rate Currencies Fund (course1, course2)” in December 2007 and “Global Bond basic (monthly closing type)” in March 2008. These funds were developed to strengthen BTMU’s line-up of investment trusts in order to meet the needs of those customers seeking investment opportunities in emerging countries that provide increased growth potential and those in high-interest currency countries.

 

Furthermore, BTMU began offering the “World Three Area’s REIT Fund (monthly closing type)” in August 2007 and “Nomura Japan Bond Index Fund” in February 2008. In order to meet the customers’ wide variety of investment needs, BTMU strengthened its investment products from high-end products to basic products.

 

In addition to these investment trust products, BTMU has been offering the Welcome Selection Campaign, which provides preferential interest rates on fixed term deposits for customers who simultaneously open a fixed term deposit account and purchase an investment trust product. BTMU has also been offering gift cards to customers who purchase investment trust products. These offers aim to enhance the attractiveness of our investment trust products.

 

Moreover, BTMU has placed significant importance on ensuring that aftercare is provided to all of its customers who have purchased its investment trust products. For instance, after the market plunge in last August caused by the collapse of the residential mortgage market, BTMU held approximately 150 seminars to explain the potential effects of such decline over the market and asset management businesses. These seminars were held mainly in the Tokyo, Nagoya and Osaka metropolitan areas.

 

   

Insurance

 

Since the Japanese government lifted the prohibition against sales of annuity insurance products by banks in October 2002, we have been actively offering individual annuities in an effort to meet the needs of our customers as agents of insurance companies. Our current line-up of insurance products consists of investment-type individual annuities, foreign currency denominated insurance annuities and yen denominated fixed-amount annuity insurance. BTMU has been offering Insurance for Death Benefit/Health-related/Cancer since December 2007 and Nursing Insurance since April 2008.

 

BTMU began offering “Kantan Jizoku Seichou Plus”, a single premium term insurance underwritten by Meiji Yasuda Life Insurance, in November 2007, and “Kibou no Tamago”, an investment-type individual annuity underwritten by Meiji Yasuda Life Insurance in January 2008. In addition, we began offering “Core Value”, an investment-type individual annuity underwritten by Daiichi Frontier Life, in April 2008, and “Ijigen Hatsu”, an investment-type individual annuity underwritten by Tokyo Marine Nichido Financial Life, in June 2008.

 

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Since the deregulation in December 2007 of over the counter sales of life insurance products by banks, BTMU has introduced seven varieties of life insurance products (four life insurance, two medical insurance, one cancer insurance). Between December 31, 2007 and June 30, 2008, the number of branches through which BTMU offers insurance products increased from 173 to 319. Professional insurance sales representatives, called “Insurance Planner”, have been assigned to each branch where these insurance products are sold in order to ensure that the branch accurately responds to our customers’ insurance needs. BTMU has plans to further strengthen its lineup of life insurance products in addition to increasing the number of branches at which life insurance products are sold.

 

   

Financial Products Intermediation Services

 

BTMU initiated financial products intermediation business in December 2004 following the lifting of the ban on securities intermediation by banks. It currently acts as a financial products intermediary for Mitsubishi UFJ Securities Co., Ltd., or MUS, and kabu.com Securities Co., Ltd. In addition, in May 2006, the unit started providing financial products intermediation services with Mitsubishi UFJ Merrill Lynch PB Securities Co., Ltd., a joint-venture company between Mitsubishi UFJ Financial Group, Inc. and Merrill Lynch & Co., Inc. that provides private banking services.

 

As of the end of March 2008, BTMU employed approximately 500 employees seconded from MUS for the purpose of providing financial product intermediation services to our clients. Approximately 360 of these employees who hold the necessary skills in investment consulting have been assigned to branches in Japan as sales representatives. Forty of the personnel have been assigned to assist the branches as Retail Money Desk representatives who specialize in the sale of investment products with enhanced sales skills and possess more sophisticated understanding and background in the field of compliance. They are working to further strengthen the branch sales force. The remaining secondees were given various other assignments relating to corporate management.

 

Additionally, in order to continuously strengthen our product lineup, BTMU has been providing Japanese Government Bonds For Individual Investors, Domestic Industrial Bonds, Foreign Bonds, Domestic/Foreign Investment Trusts, Stocks (Both IPOs and offerings of public companies) and Public Offered -Structured Bonds.

 

   

Loans

 

BTMU provides loans such as housing loans and card loans to its retail clients.

 

To meet a wide variety of customer needs, BTMU offers a variety of housing loan products such as ultra-long term fixed rate housing loans, housing loans incorporating health insurance for seven major illnesses, and the Flat 35 guaranteed housing loan in a tie-up with Japan Housing Finance Agency. Additionally, to help counteract the ever-rising customer concerns regarding loan guarantee fees, BTMU has been offering the “Zero Guarantee Fee Campaign” for customers who meet certain conditions since October 2007.

 

In November 2007, BTMU launched “BANQUIC”, a new convenient and accessible card loan product guaranteed by ACOM CO., LTD, an equity method affiliate of MUFG in the consumer finance business. Customers can apply for BANQUIC card loans through internet, telephone, fax etc., and make or repay loans at BTMU ATMs or convenience store ATMs (including E-net ATMs, Seven Bank’s ATMs, LAWSON ATMs). BTMU will continue to aim to meet the wide variety of our customers’ needs through strengthening our product lineup and increasing convenience.

 

   

Credit Cards

 

In October 2004, BTMU began to issue a multi-functional “IC cards”, which combine ATM card, credit card and electronic money functions that enhance customer convenience. For example, BTMU currently offers an “alliance credit card”, which is an integrated IC commuter pass compatible with the ticketing systems of Japanese railway companies, East Japan Railway Company (since February 2007) and Kintetsu Corporation (since February 2008), with “VISA touch”, a contact-less IC function, which can be used as a credit card.

 

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Domestic Network

 

BTMU offers products and services through a wide range of channels, including branches, ATMs (including convenience store ATMs shared by multiple banks), Tokyo-Mitsubishi UFJ Direct (telephone, internet and mobile phone banking), the BTMU “Telebank” service video conferencing counters (counters that allow face-to-face contact with operators through the use of broadband internet video conferencing) and by mail.

 

The Mitsubishi UFJ Financial Group’s integrated financial services are provided at MUFG Plaza branches that combine banking, trust banking and securities services and offer retail customers unified and flexible services at one-stop outlets. As of March 31, 2008, 51 MUFG Plaza branches existed.

 

To provide exclusive membership services for high net worth customers, private banking offices have been established since December 2006 featuring lounges and private rooms where customers can receive wealth management advice and other services in a relaxing and comfortable setting. As of March 31 2008, 19 private banking offices existed in the Tokyo metropolitan area, Nagoya and Osaka.

 

To increase customer convenience, BTMU has enhanced its ATM network and ATM related services. For example, BTMU has ceased to charge ATM usage charges from those who are customers at both BTMU and Mitsubishi UFJ Trust and Banking Corporation, or MUTB. In addition, commission fees have been reduced for transactions conducted at convenience stores ATMs shared by multiple banks on week days between 8:45 am and 6 pm as BTMU and other eight local banks have mutually opened ATM networks to provide ATM services partially free of charge.

 

Furthermore, in October 2007, BTMU made an ATM alliance with AEON bank. As a result, BTMU customers can currently make withdrawals from approximately 40,000 ATMs in Japan free of charge on weekdays between 8:45 am and 6:00 pm.

 

“Jibun Bank Corporation”, a joint venture company between BTMU and KDDI CORPORATION, started its banking business in July 2008, Jibun Bank Corporation offers comprehensive retail banking services through mobile phone network. For example, account holders can transfer funds to another account holder using the recipient’s mobile phone number as the identification code and the “mobile phone pass book” acts as both a bank pass book and a simplified housekeeping book on the account holder’s mobile phone.

 

   

Strategic Alliances

 

To strengthen the retail online securities business and offer more comprehensive Internet-based financial services, we acquired additional shares of common stock of kabu.com Securities Co., Ltd. through two tender offers conducted in April and December 2007. Moreover, we acquired additional shares of kabu.com Securities, which had been held by the MUFG Group, resulting in our ownership to approximately 41%. We aim to strengthen our alliance with kabu.com Securities by, among other things, launching a bank agency business, jointly promoting kabu.com Securities’ PTS business and promoting kabu.com Securities’ financial product intermediation business.

 

In July 2008, BTMU acquired 49.375% of the shares of JALCARD, Inc. a wholly owned subsidiary of Japan Airline International Co., Ltd. As a result, JALCARD became an equity-method affiliate of both BTMU and MUFG.

 

As a result of this business alliance, JALI plans to grant BTMU certain priority rights relating to the issuance of JALCARD, which is a frequent flyer program card with a credit function. We aim to enhance customer service and increase our profit through the synergy effects of increasing our customer base, by capitalizing on the collective products and services and brand of MUFG and the JAL group.

 

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In November 2007, MUFG acquired newly issued shares of Mitsubishi UFJ NICOS common stock. In May 2008, MUFG entered into a share exchange agreement with Mitsubishi UFJ NICOS. Through a share exchange that became effective on August 1, 2008, pursuant to this agreement, Mitsubishi UFJ NICOS became a wholly owned subsidiary of MUFG.

 

   

Trust Agency Operations.

 

As of the end of July 2007, BTMU is conducting the following eight businesses as the trust banking agent for MUTB: testamentary trusts, inheritance management, asset succession planning, inheritance management agency operations , business management financial clinic, lifetime gift trusts, share disposal trusts, and marketable securities administration trusts.

 

In October 2006 BTMU accepted approximately 30 financial consultants (sales managers specializing in inheritance business) from MUTB. Because of Japan’s increasingly aging society, customer demand for inheritance-related advice is increasing and we aim to significantly strengthen our ability to collect the relevant information from the banking market.

 

Corporate Banking Business Unit

 

As part of Mitsubishi UFJ Financial Group’s Integrated Corporate Banking Business Group, our corporate banking business unit provides banking products and services to a wide range of business customers, from large corporations to medium-sized and small businesses, and is also responsible for customer relationships. We provide services through 324 offices in Japan, and also directly from our headquarters. The unit provides traditional commercial banking services, such as deposits, settlement, foreign exchange and loans, as well as investment banking services, electronic banking and highly sophisticated consultancy services to meet our customers’ needs. The unit works closely with our other business units, such as the global business unit and the global markets unit.

 

   

CIB (Corporate and Investment Banking)

 

The unit provides CIB solutions mainly to large corporations, financial institutions and public sector organizations. Product specialists in our unit globally provide capital markets, derivatives, securitization, syndicated loans, structured finance and other services. Customers with the needs in M&A transactions and debt and equity capital markets are referred to MUS, the securities arm of the Mitsubishi UFJ Financial Group; therefore we can fully meet our customers’ needs in CIB services as a whole.

 

Capital Markets.    The unit provides arrangement services relating to private placements for mainly medium-sized enterprise issuers and institutional investors. During the fiscal year ended March 31, 2008, we arranged 4,318 issuances totaling ¥948.0 billion.

 

Derivatives.    The unit develops and offers derivatives products for risk management and other financial needs. The unit has trading desks and sales teams specializing in derivatives.

 

Securitization.    In the securitization area, the unit is primarily engaged in asset-backed commercial paper programs and has securitization teams based in Tokyo, New York and London. The unit continues to develop and structure new types of transactions.

 

Syndicated loans.    The unit structures and syndicates many types of loan transactions, including term loans, revolving credit and structured transactions. The unit has loan syndication operations in Tokyo, New York, London, Hong Kong and Singapore. We arranged syndicated loans with an aggregate principal amount totaling $109.4 billion in the fiscal year ended March 31, 2008.

 

Structured finance.    The unit engages in project finance, real estate finance, lease related finance, leveraged finance, and other types of non-recourse or limited-recourse and structured financings. The unit provides customers with financial advisory services, loan arrangements and agency services. The unit has teams located in Tokyo, Hong Kong, Singapore, London, New York and Boston.

 

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Other services.    In the United States, the unit offers leasing services through two subsidiaries, BTMU Capital Corporation and BTMU Leasing & Finance. BTMU Capital Corporation offers a wide range of leasing services to non-Japanese customers, while BTMU Leasing & Finance focuses on providing services to subsidiaries and affiliates of Japanese corporations in the United States.

 

   

Commercial Banking

 

Financing and fund management.    The unit advises on financing methods to meet various financing needs, including loans with derivatives, corporate bonds, commercial paper, asset backed securities, securitization programs and syndicated loans. The unit also offers a wide range of products to meet fund management needs, such as deposits with derivatives, government bonds, debenture notes and investment funds.

 

Advice on business expansion overseas.    The unit provides advisory services to clients launching businesses overseas, particularly for Japanese companies expanding into other Asian countries.

 

Risk management.    The unit offers swaps, options and other types of risk-hedge programs for customers seeking to reduce various business risks such as interest rate risks and exchange rate risks.

 

Corporate management/financial strategies.    The unit provides advisory services to customers in the areas of mergers and acquisitions, inheritance-related business transfers and stock listings. The unit also helps customers develop financial strategies to restructure their balance sheets. These strategies include the use of credit lines, factoring services and securitization of real estate.

 

Corporate welfare facilities.    The unit offers products and administrative services to help customers with employee benefit plans. As a service to customers, the unit often provides housing loans to their employees. The unit also provides company-sponsored employee savings plans and defined contribution plans.

 

   

Transaction Banking

 

Settlement services.    The unit provides online banking services that allow customers to electronically conduct financial transactions such as domestic and overseas remittances. The unit’s settlement and cash management services include global settlement services, Global Cash Management Services, a global pooling/netting service, and Treasury Station, a fund management system for group companies. These services are particularly useful to customers who do business worldwide.

 

Global Business Unit

 

Our global business unit provides a full range of banking services not only to the overseas operations of Japanese corporations but also to non-Japanese corporations. The unit serves these customers through a global network of 59 overseas branches and sub-branches, 15 representative offices and overseas subsidiary banks.

 

Overseas business support.    The unit provides a full range of financial services to support customers’ overseas activities, including financing, settlement and custody services, in cooperation with other business units, divisions and groups such as the global markets unit, the corporate banking business unit and the trust business division. These financial services are also offered through subsidiaries such as MUS, Mitsubishi UFJ Securities International plc and BTMU Capital Corporation.

 

Global Cash Management Service.    The unit offers the Global Cash Management Service through its foreign branches in corporation with the eBusiness & IT initiatives division. This service allows customers to monitor their foreign accounts and make remittances through their personal computers.

 

Banking Operation in the United States.    With a particular focus on California, the unit provides a wide range of financial services to consumers, small businesses, middle-market companies and major corporations through UnionBanCal Corporation, or UNBC, a publicly traded U.S. commercial bank holding company listed

 

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on the NYSE. As of March 31, 2008, we owned 65% of UNBC and UNBC comprised, and continues to comprise, a significant portion of our global business unit. Union Bank of California, N.A., or UBOC, UNBC’s subsidiary, is one of the largest commercial banks in California based on total assets and total deposits. On August 29, 2008, BTMU commenced a cash tender offer for all of the outstanding common shares of UNBC not held by us to make UNBC our wholly owned subsidiary. For more information on the tender offer and the planned second-step merger, see “Item 5. Operating and Financial Review and Prospects—Recent Developments.”

 

Global Markets Unit

 

The global markets unit is active in international financial markets, with global markets divisions in Tokyo, New York, London, Singapore and Hong Kong. The three primary functions of the global markets unit are sales and trading, Asset and Liability Management (ALM) and strategic portfolio investment. Additionally, the global markets unit manages our overall credit portfolio with the corporate banking business unit.

 

The three main functions of the global markets unit are as follows:

 

Sales and Trading.    The global markets unit is a leading market maker for derivatives and foreign exchange markets in Tokyo. It has a large market share in the US dollar-Japanese yen foreign exchange and currency options markets, as well as in other major cross-yen currency pairs. The unit also actively trades in the Japanese government bonds secondary market. In addition, it works with our other business units to provide various financial products for customers, such as interest rate derivatives, foreign currency forward agreements, currency options and commercial paper.

 

ALM: Asset Liability Management.    The global markets unit is responsible for our asset and liability management, and centrally monitors and manages all interest rate and liquidity risks by utilizing U.S. and Japanese government securities, asset-backed securities, interest rate swaps, futures and options. We are a leader in yen-dominated markets. The global markets unit is also globally active in the international money markets.

 

Strategic Portfolio Investment.    The global markets unit also manages our strategic investment portfolio. In order to enhance returns, we manage the portfolio utilizing well-diversified investment tools, including exchange traded funds and commodity funds.

 

In addition to the three functions above, the global markets unit also provides the following function:

 

Credit Portfolio Management.    The global markets unit and the corporate banking business unit manage credit risks, utilizing credit derivatives or distributing loans to investors, in order to optimize the return/risk of our overall credit portfolio.

 

Operations and Systems Unit

 

Through the operations and systems unit, we provide operations and settlement services to our other business units. The unit also earns fee income by providing settlement and remittance services, including correspondent banking services, to our customers and yen custody services to international institutional investors. In addition, the unit also offers competitive operations and settlement services to other financial institutions to meet their outsourcing needs.

 

Operations services.    The operations services planning division of our operations and systems unit provides operations services for the commercial banking activities of the retail banking, corporate banking and global business units. We have expanded centralized processes at our operations centers, which increases the efficiency of our branch offices.

 

The retail operations planning division controls operational procedures at our branch offices, and provides guidance, assistance, education, and training for them. Our retail operations planning division is under a joint supervision by the operations and systems unit as well as the retail banking business unit.

 

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The trade business division offers outsourcing services in foreign remittance, export and import operations for Japanese financial institutions. As of March 31, 2008, 90 Japanese banks utilized our foreign remittance services offered under our Global Operation Automatic Link (GOAL) service, and 69 Japanese banks outsourced their export and import operations to us.

 

Correspondent banking and settlement.    The transaction services division (formerly named the payment and clearing services division) of our operations and systems unit maintains financial institutions’ accounts with correspondent arrangements. As of March 31, 2008, we had correspondent arrangements with 3,008 foreign banks and other financial institutions, of which 1,771 had yen settlement accounts with us. We also had correspondent arrangements with 133 Japanese financial institutions, for which we held 185 yen and foreign currency accounts.

 

The Foreign Exchange Yen Clearing System (FXYCS) in Japan introduced an entrustment procedure for yen clearing through which banks may entrust other banks to conduct yen clearing for them. As of March 31, 2008, 63 regional and foreign banks in Japan outsourced their yen clearing operations to us. We handled approximately 31% of these transactions based on transaction amounts and are a market leader in the yen settlement business.

 

Our transaction services division is also taking the initiative in the global implementation of the Continuous Linked Settlement (CLS) operation, which is intended to eliminate settlement risks when foreign exchange deals are settled. Further, since December 2006, the division is responsible for the custody business for international institutional investors who invest in Japanese yen securities.

 

Indirect interface channels.    The retail banking customer center, the retail banking video counter center and the corporate banking customer service center conduct retail & corporate banking operations through indirect interface channels such as internet, television, telephone and mobile phones. The direct channel services division is in charge of supervising the operations of the three centers.

 

The systems division is responsible for our computer systems.

 

Other Business Division

 

In addition to the above, we also have other divisions, including:

 

   

trust and asset management business promotion for companies, including defined contribution plans;

 

   

eBusiness & IT initiatives, which is responsible for developing and overseeing our information technology as well as related business opportunities; and

 

   

the corporate center, which retains functions such as our strategic planning, overall risk management, internal auditing and compliance.

 

Competition

 

We face strong competition in all of our principal areas of operation. The deregulation of the Japanese financial markets as well as structural reforms in the regulation of the financial industry have resulted in dramatic changes in the Japanese financial system. Structural reforms have prompted Japanese banks to merge or reorganize their operations, thus changing the nature of the competition from other financial institutions as well as from other types of businesses.

 

Japan

 

Deregulation.    Competition in Japan has intensified as a result of the relaxation of regulations relating to Japanese financial institutions. Most of the restrictions that served to limit competition were lifted before 2000. Deregulation has eliminated barriers between different types of Japanese financial institutions, which are now able to compete directly against one another. Deregulation and market factors have also facilitated the entry of various large foreign financial institutions into the Japanese domestic market.

 

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The Banking Law, as amended, now permits banks to engage in the securities business by establishing or otherwise owning domestic and overseas securities subsidiaries with the approval of the Financial Services Agency, an agency of the Cabinet Office. The Banking Law is expected to be further amended in the fall of 2008 to expand the range of permitted business. Further increases in competition among financial institutions are expected in these new areas of permissible activities.

 

In terms of recent market entrants, other financial institutions, such as Orix Corporation, and non-financial companies have also begun to offer various banking services, often through non-traditional distribution channels. Also, in recent years, various large foreign financial institutions have significantly expanded their presence in the Japanese domestic market. Citigroup, for example, has expanded its banking activities and moved aggressively to provide investment banking and other financial services, including retail services, and, through its recent acquisition of Nikko Cordial Corporation, securities brokerage services. The privatization of Japan Post, a government-run public services corporation that is the world’s largest holder of deposits, and the establishment of Japan Post Bank Co., Ltd. that followed in October 2007, as well as the planned privatization of other governmental financial institutions, could also substantially increase competition within the financial services industry.

 

In the corporate banking sector, the principal effect of these reforms has been the increase in competition as two structural features of Japan’s highly specialized and segmented financial system have eroded:

 

   

the separation of banking and securities businesses in Japan; and

 

   

the distinctions among the permissible activities of Japan’s two principal types of private banking institutions. For a discussion of the two principal types of private banking institutions, see “—The Japanese Financial System.”

 

In addition, in recent years, Japanese corporations are increasingly raising funds by accessing the capital markets, both within Japan and overseas, resulting in a decline in demand for loan financing. Furthermore, as foreign exchange controls have been generally eliminated, customers can now have direct access to foreign financial institutions, with which we must also compete.

 

In the consumer banking sector, deregulation has enabled banks to offer customers an increasingly attractive and diversified range of products. For example, banks may now sell investment trusts and insurance products. We will face competition in this sector from other private financial institutions including Japan Post Group companies. Recently, competition has also increased due to the development of new products and distribution channels. For example, Japanese banks have started competing with one another by developing innovative proprietary computer technologies that allow them to deliver basic banking services in a more efficient manner and to create sophisticated new products in response to customer demand.

 

The trust assets business is a promising growth area that is competitive and becoming more so because of changes in the industry. In addition, there is growing corporate demand for change in the trust regulatory environment, such as reform of the pension system and related accounting regulations under Japanese GAAP. However, competition may increase in the future as regulatory barriers to entry are lowered. The amendment to the trust business law that came into effect on December 30, 2004 expanded the types of property that can be entrusted and allowed non-financial companies to conduct trust business upon approval, among other things. The amended trust business law also adopted a type of registration for companies that wish to conduct only the administration type trust business. These regulatory developments have facilitated the expansion of the trust business, but competition in this area has also intensified.

 

Integration.    Another major reason for heightened competition in Japan is the integration and reorganization of Japanese financial institutions. In 1998, amendments were made to the Banking Law to allow the establishment of bank holding companies, and this development together with various factors, such as the decline of institutional strength caused by the bad loan crisis and intensifying global competition, resulted in a number of integrations involving major banks in recent years.

 

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Foreign

 

In the United States, we face substantial competition in all aspects of our business. We face competition from other large US and foreign-owned money-center banks, as well as from similar institutions that provide financial services. Through Union Bank of California N.A., or UBOC, we currently compete principally with US and foreign-owned money-center and regional banks, thrift institutions, insurance companies, asset management companies, investment advisory companies, consumer finance companies, credit unions and other financial institutions.

 

In other international markets, we face competition from commercial banks and similar financial institutions, particularly major international banks and the leading domestic banks in the local financial markets in which we conduct business.

 

The Japanese Financial System

 

Japanese financial institutions may be categorized into three types:

 

   

the central bank, namely the Bank of Japan;

 

   

private banking institutions; and

 

   

government financial institutions.

 

The Bank of Japan

 

The Bank of Japan’s role is to maintain price stability and the stability of the financial system to ensure a solid foundation for sound economic development.

 

Private Banking Institutions

 

Private banking institutions in Japan are commonly classified into two categories (the following numbers are based on available information published by the Financial Services Agency as of August 19, 2008):

 

   

ordinary banks (130 ordinary banks and 63 foreign commercial banks with ordinary banking operations); and

 

   

trust banks (20 trust banks).

 

Ordinary banks in turn are classified as city banks, of which there are five, including us, and regional banks, of which there are 110 and other banks, of which there are 15. In general, the operations of ordinary banks correspond to commercial banking operations in the United States. City banks and regional banks are distinguished based on head office location as well as the size and scope of their operations.

 

The city banks are generally considered to constitute the largest and most influential group of banks in Japan. Generally, these banks are based in large cities, such as Tokyo, Osaka and Nagoya, and operate nationally through networks of branch offices. City banks have traditionally emphasized their business with large corporate clients, including the major industrial companies in Japan. However, in light of deregulation and other competitive factors, many of these banks, including us, in recent years have increased their emphasis on other markets, such as small and medium-sized companies and retail banking.

 

With some exceptions, the regional banks tend to be much smaller in terms of total assets than the city banks. Each of the regional banks is based in one of the Japanese prefectures and extends its operations into neighboring prefectures. Their clients are mostly regional enterprises and local public utilities, although the regional banks also lend to large corporations. In line with the recent trend among financial institutions toward mergers or business tie-ups, various regional banks have announced or are currently negotiating or pursuing integration transactions, in many cases in order to be able to undertake the large investments required in information technology.

 

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Trust banks provide various trust services relating to money trusts, pension trusts and investment trusts and offer other services relating to real estate, stock transfer agency and testamentary services as well as banking services.

 

In recent years, almost all of the city banks have consolidated with other city banks and also, in some cases, with trust banks. Integration among these banks was achieved, in most cases, through the use of a bank holding company.

 

In addition to ordinary banks and trust banks, other private financial institutions in Japan, including shinkin banks or credit associations, and credit cooperatives, are engaged primarily in making loans to small businesses and individuals.

 

Government Financial Institutions

 

Since World War II, a number of government financial institutions have been established. These corporations are wholly owned by the government and operate under its supervision. Their funds are provided mainly from government sources. Certain types of operations currently undertaken by these institutions are planned to be assumed by, or integrated with the operations of, private corporations through privatization and other measures.

 

Among them are the following:

 

   

The Development Bank of Japan, whose purpose is to contribute to the economic development of Japan by extending long-term loans, mainly to primary and secondary sector industries, which is scheduled to be privatized on October 1, 2008;

 

   

Japan Bank for International Cooperation, whose purpose is to supplement and encourage the private financing of exports, imports, overseas investments and overseas economic cooperation;

 

   

Japan Finance Corporation for Small and Medium Enterprise, National Life Finance Corporation, and The Agriculture, Forestry and Fisheries Finance Corporation, the purpose of each of which is to supplement private financing in its relevant field of activity; and

 

   

The Postal Service Agency, which was reorganized in April 2003 into Japan Post Bank Co., Ltd., a government-run public services corporation which was privatized on October 1, 2007.

 

Supervision and Regulation

 

Japan

 

Supervision.    As a result of the deregulation and structural reforms in the Japanese financial industry, Japanese financial institutions gained the opportunity to provide a wider range of financial products and options to their clients, while at the same time becoming subject to stricter control and supervision.

 

After several reorganizations of Japanese governmental agencies, the Financial Services Agency was established as an agency of the Cabinet Office in 1998. It is responsible for supervising and inspecting financial institutions, making policy for the overall Japanese financial system and conducting insolvency proceedings with respect to financial institutions. The Bank of Japan, as the central bank for financial institutions, conducts “on-site inspections,” in which its staff visits financial institutions and inspects the assets and risk management systems of those institutions.

 

The Banking Law.    Among the various laws that regulate financial institutions, the Banking Law and its subordinated orders and ordinances are regarded as the fundamental law for ordinary banks and other private financial institutions. The Banking Law addresses bank holding companies, capital adequacy, inspections and reporting, as well as the scope of business activities, disclosure, accounting, limitation on granting credit and standards for arm’s length transactions. In addition, the amendment to the Banking Law which came into effect

 

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in April 2006 relaxed the standards relating to bank-agent eligibility, which encourages to encourage banks to expand their operations through the use of bank agents. Banks and other financial institutions will be required to establish an internal control system to cope with conflicts of interest as a result of the recent amendments to the Financial Instruments and Exchange Law, Banking Law and Insurance Business Law which are to take effect by June 2009.

 

Bank holding company regulations.    A bank holding company is prohibited from carrying on any business other than the management of its subsidiaries and other incidental businesses. A bank holding company may have any of the following as a subsidiary: a bank, a securities company, an insurance company and a foreign subsidiary that is engaged in the banking, securities or insurance business. In addition, a bank holding company may have as a subsidiary any company that is engaged in a finance-related business, such as a credit card company, a leasing company or an investment advisory company. Certain companies that are designated by a ministerial ordinance at those that cultivate new business fields may also become the subsidiary of a bank holding company. The recent amendment to the Banking Law which is to take effect by June 2009 will expand a range of permitted subsidiaries. Particularly this amendment will permit a bank holding company which satisfies certain requirement on financial soundness and appropriate risk control to have a subsidiary engaging in commodity transactions.

 

Capital adequacy.    The capital adequacy guidelines adopted by the Financial Services Agency that are applicable to Japanese bank holding companies and banks with international operations closely follow the risk-weighted approach introduced by the Basel Committee on Banking Supervision of the Bank for International Settlements, or BIS. In June 2004, the Basel Committee released revised standards called “International Convergence of Capital Measurement and Capital Standards: A Revised Framework,” or Basel II, which has become applicable to Japanese banks since the end of March 2007. Basel II has three core elements, or “pillars”: requiring minimum regulatory capital, the self-regulation of financial institutions based on supervisory review, and market discipline through the disclosure of information. Basel II is based on the belief that these three “pillars” will collectively ensure the stability and soundness of financial systems, and also reflect the nature of risks at each bank more closely. These amendments do not change the minimum capital requirements applicable to internationally active banks.

 

Basel II provides more risk-sensitive approaches and a range of options for measuring risks and determining the capital requirements. As a result, Basel II also reflects the nature of risks at each bank more closely. Under Basel II, MUFG and its subsidiary banks, including us, adopted the Foundation Internal Ratings-Based Approach, or IRB approach, to calculate capital requirements for credit risk. The Standardised Approach is used for some subsidiaries that are considered to be immaterial to the overall MUFG capital requirements and a few subsidiaries adopted a phased rollout of the IRB approach. MUFG and its subsidiary banks adopted the Standardised Approach to calculate capital requirements for operational risk. As for market risk, MUFG and its subsidiary banks, including us, adopted the Internal Models Approach mainly to calculate general market risk and adopted the Standardised Methodology to calculate specific risk.

 

The capital adequacy guidelines are in accordance with the standards of the Bank for International Settlement for a target minimum standard ratio of capital to modified risk-weighted assets of 8.0% on both consolidated and non-consolidated bases for banks with international operations, including us and MUTB or on a consolidated basis for bank holding companies with international operations, such as MUFG. Modified risk-weighted assets is the sum of risk-weighted assets compiled for credit risk purposes, market risks equivalent amount divided by 8% and operational risks equivalent amount divided by 8%. The capital adequacy guidelines place considerable emphasis on tangible common stockholders’ equity as the core element of the capital base, with appropriate recognition of other components of capital.

 

Capital is classified into three tiers, referred to as Tier I, Tier II and Tier III. Tier I capital generally consists of stockholders’ equity items, including common stock, preferred stock, capital surplus, retained earnings (which includes deferred tax assets) and minority interests, but recorded goodwill and other items, such as treasury stock, are deducted from Tier I capital. Tier II capital generally consists of:

 

   

The amount (up to a maximum of 0.6% of credit risk-weighted assets) that eligible reserves for credit losses exceed expected losses in the IRB approach, and general reserves for credit losses, subject to a

 

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limit of 1.25% of modified risk-weighted assets in the partial use of the Standardised Approach (including a phased rollout of the IRB approach);

 

   

45% of the unrealized gains on investment securities classified as “other securities” under Japanese accounting rules;

 

   

45% of the land revaluation excess;

 

   

the balance of perpetual subordinated debt; and

 

   

the balance of subordinated term debt with an original maturity of over five years and preferred stock with a maturity up to 50% of Tier I capital.

 

Tier III capital generally consists of short-term subordinated debt with an original maturity of at least two years and which is subject to a “lock-in” provision, which stipulates that neither interest nor principal may be paid if such payment would cause the bank’s overall capital amount to be less than its minimum capital requirement. At least 50% of the minimum total capital requirements must be maintained in the form of Tier I capital.

 

Amendments to the capital adequacy guidelines limiting the portion of Tier I capital consisting of deferred tax assets became effective on March 31, 2006. The restrictions are targeted at major Japanese banks and their holding companies, which include Mitsubishi UFJ Financial Group, Inc. and its subsidiary banks. The cap was initially set at 40% for the fiscal year ended March 31, 2006 and 30% for the fiscal year ended March 31, 2007. It has been lowered to 20% since the fiscal year ending March 31, 2008. The banks subject to the restrictions will not be able to reflect any deferred tax assets that exceed the relevant limit in their capital adequacy ratios.

 

Inspection and reporting.    By evaluating banks’ systems of self-assessment, auditing their accounts and reviewing their compliance with laws and regulations, the Financial Services Agency monitors the financial soundness of banks, including the status and performance of their control systems for business activities. The Financial Services Agency implemented the Financial Inspection Rating System (“FIRST”) for deposit-taking financial institutions which has become applicable since April 1, 2007. By providing inspection results in the form of graded evaluations (i.e., ratings), the Financial Services Agency expects this rating system to motivate financial institutions to voluntarily improve their management and operations. Additionally, the Financial Services Agency currently takes the “better regulation” approach in its financial regulation and supervision. This consists of four pillars: optimal combination of rules-based and principles-based supervisory approaches; timely recognition of priority issues and effective response; encouraging voluntary efforts by financial firms and placing greater emphasis on providing them with incentives; improving the transparency and predictability of regulatory actions, in pursuit of improvement of the quality of financial regulation and supervision.

 

The Financial Services Agency, if necessary to secure the sound and appropriate operation of a bank’s business, may request the submission of reports or materials from, or conduct an on-site inspection of, the bank or the bank holding company. If a bank’s capital adequacy ratio falls below a specified level, the Financial Services Agency may request the bank to submit an improvement plan and may restrict or suspend the bank’s operations when it determines that action is necessary.

 

The Bank of Japan also conducts inspections of banks similar to those undertaken by the Financial Services Agency. The Bank of Japan Law provides that the Bank of Japan and financial institutions may agree as to the form of inspection to be conducted by the Bank of Japan.

 

Laws limiting shareholdings of banks.    The provisions of the Anti-Monopoly Law that prohibit a bank from holding more than 5% of another company’s voting rights do not apply to a bank holding company. However, the Banking Law prohibits a bank holding company and its subsidiaries from holding, on an aggregated basis, more than 15% of the voting rights of companies other than those which can legally become subsidiaries of bank holding companies.

 

On September 30, 2006, a law which imposes a limitation on a bank’s shareholding of up to the amount equivalent to its Tier I capital took effect.

 

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Financial Instruments and Exchange Law.    The Financial Instruments and Exchange Law amending the Securities and Exchange Law in its most parts became effective on September 30, 2007. The new law not only preserves the basic concepts of the Securities and Exchange Law, but is also intended to further protect investors. The new law also regulates sales of a wide range of financial instruments and services, requiring financial institutions to revise their sales rules and strengthen compliance frameworks and procedures accordingly. Among the instruments that the Japanese banks deal with, derivatives, foreign currency denominated deposits, and variable insurance and annuity products are subject to regulations that are applicable to securities covered by sales-related rules of conduct.

 

Article 33 of the Financial Instruments and Exchange Law generally prohibits banks from engaging in the securities business, as it was provided in Article 65 of the Securities and Exchange Law. Under certain circumstances, registered banks are allowed to provide securities intermediation services and certain types of securities business.

 

The recent amendment to the Banking Law which is to take effect by June 2009 will require a bank to implement an internal system to appropriately control and monitor conflict of interest issues among a bank and its affiliated financial institutions, including a securities company and an insurance company.

 

Anti-money laundering laws.    Under the Law for Punishment of Transfer of Criminal Proceeds, banks and other financial institutions are required to report to the competent minister, in the case of banks, the Commissioner of the Financial Services Agency, any assets which they receive while conducting their businesses that are suspected of being illicit profits from criminal activity.

 

Law concerning trust business conducted by financial institutions.    Under the Trust Business Law, joint stock companies that are licensed by the Prime Minister as trust companies are allowed to conduct trust business. In addition, under the Law Concerning Concurrent Operation for Trust Business by Financial Institutions, banks and other financial institutions, as permitted by the Prime Minister, are able to conduct trust business. The Trust Business Law was amended in December 2004 to expand the types of property that can be entrusted, to allow non-financial companies to conduct trust business and to allow a new type of registration for trustees who conduct only administration type trust business. The trust business Law was further amended in December 2006, in order to cope with new types of trust and to amend the duties imposed on the trustee in accordance with the sweeping amendment to the Trust Law.

 

Deposit insurance system and government investment in financial institutions.    The Deposit Insurance Law is intended to protect depositors if a financial institution fails to meet its obligations. The Deposit Insurance Corporation was established in accordance with that law.

 

City banks, regional banks, trust banks, and various other credit institutions participate in the deposit insurance system on a compulsory basis.

 

Under the Deposit Insurance Law, the maximum amount of protection is ¥10 million per customer within one bank. Since April 1, 2005, all deposits are subject to the ¥10 million maximum, except non-interest bearing deposits that are redeemable on demand and used by the depositor primarily for payment and settlement functions or, the settlement accounts, which are fully protected without a maximum amount limitation. Currently, the Deposit Insurance Corporation charges insurance premiums equal to 0.108% on the deposits in current accounts, ordinary accounts and other similar accounts, which are fully protected as mentioned above, and premiums equal to 0.081% on the deposits in other accounts.

 

Starting in April 2001, amendments to the Deposit Insurance Law established a new framework which enables the Deposit Insurance Corporation to inject capital into a bank if the Commissioner of the Financial Services Agency recognizes that it must do so to guard against financial systemic risk.

 

On June 14, 2004, the Strengthening Financial Functions Law was enacted to establish a new framework for injecting public funds into financial institutions. The Strengthening Financial Functions Law broadens the range of financial institutions eligible to receive public funds and facilitates the preventive injection of public funds

 

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into troubled or potentially troubled financial institutions in order to avert financial crises. However, due date for this applications for public-funds injection under the Strengthening Financial Functions Law was March 31, 2008, and was not extended.

 

Personal Information Protection Law.    With regards to protection of personal information, current Personal Information Protection Law became fully effective on April 1, 2005. Among other matters, the law requires Japanese banking institutions to limit the use of personal information to the stated purpose and to properly manage the personal information in their possession, and forbids them from providing personal information to third parties without consent. If a bank violates certain provisions of the law, the Financial Services Agency may advise or order the bank to take proper action. The Financial Services Agency announced related guidelines for the financial services sector in December 2004.

 

Law concerning Protection of Depositors from Illegal Withdrawals Made by Counterfeit or Stolen Cards.    This law became effective in February 2006, and requires financial institutions to establish internal systems to prevent illegal withdrawals of deposits made using counterfeit or stolen bank cards. The law also requires financial institutions to compensate depositors for any amount illegally withdrawn using counterfeit bank cards, unless the financial institution can verify that it acted in good faith without negligence, and there is gross negligence on the part of the relevant account holder.

 

Recent Regulatory Actions.    In February 2007, BTMU received an administrative order from the Financial Services Agency of Japan in respect of compliance management at certain of its operations regarding the occurrence of certain inappropriate transactions. The administrative order required, among other things, temporary suspensions of credit extensions to new corporate customers, training of all staff and directors regarding compliance, temporary suspension of the establishment of new domestic corporate business locations, strengthening of the management and internal control framework, presentation and implementation of a business improvement plan, and reports on the progress of such business improvement plan. Further, in June 2007, BTMU received separate administrative orders from the Financial Services Agency of Japan in respect of its overseas business and its investment trust sales and related business. The administrative orders require BTMU to make improvements of its compliance structure and related internal control functions in its overseas business and its domestic investment trust sales and related business, presentation and implementation of a business improvement plan, and reports on the progress of such business improvement plan.

 

Proposed government reforms to restrict maximum interest rates on consumer lending business.    The Japanese government is implementing regulatory reforms affecting the consumer lending industry. In December 2006, the Diet passed legislation to reduce the maximum permissible interest rate under the Law Concerning Acceptance of Investment, Cash Deposit and Interest Rate etc., which is currently 29.2% per annum, to 20% per annum. Currently, consumer finance companies are able to charge interest rates exceeding the limits stipulated by the Interest Rate Restriction Law provided that they satisfy certain conditions set forth in the Law Concerning Lending Business. Accordingly, BTMU’s consumer finance subsidiaries and equity method investees offer loans at interest rates above the Interest Rate Restriction Law. This so-called “gray-zone interest” will be abolished as well. Such reduction in the maximum permissible interest rate will be implemented before mid-2010. Under the reforms, all interest rates will be subject to the lower limits (15-20% per annum) imposed by the Interest Rate Restriction Law, which will compel, or has already compelled lending institutions to lower the interest rates they charge borrowers.

 

In addition, currently, consumer finance companies that satisfy certain conditions are able to charge interest rates exceeding the limits stipulated by the Interest Rate Restriction Law. Recently, the Supreme Court of Japan passed decisions concerning interest exceeding the limits stipulated by the Interest Rate Restriction Law, and the business environment for consumer finance companies in Japan has been altered in favor of borrowers. Due to such environmental changes, borrowers’ demands for reimbursement of such excess interest that they have once paid to the consumer finance companies have continued to be significantly high. Furthermore, new regulations that are scheduled to be effective before mid-2010 are expected to require, among other things, consumer finance companies to review the repayment capability of borrowers before lending, thereby limiting the amount of borrowing available to individual borrowers.

 

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United States

 

As a result of our operations in the United States, we are subject to extensive US federal and state supervision and regulation.

 

Overall supervision and regulation.    We are subject to supervision, regulation and examination with respect to our US operations, by the Board of Governors of the Federal Reserve System, or FRB, pursuant to the US Bank Holding Company Act of 1956, as amended, or BHCA, because we are a bank holding company, or BHC, and the International Banking Act of 1978, or IBA, because we are a foreign banking organization, or FBO.

 

The FRB functions as our “umbrella” supervisor under amendments to the BHCA effected by the Gramm-Leach-Bliley Act of 1999, or GLBA, which among other things:

 

   

prohibited further expansion of the types of activities in which bank holding companies, acting directly or through nonbank subsidiaries, may engage;

 

   

authorized qualifying bank holding companies to opt to become “financial holding companies,” (each a “FHC”) and thereby acquire the authority to engage in an expanded list of activities, including merchant banking, insurance underwriting and a full range of securities activities; and

 

   

modified the role of the Federal Reserve Board by specifying new relationships between the Federal Reserve Board and the functional regulators of nonbank subsidiaries of both bank holding companies and financial holding companies.

 

We have not elected to become a financial holding company.

 

Applicable U.S. banking laws generally prohibit a BHC or FBO that maintains branches or agencies in the United States from, directly or indirectly, acquiring more than 5% of the voting shares of any company engaged in nonbanking activities in the United States unless that BHC or FBO has elected to become a FHC or the FRB has determined, by order or regulation, that such nonbanking activities are so closely related to banking as to be a proper incident thereto and has granted its approval to the BHC or FBO for such an acquisition. These laws also require such BHC or FBO to obtain the prior approval of an appropriate federal banking authority before acquiring, directly or indirectly, the ownership of more than 5% of the voting shares or control of any US bank or BHC. In addition, under the BHCA, a US bank or a US branch or agency of a FBO is prohibited from engaging in various tying arrangements involving it or its affiliates in connection with any extension of credit, sale or lease of any property or provision of any services.

 

U.S. branches and agencies of subsidiary Japanese banks.    Under the authority of the IBA, we operate six branches, two agencies and five representative offices in the United States. We operate branches in Los Angeles and San Francisco, California; Chicago, Illinois; New York, New York; Portland, Oregon; and Seattle, Washington; agencies in Atlanta, Georgia and Houston, Texas; and representative offices in Washington, D.C; Minneapolis, Minnesota; Dallas, Texas; Jersey City, New Jersey; and Florence, Kentucky.

 

The IBA provides, among other things, that the FRB may examine US branches and agencies of foreign banks, and that each such branch and agency shall be subject to on-site examination by the appropriate federal or state bank supervisor as frequently as would a U.S. bank. The IBA also provides that if the FRB determines the FBO is not subject to comprehensive supervision or regulation on a consolidated basis by the appropriate authorities in its home country, or if there is reasonable cause to believe that the FBO or its affiliate has committed a violation of law or engaged in an unsafe or unsound banking practice in the United States, the Federal Reserve Board may order the foreign bank to terminate activities conducted at a branch or agency in the United States.

 

FBO US branches and agencies must be licensed, and are also supervised and regulated by a state or by the Office of the Comptroller of the Currency, or OCC, the federal regulator of national banks. All of our branches and agencies in the United States are state-licensed. Under US federal banking laws, state-licensed branches and

 

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agencies of foreign banks may engage only in activities that would be permissible for their federally-licensed counterparts, unless the FRB determines that the additional activity is consistent with sound practices. US federal banking laws also subject state-licensed branches and agencies to the single-borrower lending limits that apply to federal branches and agencies, which generally are the same as the lending limits applicable to national banks. However, local lending limit laws of the state in which an office is located will control, if they are more restrictive. In all cases, these limits are calculated based on the entire bank’s capital.

 

As an example of state supervision, our branch in New York is licensed by the New York State Superintendent of Banks, or the Superintendent, pursuant to the New York Banking Law. Under the New York Banking Law and the Superintendent’s Regulations, we must maintain with banks in the State of New York eligible assets as defined and in amounts determined by the Superintendent. The New York branch must also submit written reports concerning its assets and liabilities and other matters, to the extent required by the Superintendent, and is examined at periodic intervals by the New York State Banking Department. In addition, the Superintendent is authorized to take possession of our business and property located in New York whenever events specified in the New York Banking Law occur.

 

US subsidiary banks.    We own and control two US banks.

 

   

Bank of Tokyo-Mitsubishi UFJ Trust Company, New York, New York, or BTMUT.

 

   

UBOC through our subsidiary, UNBC, which is a registered bank holding company.

 

BTMUT is chartered by the State of New York and is subject to the supervision, examination and regulatory authority of the Superintendent pursuant to the New York Banking Law. UBOC is a national bank chartered by, and subject to the supervision, examination and regulatory authority of, the OCC pursuant to the National Bank Act.

 

The Federal Deposit Insurance Corporation, or FDIC, is the primary federal agency responsible for the supervision, examination and regulation of BTMUT. The FDIC may take enforcement action, including the issuance of prohibitive and affirmative orders, if it determines that a financial institution under its supervision has engaged in unsafe or unsound banking practices, or has committed violations of applicable laws or regulations. The FDIC insures the deposits of both BTMUT and UBOC. In the event of the irreparable financial degradation of an FDIC-insured bank or the occurrence of certain other substantial adverse events impacting such bank, the FDIC is virtually certain to be appointed as receiver, and would resolve the bank’s affairs consistent with the powers conferred under the Federal Deposit Insurance Act. Moreover, an FDIC-insured institution that is affiliated with a bank subject to FDIC receivership can be required to indemnify the FDIC for losses resulting from that receivership, even if this causes the affiliated FDIC-insured bank to also become subject to FDIC receivership. In the liquidation or other resolution of a failed FDIC-insured bank, the repayment of claims arising from deposits in its US offices, and other claims for administrative expenses and employee compensation, are afforded priority over other general unsecured claims, including claims arising from deposits in the same bank’s offices located outside the US, non-deposit obligations relating to all bank offices’ conduct of business and obligations to a parent company. Moreover, under longstanding FRB policy, a BHC is expected to act as a source of financial strength for its subsidiary banks and, to the extent it is able to do so, commit resources necessary to support the ongoing conduct of business by those banks.

 

Bank capital requirements and capital distributions.    Our US banking subsidiaries, BTMUT and UBOC, and UNBC, our US subsidiary bank holding company, are subject to applicable risk-based and leverage capital guidelines issued by US regulators for banks and bank holding companies. All of our US subsidiary banks are “well capitalized” under those guidelines as they apply to banks, and our US subsidiary bank holding company exceeds all minimum regulatory capital requirements applicable to domestic bank holding companies. The Federal Deposit Insurance Corporation Improvement Act of 1991, or FDICIA, provides, among other things, for expanded regulation of insured depository institutions, including banks, and their parent holding companies. As required by FDICIA, the federal banking agencies have established five capital tiers ranging from “well capitalized” to “critically undercapitalized” for each entity. As an entity’s capital position deteriorates, the

 

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federal banking regulators may take progressively stronger actions, such as further restricting affiliate transactions, activities, asset growth or interest payments. In addition, FDICIA generally prohibits an insured depository institution from making capital distributions, including the payment of dividends, or the payment of any management fee to its holding company if the insured depository institution would subsequently become “undercapitalized”.

 

The availability of dividends from insured depository institutions in the United States is limited by various other statutes and regulations. The National Bank Act and other federal laws prohibit the payment of dividends by a national bank under various circumstances and limit the amount a national bank can pay without the prior approval of the OCC. In addition, state-chartered banking institutions are subject to dividend limitations imposed by applicable federal and state laws.

 

Other regulated US subsidiaries.    Our non-bank subsidiaries that engage in securities-related activities in the United States are regulated by appropriate functional regulators, such as the Securities and Exchange Commission (“SEC”), any self-regulatory organizations of which they are members, and the appropriate state regulatory agencies. These non-bank subsidiaries are required to meet separate minimum capital standards as imposed by those regulatory authorities.

 

The GLBA removed almost all of the pre-existing statutory barriers to affiliations between commercial banks and securities firms by repealing Sections 20 and 32 of the Glass-Steagall Act. At the same time, however, the so-called GLBA “push-out” provisions narrowed the exclusion of banks, including the US branches of foreign banks, from the definitions of “broker” and “dealer” under the Securities Exchange Act of 1934, potentially requiring all such banks to transfer some formerly excluded securities activities they conducted to broker-dealers. The SEC has issued rules regarding the push-out of “dealer” functions that became effective on September 30, 2003 has issued rules regarding the push-out requirements for “broker” functions that became effective on September 28, 2007. The rules must be complied with on the first day of each banks’ fiscal year commencing after September 30, 2008. At this time, we do not believe that these push-out rules as adopted will have a significant impact on our business as currently conducted in the United States.

 

Anti-Money Laundering Initiatives and the USA PATRIOT Act.    A major focus of US governmental policy relating to financial institutions in recent years has been aimed at preventing money laundering and terrorist financing. The USA PATRIOT Act of 2001 substantially broadened the scope of US anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties, and expanding the extra-territorial application of those legal authorities. The US Department of the Treasury has issued a number of implementing regulations that impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing, and to verify the identity of their customers. In addition, the bank regulatory agencies carefully scrutinize the adequacy of an institution’s policies, procedures and controls. As a result, there has been an increased number of regulatory sanctions and law enforcement authorities have been taking a more active role. Failure of a financial institution to maintain and implement adequate policies, procedures and controls to prevent money laundering and terrorist financing could in some cases have serious legal and reputational consequences for the institution, including the incurring of expenses to enhance the relevant programs, the imposition of limitations on the scope of their operations, and the imposition of fines and other monetary penalties.

 

Recent Regulatory Actions.    In December 2006, MUFG and BTMU entered into a written agreement with the Federal Reserve Banks of San Francisco and New York and the New York State Banking Department, and BTMUT consented to an Order to Cease and Desist issued by the FDIC and the New York State Banking Department, to strengthen the compliance framework of BTMU, its New York Branch and BTMUT, respectively, for preventing anti-money laundering. As a result of the written agreement and the consent to the Order to Cease and Desist, we are required, among other things, to implement corrective measures, submit periodic progress reports to the authorities, and take other actions.

 

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Separately, on September 14, 2007, UBOC agreed to a Consent Order and payment of a civil money penalty of $10.0 million assessed concurrently by the OCC and US Financial Crimes Enforcement Network relating to its Bank Secrecy Act Anti-Money Laundering compliance controls and processes. On September 17, 2007, UBOC also entered into a deferred prosecution agreement with the US Department of Justice under which UBOC agreed to a payment of $21.6 million and the government agreed to defer prosecution of a Bank Secrecy Act Program violation primarily related to UBOC’s discontinued international banking business and to dismiss prosecution if UBOC meets the conditions of the deferred prosecution agreement, including complying with the OCC Consent Order for one year.

 

In October 2004, Union Bank of California International, or UBOCI, a UNBC subsidiary, entered into a written agreement with the Federal Reserve Bank of New York relating to its anti-money laundering controls and processes. With the liquidation of UBOCI in March 2007, the written agreement is no longer effective.

 

The SEC is also currently conducting an inquiry regarding marketing and distribution practices of mutual funds managed by a UBOC subsidiary. Neither we nor UNBC can be certain at this time as to the final results of that inquiry.

 

C.    Organizational Structure

 

MUFG is a holding company for BTMU, MUTB, MUS and other subsidiaries. Through its subsidiaries and affiliated companies, MUFG engages in a broad range of financial operations, including commercial banking, investment management, trust banking and asset management services, and securities business and provide related services to individual and corporate customers.

 

BTMU is a consolidated subsidiary of MUFG and, together with MUTB and MUS, is one of the core companies of the MUFG Group. Together with its subsidiaries and affiliated companies, BTMU engages in a broad range of financial operations, including commercial banking, credit card-related services and provides other financial services, including securities businesses and leasing services.

 

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Set forth below is a list of our principal consolidated subsidiaries at March 31, 2008:

 

Name

   Country of
incorporation
   Proportion of
ownership
interest (%)
   Proportion of
voting
interest (%)

Mitsubishi UFJ NICOS Co., Ltd.(1)

   Japan    47.25    47.29

The Senshu Bank, Ltd.

   Japan    67.87    68.03

NBL Co., Ltd.

   Japan    89.74    89.74

Kabu.com Securities Co., Ltd.

   Japan    41.14    41.14

BOT Lease Co., Ltd.

   Japan    17.57    17.57

Mitsubishi UFJ Factors Limited

   Japan    82.65    82.65

Mitsubishi UFJ Research and Consulting Ltd.

   Japan    49.56    49.56

MU Frontier Servicer Co., Ltd.

   Japan    94.44    94.44

Tokyo Associates Finance Corporation

   Japan    100.00    100.00

MU Business Engineering, Ltd.

   Japan    100.00    100.00

Tokyo Credit Services, Ltd.

   Japan    72.00    72.00

UnionBanCal Corporation(2)

   USA    65.40    65.40

Bank of Tokyo-Mitsubishi UFJ Trust Company(3)

   USA    100.00    100.00

BTMU Capital Corporation

   USA    100.00    100.00

BTMU Leasing & Finance, Inc.

   USA    100.00    100.00

Bank of Tokyo-Mitsubishi UFJ (Mexico) S.A.

   Mexico    100.00    100.00

Bank of Tokyo-Mitsubishi UFJ (Canada)

   Canada    100.00    100.00

Banco de Tokyo-Mitsubishi UFJ Brasil S/A

   Brazil    98.97    98.97

Bank of Tokyo-Mitsubishi UFJ (Holland) N.V.

   Netherlands    100.00    100.00

BTMU Lease (Deutschland) GmbH.

   Germany    100.00    100.00

Bank of Tokyo-Mitsubishi UFJ (Polska) S.A.

   Poland    100.00    100.00

ZAO Bank of Tokyo-Mitsubishi UFJ (Eurasia)

   Russia    100.00    100.00

Bank of Tokyo-Mitsubishi UFJ (China), Ltd.

   China    100.00    100.00

BTMU Participation (Thailand) Co., Ltd.

   Thailand    24.49    24.49

Bank of Tokyo-Mitsubishi UFJ (Malaysia) Berhad

   Malaysia    100.00    100.00

PT U Finance Indonesia

   Indonesia    95.00    95.00

PT UFJ-BRI Finance

   Indonesia    55.00    55.00

 

(1)   Mitsubishi UFJ NICOS Co., Ltd. became a wholly owned subsidiary of MUFG, through a share exchange that became effective on August 1, 2008.
(2)   On August 29, 2008, we commenced a cash tender offer for the all of the outstanding common stock of UnionBanCal Corporation not held by us. For further information, see Item 5. Operating and Financial Review and Prospects – Recent Developments.
(3)   The U.S. custody related business and securities lending related business that were performed by Bank of Tokyo-Mitsubishi UFJ Trust Company are being transferred to Mitsubishi UFJ Trust & Banking Corporation (U.S.A.) and Mitsubishi UFJ Trust International Limited, which are wholly owned subsidiaries of MUTB. This transfer is expected to be completed during the second quarter of the fiscal year ending March 31, 2009.

 

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D.    Property, Plants and Equipment

 

The following table presents our premises and equipment at cost as of March 31, 2007 and 2008:

 

     At March 31
     2007    2008
     (in millions)

Land

   312,708    296,775

Buildings

   418,571    431,874

Equipment and furniture

   542,939    555,239

Leasehold improvements

   304,918    312,932

Construction in progress

   12,204    6,496
         

Total

   1,591,340    1,603,316

Less accumulated depreciation

   695,460    774,555
         

Premises and equipment—net

   895,880    828,761
         

 

Our head office is located at 7-1, Marunouchi 2-chome, Chiyoda-ku, Tokyo, and comprises 1,308,675 square feet of office space. At March 31, 2008, we conducted our banking operations either in our owned premises or in leased properties.

 

The following table presents the areas and book values of our material office and other properties at March 31, 2008:

 

     Area    Book value
     (in thousands of square feet)    (in millions)

Owned land

   17,613    ¥ 296,775

Leased land

   1,856      —  

Owned buildings

   23,994      195,600

Leased buildings

   12,373      —  

 

Our owned buildings and land are primarily used by our branches. Most of the buildings and land owned by us are free from material encumbrances, except as described below.

 

In March 1999, we sold to Mitsubishi Estate, Co., Ltd., or Mitsubishi Estate, a 50% undivided interest in the buildings and land comprising our head office and Nihonbashi office and at the same time, entered into an agreement to lease back from the buyer the 50% undivided interests of the buildings sold for a period of seven years. We accounted for these transactions as financing agreements. On August 31, 2005, we bought back the aforementioned buildings and land from Mitsubishi Estate. For further information, see note 9 to our consolidated financial statements.

 

During the fiscal year ended March 31, 2008, we invested approximately ¥162.8 billion primarily for office renovations and purchases of furniture and equipment.

 

Item 4A. Unresolved Staff Comments.

 

None.

 

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Item 5. Operating and Financial Review and Prospects.

 

The following discussion and analysis should be read in conjunction with “Item 3.A. Key Information—Selected Financial Data,” “Selected Statistical Data” and our consolidated financial statements and related notes included elsewhere in this Annual Report.

 

          Page

Roadmap to Reading the Discussion of Our Operating and Financial Review and Prospects

  
  

  Introduction

   41
  

  Recent Developments

   43
  

  Business Environment

   47
  

  Critical Accounting Estimates

   51
  

  Accounting Changes and Recently Issued Accounting Pronouncements

   55

A.

  

Operating Results

   56
  

  Results of Operations

   56
  

  Business Segment Analysis

   67
  

  Geographic Segment Analysis

   71
  

  Effect of the Change in Exchange Rates on Foreign Currency Translation

   72

B.

  

Liquidity and Capital Resources

   73
  

  Financial Condition

   73
  

  Capital Adequacy

   86
  

  Non-exchange Traded Contracts Accounted for at Fair Value

   88

C.

  

Research and Development, Patents and Licenses, etc.

   89

D.

  

Trend Information

   89

E.

  

Off-balance-sheet Arrangements

   89

F.

  

Tabular Disclosure of Contractual Obligations

   92

G.

  

Safe Harbor

   92

 

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Introduction

 

We are a subsidiary of Mitsubishi UFJ Financial Group, Inc., or MUFG. We engage in a broad range of financial operations, including commercial banking, investment banking, asset management and securities-related businesses, and provide related services to individual and corporate customers.

 

Key Financial Figures

 

The following are some key figures prepared in accordance with US GAAP relating to our business.

 

The results for the fiscal year ended March 31, 2006 reflect the pre-merger results of The Bank of Tokyo-Mitsubishi, Ltd. and its subsidiaries, or the BTM Group, for the six months ended September 30, 2005 and the post-merger results of The Bank of Tokyo-Mitsubishi UFJ, Ltd. and its subsidiaries, or the BTMU Group, for the six months ended March 31, 2006.

 

     Fiscal years ended March 31,  
     2006    2007    2008  
     (in billions)  

Net interest income

   ¥ 1,520.5    ¥ 2,165.1    ¥ 2,114.5  

Provision for credit losses

     163.4      341.6      407.2  

Non-interest income

     556.8      1,220.5      1,213.6  

Non-interest expense

     1,616.8      2,172.0      2,886.9  

Net income (loss)

     228.8      460.9      (458.1 )

Total assets (at end of period)

     158,825.7      153,605.2      152,079.2  

 

Our revenues consist of net interest income and non-interest income.

 

Net interest income is a function of:

 

   

the amount of interest-earning assets,

 

   

the general level of interest rates,

 

   

the so-called “spread,” or the difference between the rate of interest earned on interest-earning assets and the rate of interest paid on interest-bearing liabilities, and

 

   

the proportion of interest-earning assets financed by non-interest-bearing liabilities and equity.

 

Non-interest income consists of:

 

   

fees and commissions, including

   

trust fees,

   

fees on funds transfer and service charges for collections,

   

fees and commissions on international business,

   

fees and commissions on credit card business,

   

service charges on deposits,

   

fees and commissions on securities business,

   

insurance commissions,

   

guarantee fees,

   

fees on investment funds business, and

   

other fees and commissions;

 

   

foreign exchange gains (losses)—net, which primarily include net gains (losses) on currency derivative instruments entered into for trading purposes and transaction gains (losses) on the translation into Japanese yen of monetary assets and liabilities denominated in foreign currencies;

 

   

trading account profits (losses)—net, which primarily include net profits (losses) on trading account securities and interest rate derivative contracts entered into for trading purposes;

 

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investment securities gains (losses)—net, which primarily include net gains (losses) on sales and impairment losses on securities available for sale;

 

   

equity in earnings (losses) of equity method investees;

 

   

gains on sales of loans; and

 

   

other non-interest income.

 

Provision for credit losses is charged to operations to maintain the allowance for credit losses at a level deemed appropriate by management.

 

Merger of BTM with UFJ Bank to Form BTMU

 

On October 1, 2005, Mitsubishi Tokyo Financial Group, Inc., or MTFG, merged with UFJ Holdings, Inc., to form MUFG. At the same time, their respective trust banking and securities companies merged to form Mitsubishi UFJ Trust and Banking Corp., or MUTB, and Mitsubishi UFJ Securities Co., Ltd. Subsequently, BTM and UFJ Bank Ltd., or UFJ Bank, merged to form BTMU on January 1, 2006. As part of our integration process, we are currently undertaking a significant project to fully integrate the IT systems of the two banks.

 

Because BTM and UFJ Bank became subject to common control under MUFG as of October 1, 2005, the two banks were accounted for as having completed their merger as of that date. The merger of BTM with UFJ Bank was accounted for under the purchase method of accounting, and the assets and liabilities of the UFJ Bank and its subsidiaries, or the UFJ Bank Group, were recorded at fair value as of October 1, 2005. The purchase price of the UFJ Bank Group amounted to ¥4,628.0 billion, of which ¥4,626.0 billion was recorded in capital surplus relating to the merger with UFJ Bank and the direct acquisition costs of ¥2.0 billion were included in the purchase price. Shareholder’s equity of the UFJ Bank Group was ¥2,738.9 billion and the goodwill relating to the merger with UFJ Bank was ¥1,701.0 billion.

 

In the fiscal year ended March 31, 2008, we recorded an impairment of goodwill of ¥816.3 billion due to the recent global financial market instability that negatively affected the fair value of our reporting units for the purposes of our impairment testing. For further information, see Notes 2 and 10 to our consolidated financial statements included elsewhere in this Annual Report.

 

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Recent Developments

 

Merger of UFJ NICOS and DC Card

 

On April 1, 2007, UFJ NICOS Co., Ltd. and DC Card Co., Ltd., our credit card subsidiaries, merged to become Mitsubishi UFJ NICOS Co., Ltd. The objective of the merger was to combine UFJ NICOS’ large and extensive network, reputation and product development capabilities with DC Card’s co-branding relationships with and acceptance of regional cards.

 

Share Exchange Transaction to Make Mitsubishi UFJ NICOS a Wholly Owned Subsidiary of MUFG

 

In November 2007, MUFG acquired ¥120 billion of newly issued shares of Mitsubishi UFJ NICOS common stock, thereby decreasing our shareholding to approximately 47% of Mitsubishi UFJ NICOS’ total issued shares. However, because our relationship with Mitsubishi UFJ NICOS provided us with controlling financial interest in Mitsubishi UFJ NICOS, it was continued to be accounted for as our consolidated subsidiary as of March 31, 2008.

 

On May 28, 2008, MUFG and Mitsubishi UFJ NICOS entered into a share exchange agreement. The share exchange ratios were set at 0.37 shares of MUFG common stock to one share of Mitsubishi UFJ NICOS common stock and at 1.39 shares of MUFG common stock to one share of Mitsubishi UFJ NICOS Class 1 Stock. Through a share exchange that became effective on August 1, 2008, pursuant to this agreement, Mitsubishi UFJ NICOS, our former consolidated subsidiary, became a wholly owned subsidiary of MUFG.

 

Business and Capital Alliance with JACCS

 

In September 2007, we entered into a basic agreement with MUFG, Mitsubishi UFJ NICOS and JACCS Co., Ltd. with respect to a business and capital alliance. As part of the basic agreement, Mitsubishi UFJ NICOS transferred its installment credit sales business, automobile loan business and automobile leasing business to JACCS on April 1, 2008. In addition to transferring installment credit sale contracts, Mitsubishi UFJ NICOS transferred approximately 340 personnel and five business offices to JACCS. At the same time, we, together with MUFG and Mitsubishi UFJ NICOS, formed a business alliance with JACCS with respect to credit card related operations, installment credit sales business, settlement operations and housing loan related operations. In addition, we acquired approximately ¥9.0 billion of newly issued common shares of JACCS on March 17, 2008. As a result of the acquisition of the additional JACCS shares, we own approximately 20% of the voting rights in JACCS and, accordingly, JACCS became our equity method investee.

 

Establishment of BTMU China as a Local Subsidiary

 

On June 28, 2007, we established a wholly owned local subsidiary, Bank of Tokyo-Mitsubishi UFJ (China), Ltd., or BTMU China, and on July 1, 2007, transferred our 6 branches and 2 sub-branches already located in China to the new company. With the establishment of the Guangzhou Branch in March 2008, BTMU China now has a network of 7 branches and 2 sub-branches in the country. Combined with our 2 representative offices, we now have a local network of 11 locations in China from which we plan to fulfill a diverse range of customer needs.

 

Reorganization of Our Custody Business

 

On April 2, 2007, MUTB acquired 70% of the shares of our wholly owned subsidiary, Bank of Tokyo-Mitsubishi UFJ (Luxembourg) S.A., which became a subsidiary of MUTB and was renamed Mitsubishi UFJ Global Custody S.A. Moreover, the US custody related business and securities lending related business that were performed by Bank of Tokyo-Mitsubishi UFJ Trust Company (New York, U.S.A.), our wholly owned subsidiary, are now being transferred to Mitsubishi UFJ Trust & Banking Corporation (U.S.A) and Mitsubishi UFJ Trust International Limited, which are wholly owned subsidiaries of MUTB located in New York, U.S.A. and London, U.K., respectively. This process is expected to be completed during the second quarter of the fiscal year ending March 31, 2009.

 

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In April 2008, Mitsubishi UFJ Global Custody Japan Limited, a wholly owned subsidiary of Mitsubishi UFJ Global Custody S.A., commenced operations in order to meet the diverse needs of Japanese customers. Through this new company, we intend to provide global custody services to new customers as well as our current customers.

 

Rationalization of Corporate Outlets of MUTB

 

On August 29, 2007, MUFG, MUTB and we resolved to transfer a part of MUTB’s corporate lending business conducted at nine of MUTB’s outlets to us on November 12, 2007. In consideration of this transfer, we issued 1,000,000 shares of Class 6 Preferred Stock to MUTB.

 

JALCARD Share Transfer and Business Partnership

 

In May 2008, we reached an agreement with Japan Airlines International Co., Ltd., or JALI, a subsidiary of the Japan Airlines Corporation, on the transfer to us of 49.375% of the issued shares of JALCARD Inc., a wholly owned subsidiary of JALI, effective on July 1, 2008. As part of the agreement, JALI, JALCARD, Mitsubishi UFJ NICOS, JCB Co., Ltd. and we agreed on a business partnership relating to our credit card operations.

 

kabu.com Securities Became a Consolidated Subsidiary

 

To strengthen the retail online securities business and enhance comprehensive Internet-based financial services, we acquired approximately 20% ownership of kabu.com Securities Co., Ltd., a retail online securities company in Japan through tender offers implemented in April and December 2007. Moreover, we acquired additional shares of kabu.com Securities held by the MUFG Group, resulting in the increase of our ownership to approximately 41%. In addition to our increased record ownership of voting stock of kabu.com Securities, our relationship with kabu.com Securities provides us with controlling financial interest equivalent to majority ownership of voting stock. As a result, kabu.com Securities, our former equity method investee, became our consolidated subsidiary.

 

Basic Agreement on Integration between Bank of Ikeda and Senshu Bank

 

On May 30, 2008, we signed a basic agreement with the Senshu Bank Ltd., our regional bank subsidiary headquartered in Osaka and the Bank of Ikeda Ltd., another regional bank headquartered in Osaka, concerning the planned business integration between the two regional banks. Senshu Bank and Bank of Ikeda are planning to establish a new company on April 1, 2009 after the execution of a definitive agreement, which is expected to occur by November 28, 2008. As of March 31, 2008, we owned 3.43% of the outstanding common shares and ¥30.0 billion of non-convertible preferred shares of Bank of Ikeda.

 

New Mobile Internet Banking Service

 

On June 17, 2008, Jibun Bank Corporation, a new mobile internet bank co-founded by us and KDDI CORPORATION, acquired a banking business license. Jibun Bank started to receive orders for opening bank accounts on July 17, 2008 and currently provides banking services such as ordinary accounts, fixed term deposits and fund transfers via mobile phone.

 

Commencement of a Cash Tender Offer to Acquire All Publicly Held Shares of UNBC

 

On August 18, 2008, we entered into a merger agreement with UnionBanCal Corporation, or UNBC, in which we hold approximately 65% of the outstanding common shares. In accordance with the merger agreement, on August 29, 2008, we commenced a tender offer to acquire all of the shares of UNBC’s common stock not owned by us for US$73.50 per share in cash. The tender offer will expire on September 26, 2008, unless it is extended. Under the merger agreement, the consummation of the tender offer is expected to be followed by a

 

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merger in which any share of UNBC not tendered through the tender offer will be acquired at the same price in cash, subject to customary appraisal rights. The tender offer and the subsequent merger are not subject to a financing condition and do not require Japanese or US bank regulatory or antitrust approval. Upon completion of the merger, UNBC will become our wholly owned subsidiary.

 

We estimate the total funds required to complete the acquisition of UNBC to be approximately US$3.5 billion. We intend to use cash on hand to fund the acquisition.

 

Effects of Recent Global Financial Market Instability

 

The recent global market instability since the second half of 2007 originating primarily from disruptions in the US residential mortgage market has negatively affected our investment portfolio. We continue to hold assets that may decline in value or that may otherwise lead to further losses, and the amount of assets exposed to such risk may increase in the future depending on market conditions and other factors. As of March 31, 2008, the estimated fair value of our securities available for sale was ¥27.3 trillion for debt securities and ¥5.1 trillion for marketable equity securities. Net investment securities losses for the fiscal year ended March 31, 2008 was ¥1.18 trillion, compared to ¥0.17 trillion in net investment securities gains for the previous fiscal year. This change mainly reflected the impairment losses of ¥0.25 trillion on marketable equity securities available for sale and ¥1.03 trillion on debt securities available for sale. The impairment losses on debt securities were mainly due to the effect of changes in exchange rates on foreign currency transactions amounting to ¥0.76 trillion. For a detailed discussion of our investment portfolio as of March 31, 2008, see “—A. Operating Results—Results of Operations—Net investment securities gains (losses)” and “—B. Financial Condition—Investment Portfolio” below.

 

The recent global financial market instability has also negatively affected our goodwill. In the fiscal year ended March 31, 2008, we recorded an impairment of goodwill of ¥816.3 billion. This impairment in goodwill was due to, among other factors, the recent global financial market instability which negatively impacted the fair value of our reporting units for purposes of our periodic testing of goodwill for impairment. For a more detailed discussion of our goodwill as of March 31, 2008, see “—Critical Accounting Estimates—Accounting for Goodwill and Intangible Assets” and “—A. Operating Results—Results of Operations—Non-Interest Expense” below.

 

Filing of a Bankruptcy Petition by Lehman Brothers Holdings

 

On September 15, 2008, Lehman Brothers Holdings Inc., or LBHI, filed a petition under Chapter 11 of the US Bankruptcy Code with the US Bankruptcy Court for the Southern District of New York. We determined that the filing by LBHI was attributable to the deterioration of the asset-backed securitization products market and residential mortgage market in the United States subsequent to March 31, 2008, and did not reflect the impact of LBHI’s bankruptcy on the accompanying consolidated financial statements for the fiscal year ended March 31, 2008. Although the impact of these developments is currently being reviewed, we estimate that these developments will adversely affect income from continuing operations before income tax expense for the fiscal year ending March 31, 2009 by approximately ¥20 to ¥30 billion.

 

Stock-Based Compensation Plans

 

As part of our compensation structure, in December 2007, our directors, corporate auditors and officers were allotted an aggregate of 15,908 stock acquisition rights. Each stock acquisition right represents a right to purchase 100 shares of MUFG common stock at ¥1 per common share. The stock acquisition rights were subject to a one-year vesting period. The rights are exercisable until December 5, 2037, but only after the date on which a grantee’s service to BTMU as a director, corporate auditor or officer terminates. The fair value of each stock acquisition right was ¥103,200.

 

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As part of our compensation structure, in July 2008, our directors, corporate auditors and officers were allotted an aggregate of 16,955 stock acquisition rights. Each stock acquisition right represents a right to purchase 100 shares of MUFG common stock at ¥1 per common share. The stock acquisition rights are subject to a one-year vesting period. The rights are exercisable until July 14, 2038, but only after the date on which a grantee’s service to BTMU as a director, corporate auditor or officer terminates. The fair value of each stock acquisition right was ¥92,300.

 

For more information on the stock-based compensation plans, see “Item 6.B. Compensation,” “Item 7.B. Major Shareholders and Related Party Transactions—Related Party Transactions” and Note 31 to our consolidated financial statements included elsewhere in this Annual Report.

 

Issuance of Preferred Securities by Special Purpose Companies

 

In order to enhance the flexibility of our capital management, in December 2007, BTMU Preferred Capital 6 Limited, a special purpose company established in the Cayman Islands, issued ¥150 billion in non-cumulative and non-dilutive perpetual preferred securities to MUFG Capital Finance 6 Limited, a special purpose company established in the Cayman Islands, which then issued ¥150 billion in non-cumulative and non-dilutive perpetual preferred securities in an offering targeting Japanese institutional investors.

 

These preferred securities were reflected in our Tier I capital as of March 31, 2008, under the BIS capital adequacy requirements, which is calculated primarily from our Japanese GAAP financial information. However, for accounting purposes under US GAAP, because those special purpose companies are not consolidated entities, the loans, which are made to us from the proceeds from the preferred securities issued by the special purpose company, are presented as long-term debt on our consolidated balance sheet as of March 31, 2008.

 

Also, in September 2008, BTMU Preferred Capital 7 Limited, a special purpose company established in the Cayman Islands, issued ¥122 billion in non-cumulative and non-dilutive perpetual preferred securities to MUFG Capital Finance 7 Limited, a special purpose company established in the Cayman Islands, which then issued ¥222 billion in non-cumulative and non-dilutive perpetual preferred securities in an offering targeting Japanese institutional investors. These securities are also accounted for as part of our Tier I capital.

 

Redemption of Global Senior Subordinated Notes

 

In order to enhance the flexibility of our capital management, from February 2008 to March 2008, we redeemed in total approximately US$65.3 million of Global Senior Subordinated Notes. A portion of the subordinated debt was previously accounted for as part of our Tier II capital.

 

Redemption of Preferred Securities Issued by a Special Purpose Company

 

In June 2008, Tokai Preferred Capital Company L.L.C., a special purpose company established in Delaware, redeemed in total US$1 billion of non-cumulative and non-dilutive perpetual preferred securities. These securities were previously accounted for as part of our Tier I capital.

 

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Business Environment

 

We engage in a broad range of financial operations, including commercial banking, investment banking, asset management and securities-related businesses, and provide related services to individuals primarily in Japan and the United States, and to corporate customers around the world. Our results of operations and financial condition are exposed to changes in various external economic factors, including:

 

   

general economic conditions;

 

   

interest rates;

 

   

currency exchange rates; and

 

   

stock and real estate prices.

 

Economic Environment in Japan

 

The Japanese economy showed a moderate slowdown, partly offset by Japan’s continuous strong exports to emerging countries. However, private consumption grew at a sluggish pace due to the weakness of wage growth. Towards the end of the fiscal year ended March 31, 2008, business confidence rapidly worsened and uncertainty increased about a corporate performance downturn because of a slowdown in overseas economies as well as a steep rise in the price of raw materials and oil prices. The rate of increase in the consumer price index accelerated towards the end of the fiscal year ended March 31, 2008 mainly due to soaring oil prices.

 

The Bank of Japan kept its uncollateralized overnight call rate target unchanged at 0.5% from the prior year. Although long-term interest rates rose in June, they have been on a downward trend with some fluctuations. As of mid-September 2008, the uncollateralized overnight call rate target was around 0.5% and the yield on ten-year Japanese government bonds was around 1.5%. The following chart shows the interest rate trends in Japan since April 2006:

 

LOGO

 

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Regarding the Japanese stock market, the Nikkei Stock Average, which is an average of 225 blue chip stocks listed on the Tokyo Stock Exchange, declined from ¥17,287.65 at March 30, 2007 to ¥12,525.54 at March 31, 2008. As for the Tokyo Stock Price Index, or TOPIX, a composite index of all stocks listed on the First Section of the Tokyo Stock Exchange, the index declined from 1,713.61 at March 30, 2007 to 1,212.96 at March 31, 2008, mainly due to a slowdown of the Japanese economy and the uncertainty of the overseas economies. As of mid-September 2008, the Nikkei Stock Average was around ¥11,700 and TOPIX was around 1,120. The following chart shows the daily closing price of the Nikkei Stock Average since April 2006.

 

LOGO

 

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In the foreign exchange markets, the Japanese yen/US dollar foreign exchange rate was around ¥118 to US$1 at the beginning of April 2007, and the yen generally continued to appreciate during the year and broke ¥100 to US$1 in March 2008. Thereafter, the Japanese yen depreciated slightly to around ¥100 to ¥110 to US$1 and, as of mid-September 2008, the Japanese yen/US dollar foreign exchange rate was around ¥105 to US$1. Against the Euro, the Japanese yen was traded in a range of approximately between ¥157 and ¥168 during the fiscal year ended March 31, 2008, and finished around ¥157 to the Euro at the end of March 2008. As of mid-September 2008, the Japanese yen/Euro foreign exchange rate was around ¥150 to the Euro. The following chart shows the foreign exchange rates expressed in Japanese yen per US dollar since April 2006:

 

LOGO

 

Based on the average official land prices set by the government, average land prices in Japan as of January 1, 2008 increased for two years in a row after a consecutive 16-year decline that ended in 2006. Nationwide residential land prices and land prices for commercial properties as of January 1, 2008 rose by 1.3% and 3.8%, respectively, compared to January 1, 2007. In the three major metropolitan areas, Tokyo, Osaka and Nagoya, residential land prices on average rose by 4.3% over the last two years starting in January 1, 2006, and commercial properties rose by 10.4% over the last three years starting in January 1, 2005. On the other hand, in the local regions of Japan, which consist of regions other than the major metropolitan areas, residential land prices on average declined by 1.8%, and commercial properties declined by 1.4%, for four years in a row after January 1, 2004.

 

According to Teikoku Databank, a Japanese research institution, the number of companies who filed for legal bankruptcy in Japan between April 2007 and March 2008 was approximately 11,300, an increase of approximately 18% from the previous fiscal year, mainly due to an increase in legal bankruptcies of small sized companies, especially in construction, retail, and service sectors. Similarly, the aggregate amount of liabilities subject to bankruptcy filings for the same period was approximately ¥5.5 trillion, an increase of approximately 5% from the previous fiscal year, owing to an increase in the number of bankruptcy filings and a large-scale real estate related bankruptcy.

 

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International Financial Markets

 

With respect to the international financial and economic environment for the fiscal year ended March 31, 2008, uncertainty about the outlook for overseas economies, especially the United States economy, significantly increased. The US economy has further decelerated since the beginning of 2008 due to the turmoil in the financial markets triggered by the collapse of the residential mortgage market which has resulted in reduced liquidity, greater volatility, widening of credit spreads and a lack of price transparency in the United States. Meanwhile, the European economy has shown clear signs of slowdown. In contrast, economies of the emerging countries, such as the Chinese economy, sustained high growth.

 

In the United States, the target for the federal funds rate has been lowered by 3.0 percentage points to 2.25% in total since last fall in response to the deteriorating market conditions until March 2008, and was further lowered to 2.00% in April 2008. In the EU, the European Central Bank kept its key interest rate unchanged at 4.0% due to the strong concern about inflation in Europe until March 2008, and raised it 0.25 percentage points to 4.25% in July 2008.

 

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Critical Accounting Estimates

 

Our consolidated financial statements are prepared in accordance with US GAAP. Many of the accounting policies require management to make difficult, complex or subjective judgments regarding the valuation of assets and liabilities. The accounting policies are fundamental to understanding our operating and financial review and prospects. The notes to our consolidated financial statements included elsewhere in this Annual Report provide a summary of our significant accounting policies. The following is a summary of the critical accounting estimates:

 

Allowance for Credit Losses

 

The allowance for credit losses represents management’s estimate of probable losses in our loan portfolio. The evaluation process, including credit-ratings and self-assessments, involves a number of estimates and judgments. The allowance is based on two principles of accounting: (1) SFAS No. 5, “Accounting for Contingencies,” which requires that losses be accrued when they are probable of occurring and can be estimated; and (2) SFAS No. 114, “Accounting by Creditors for Impairment of a Loan” and SFAS No. 118, “Accounting by Creditors for Impairment of a Loan—Income Recognition and Disclosures,” which require that losses be accrued based on the difference between the loan balance, on the one hand, and the present value of expected future cash flows discounted at the loan’s effective interest rate and the fair value of collateral or the loan’s observable market value, on the other hand.

 

Our allowance for credit losses consists of an allocated allowance and an unallocated allowance. The allocated allowance comprises (a) the allowance for specifically identified problem loans, (b) the allowance for large groups of smaller balance homogeneous loans, (c) the allowance for loans exposed to specific country risk and (d) the formula allowance. Both the allowance for loans exposed to specific country risk and the formula allowance are provided for performing loans that are not subject to either the allowance for specifically identified problem loans or the allowance for large groups of smaller balance homogeneous loans. The allowance for loans exposed to specific country risk covers transfer risk which is not specifically covered by other types of allowance. Each of these components is determined based upon estimates that can and do change when actual events occur.

 

The allowance for specifically identified problem loans, which represent large-balance, non-homogeneous loans that have been individually determined to be impaired, is calculated by using various techniques to arrive at an estimate of loss. Historical loss information, discounted cash flows, fair value of collateral and secondary market information are all used to estimate those losses.

 

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment, and the allowance for such loans is established through a process that begins with estimates of probable losses inherent in the portfolio. These estimates are based upon various analyses, including historical delinquency and credit loss experience.

 

The allowance for loans exposed to specific country risk is based on an estimate of probable losses relating to our exposure to countries that we identify as having a high degree of transfer risk. We use a country risk grading system that assigns risk ratings to individual countries. To determine the risk rating, we consider the instability of foreign currency and difficulties regarding our borrowers’ ability to service their debt.

 

The formula allowance uses a model based on historical losses as an indicator of future probable losses. However, the use of historical losses is inherently uncertain and as a result could differ from losses incurred in the future. However, since this history is updated with the most recent loss information, the differences that might otherwise occur are mitigated.

 

Our actual losses could be more or less than the estimates. The unallocated allowance captures losses that are attributable to various economic events, industry or geographic sectors whose impact on the portfolio have

 

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occurred but have yet to be recognized in the allocated allowance. For further information regarding our allowance for credit losses, see “—B. Liquidity and Capital Resources—Financial Condition—Allowance for Credit Losses, Nonperforming and Past Due Loans.”

 

In addition to the allowance for credit losses on our loan portfolio, we maintain an allowance for credit losses on off-balance-sheet credit instruments, including commitments to extend credit, a variety of guarantees and standby letters of credit. Such allowance is included in other liabilities. With regard to the allocated allowance for specifically identified credit exposure and the allocated formula allowance, we apply the same methodology that we use in determining the allowance for loan credit losses.

 

Determining the adequacy of the allowance for credit losses requires the exercise of considerable judgment and the use of estimates, such as those discussed above. To the extent that actual losses differ from management’s estimates, additional provisions for credit losses may be required that would adversely impact our operating results and financial condition in future periods.

 

Impairment of Investment Securities

 

US GAAP requires the recognition in earnings of an impairment loss on investment securities for a decline in fair value that is other than temporary. Determination of whether a decline is other than temporary often involves estimating the outcome of future events. Management judgment is required in determining whether factors exist that indicate that an impairment loss has been incurred at the balance sheet date. These judgments are based on subjective as well as objective factors. We conduct a review semi-annually to identify and evaluate investment securities that have indications of possible impairment. The assessment of other than temporary impairment requires judgment and therefore can have an impact on the results of operations. Impairment is evaluated considering various factors, and their significance varies from case to case.

 

Debt and marketable equity securities.    In determining whether a decline in fair value below cost is other than temporary for a particular security, we generally consider factors such as the ability and positive intent to hold the investments for a period of time sufficient to allow for any anticipated recovery in fair value. In addition, indicators of an other than temporary decline for both debt and marketable equity securities include, but are not limited to, the extent of decline in fair value below cost and the length of time that the decline in fair value below cost has continued. If a decline in fair value below cost is 20% or more or has continued for six months or more, we generally deem such decline as an indicator of an other than temporary decline. We also consider the current financial condition and near-term prospects of issuers primarily based on the credit standing of the issuers as determined by our credit rating system.

 

Certain securities held by us and our certain other subsidiaries, which primarily consist of debt securities issued by the Japanese national government and generally considered to be of minimal credit risk, were determined not to be impaired in some cases, on the basis of the respective entity’s ability and positive intent to hold such securities to maturity.

 

The determination of other than temporary impairment for certain securities held by UNBC, our US subsidiary, which primarily consist of securities backed by the full faith and credit of the US government and corporate asset-backed and debt securities, are made on the basis of a cash flow analysis of securities and/or the ability of UNBC to hold such securities to maturity.

 

Nonmarketable equity securities.    Nonmarketable equity securities are equity securities of companies that are not publicly traded or are thinly traded. Such securities are primarily held at cost less other than temporary impairment if applicable. For the securities carried at cost, we consider factors such as the credit standing of issuers and the extent of decline in net assets of issuers to determine whether the decline is other than temporary. When we determine that the decline is other than temporary, nonmarketable equity securities are written down to the estimated fair value, determined based on such factors as the ratio of our investment in the issuer to the issuer’s net assets and the latest transaction price if applicable. When the decline is other than temporary, certain nonmarketable equity securities issued by public companies, such as preferred stock convertible to marketable

 

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common stock in the future, are written down to fair value estimated by commonly accepted valuation models, such as option pricing models based on a number of factors, including the quoted market price of the underlying marketable common stock, volatility and dividend payments as appropriate.

 

The markets for equity securities and debt securities are inherently volatile, and the values of both types of securities have fluctuated significantly in recent years. Accordingly, our assessment of potential impairment involves risks and uncertainties depending on market conditions that are global or regional in nature and the condition of specific issuers or industries, as well as management’s subjective assessment of the estimated future performance of investments. If we later conclude that a decline is other than temporary, the impairment loss may significantly affect our operating results and financial condition in future periods.

 

For further information on the amount of the impairment losses and the aggregate amount of unrealized gross losses on investment securities, see Note 6 to our consolidated financial statements included elsewhere in this Annual Report.

 

Income Taxes

 

Valuation of deferred tax assets.    A valuation allowance for deferred tax assets is recognized if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. All available evidence, both positive and negative, is considered to determine whether, based on the weight of that evidence, a valuation allowance is needed. Future realization of the tax benefit of existing deductible temporary differences or carryforwards ultimately depends on the existence of sufficient taxable income in future periods.

 

In determining a valuation allowance, we perform a review of future taxable income (exclusive of reversing temporary differences and carryforwards) and future reversals of existing taxable temporary differences. Future taxable income is developed from forecasted operating results, based on recent historical trends and approved business plans, the eligible carryforward periods and other relevant factors. For certain subsidiaries where strong negative evidence exists, such as the existence of significant amounts of operating loss carryforwards, cumulative losses and the expiration of unused operating loss carryforwards in recent years, a valuation allowance is recognized against the deferred tax assets to the extent that it is more likely than not that they will not be realized.

 

Among other factors, forecasted operating results, which serve as the basis of our estimation of future taxable income, have a significant effect on the amount of the valuation allowance. In developing forecasted operating results, we assume that our operating performance is stable for certain entities where strong positive evidence exists, including core earnings based on past performance over a certain period of time. The actual results may be adversely affected by unexpected or sudden changes in interest rates as well as an increase in credit-related expenses due to the deterioration of economic conditions in Japan and material declines in the Japanese stock market to the extent that such impacts exceed our original forecast. In addition, near-term taxable income is also influential on the amount of the expiration of unused operating loss carryforwards since the Japanese corporate tax law permits operating losses to be deducted for a predetermined period generally no longer than seven years. For further information on the amount of operating loss carryforwards and the expiration dates, see Note 11 to our consolidated financial statements included elsewhere in this Annual Report.

 

Because the establishment of the valuation allowance is an inherently uncertain process involving estimates as discussed above, the currently established allowance may not be sufficient. If the estimated allowance is not sufficient, we will incur additional deferred tax expenses, which could materially affect our operating results and financial condition in future periods.

 

Tax reserves.    We provide reserves for unrecognized tax benefits as required under FASB Interpretation, or FIN, No. 48, “Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109.” In applying the standards of the Interpretation, we consider the relative risks and merits of positions taken in tax

 

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returns filed and to be filed, considering statutory, judicial, and regulatory guidance applicable to those positions. The Interpretation requires us to make assumptions and judgments about potential outcomes that lie outside management’s control. To the extent the tax authorities disagree with our conclusions, and depending on the final resolution of those disagreements, our effective tax rate may be materially affected in the period of final settlement with tax authorities.

 

Accounting for Goodwill and Intangible Assets

 

US GAAP requires us to test goodwill for impairment at least annually, or more frequently if events or changes in circumstances indicate that goodwill may be impaired, using a two-step process that begins with an estimation of the fair value of a reporting unit of our business, which is to be compared with the carrying amount of the unit, to identify potential impairment of goodwill. A reporting unit is an operating segment or component of an operating segment that constitutes a business for which discrete financial information is available and is regularly reviewed by management. The fair value of a reporting unit is defined as the amount at which the unit as a whole could be bought or sold in a current transaction between willing parties. For a reporting unit for which an observable quoted market price is available, the price is used for the fair value and control premium is also considered. For a reporting unit which an observable quoted market price is not available, the fair value is determined using an income approach. In the income approach, discounted cash flows are calculated by taking the net present value based on each reporting unit’s internal forecasts. Cash flows are discounted using a discount rate approximating the weighted average cost of capital, and the discount rate reflects current market capitalization. A control premium factor is considered for the market capitalization as well. If the carrying amount of a reporting unit exceeds its estimated fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss recorded in income. This test requires comparison of the implied fair value of the unit’s goodwill with the carrying amount of that goodwill. The estimate of the implied fair value of the reporting unit’s goodwill requires us to allocate the fair value of a reporting unit to all of the assets and liabilities of that reporting unit, including unrecognized intangible assets, if any, since the implied fair value is determined as the excess of the fair value of a reporting unit over the net amounts assigned to its assets and liabilities in the allocation. Accordingly, the second step of the impairment test also requires an estimate of the fair value of individual assets and liabilities, including any unrecognized intangible assets that belong to that unit. A change in the estimation could have an impact on impairment recognition since it is driven by hypothetical assumptions, such as customer behavior and interest rate forecasts. The estimation is based on information available to management at the time the estimation is made.

 

Intangible assets are amortized over their estimated useful lives unless they have indefinite useful lives. Amortization for intangible assets is computed in a manner that best reflects the economic benefits of the intangible assets. Intangible assets having indefinite useful lives are subject to annual impairment tests. An impairment exists if the carrying value of an indefinite-lived asset exceeds its fair value. For other intangible assets subject to amortization, an impairment is recognized if the carrying amount exceeds the fair value of the intangible asset.

 

Accrued Severance Indemnities and Pension Liabilities

 

We have defined retirement benefit plans, including lump-sum severance indemnities and pension plans, which cover substantially all of our employees. Severance indemnities and pension costs are calculated based upon a number of actuarial assumptions, including discount rates, expected long-term rates of return on our plan assets and rates of increase in future compensation levels. In accordance with US GAAP, actual results that differ from the assumptions are accumulated and amortized over future periods, and affect our recognized net periodic pension costs and accrued severance indemnities and pension obligations in future periods. Differences in actual experience or changes in assumptions may affect our financial condition and operating results in future periods.

 

The discount rates for the domestic plans are set to reflect the interest rates of high-quality fixed-rate instruments with maturities that correspond to the timing of future benefit payments.

 

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In developing our assumptions for expected long-term rates of return, we refer to the historical average returns earned by the plan assets and the rates of return expected to be available for reinvestment of existing plan assets, which reflect recent changes in trends and economic conditions, including market price. We also evaluate input from our actuaries, including their reviews of asset class return expectations.

 

We adopted the recognition provisions of SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R)” as of March 31, 2007. See “Accounting Changes—Defined Benefit Pension and Other Postretirement Plans” in Note 1 and Note 16 to our consolidated financial statements included elsewhere in this Annual Report for further information.

 

Valuation of Financial Instruments with No Available Market Prices

 

Fair values for the substantial majority of our portfolio of financial instruments, including available-for-sale and held-to-maturity securities, trading accounts and derivatives, with no available market prices are determined based upon externally verifiable model inputs and quoted prices. All financial models, which are used for independent risk monitoring, must be validated and periodically reviewed by qualified personnel independent of the area that created the model. The fair value of derivatives is determined based upon liquid market prices evidenced by exchange-traded prices, broker-dealer quotations or prices of other transactions with similarly rated counterparties. If available, quoted market prices provide the best indication of value. If quoted market prices are not available for fixed maturity securities and derivatives, we discount expected cash flows using market interest rates commensurate with the credit quality and maturity of the investment. Alternatively, we may use matrix or model pricing to determine an appropriate fair value. In determining fair values, we consider various factors, including time value, volatility factors and underlying options, warrants and derivatives.

 

The estimated fair values of financial instruments without quoted market prices were as follows:

 

     At March 31,
     2007    2008
     (in billions)

Financial assets:

     

Trading account assets, excluding derivatives

   ¥ 1,720    ¥ 1,879

Investment securities

     35,046      29,515

Derivative financial instruments, net

     41      702

Financial liabilities:

     

Trading account liabilities, excluding derivatives

     6      12

Obligations to return securities received as collateral

     809      414

 

A significant portion of trading account assets and liabilities, excluding derivatives, investment securities and obligations to return securities received as collateral consists of Japanese national government and agency bonds, and foreign government and official institutions bonds, for which prices are actively quoted among brokers and are readily available but are not publicly reported and therefore are not considered quoted market prices. Additionally, a substantial portion of derivative financial instruments are comprised of over-the-counter interest rate and currency swaps and options. Estimates of fair value of these derivative transactions are determined using quantitative models with multiple market inputs, which can be validated through external sources, including brokers and market transactions with third parties.

 

Accounting Changes and Recently Issued Accounting Pronouncements

 

See “Accounting Changes” and “Recently Issued Accounting Pronouncements” in Note 1 to our consolidated financial statements included elsewhere in this Annual Report.

 

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A.    Operating Results

 

Results of Operations

 

The following table sets forth a summary of our results of operations for the fiscal years ended March 31, 2006, 2007 and 2008:

 

     Fiscal years ended March 31,  
     2006     2007     2008  
     (in billions)  

Interest income

   ¥ 2,249.3     ¥ 3,444.3     ¥ 3,693.8  

Interest expense

     728.8       1,279.2       1,579.3  
                        

Net interest income

     1,520.5       2,165.1       2,114.5  
                        

Provision for credit losses

     163.4       341.6       407.2  

Non-interest income

     556.8       1,220.5       1,213.6  

Non-interest expense

     1,616.8       2,172.0       2,886.9  
                        

Income from continuing operations before income tax expense and cumulative effect of a change in accounting principle

     297.1       872.0       34.0  

Income tax expense

     68.9       410.3       490.3  
                        

Income (loss) from continuing operations before cumulative effect of a change in accounting principle

     228.2       461.7       (456.3 )

Income (loss) from discontinued operations—net

     9.0       (0.8 )     (1.8 )

Cumulative effect of a change in accounting principle, net of tax

     (8.4 )     —         —    
                        

Net income (loss)

   ¥ 228.8     ¥ 460.9     ¥ (458.1 )
                        

 

We reported a net loss of ¥458.1 billion for the fiscal year ended March 31, 2008, compared to a net income of ¥460.9 billion for the fiscal year ended March 31, 2007. Our basic loss per common share (net loss available to a common shareholder) for the fiscal year ended March 31, 2008 was ¥45.27, compared with our basic earnings per common share of ¥44.81 for the fiscal year ended March 31, 2007. Income from continuing operations before income tax expense and cumulative effect of a change in accounting principle for the fiscal year ended March 31, 2008 was ¥34.0 billion, compared with ¥872.0 billion for the fiscal year ended March 31, 2007.

 

The merger of BTM with UFJ Bank was the major factor in many of the changes in our consolidated statements of operations between the two fiscal years ended March 31, 2006 and 2007. The results for the fiscal year ended March 31, 2006 reflect the pre-merger results of the BTM Group for the six months ended September 30, 2005 and the post-merger results of the BTMU Group for the six months ended March 31, 2006. The results for the fiscal years ended March 31, 2007 and 2008 reflect the post-merger results of the BTMU Group for the full twelve-month period.

 

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Net Interest Income

 

The following is a summary of the interest rate spread for the fiscal years ended March 31, 2006, 2007 and 2008:

 

     Fiscal years ended March 31,  
     2006     2007     2008  
     Average
balance
   Average
rate
    Average
balance
   Average
rate
    Average
balance
   Average
rate
 
     (in billions, except percentages)  

Interest-earning assets:

               

Domestic

   ¥ 86,668.5    1.39 %   ¥ 108,531.2    1.73 %   ¥ 102,839.0    1.84 %

Foreign

     25,354.9    4.11       32,200.5    4.86       38,473.8    4.68  
                           

Total

   ¥ 112,023.4    2.01 %   ¥ 140,731.7    2.45 %   ¥ 141,312.8    2.61 %
                           

Financed by:

               

Interest-bearing funds:

               

Domestic

   ¥ 82,096.9    0.35 %   ¥ 99,673.2    0.52 %   ¥ 99,285.0    0.69 %

Foreign

     15,977.0    2.74       19,404.1    3.92       23,534.9    3.80  
                           

Total

     98,073.9    0.74       119,077.3    1.07       122,819.9    1.29  

Non-interest-bearing funds

     13,949.5    —         21,654.4    —         18,492.9    —    
                           

Total

   ¥ 112,023.4    0.65 %   ¥ 140,731.7    0.91 %   ¥ 141,312.8    1.11 %
                           

Spread on:

               

Interest-bearing funds

      1.27 %      1.38 %      1.32 %

Total funds

      1.36 %      1.54 %      1.50 %

 

We use interest rate and other derivative contracts for hedging the risks affecting the values of our financial assets and liabilities. Although these contracts are generally entered into for risk management purposes, a majority of them do not meet the specific conditions to qualify for hedge accounting under US GAAP and thus are accounted for as trading positions. Therefore, our net interest income for each of the fiscal years ended March 31, 2006, 2007 and 2008 was not materially affected by gains or losses resulting from such derivative instruments.

 

For a detailed discussion of our risk management systems, refer to “Item 11. Quantitative and Qualitative Disclosures about Credit, Market and Other Risk.”

 

Fiscal Year Ended March 31, 2008 Compared to Fiscal Year Ended March 31, 2007

 

Net interest income for the fiscal year ended March 31, 2008 was ¥2,114.5 billion, a decrease of ¥50.6 billion, from ¥2,165.1 billion for the fiscal year ended March 31, 2007. This decrease was mainly due to an increase in the average interest rate on domestic interest-bearing funds and an increase in the average balance of foreign interest-bearing funds. These increases offset the effect of the increase in the average balance of foreign interest-earning assets.

 

The average interest rate spread on interest-bearing funds decreased six basis points from 1.38% for the fiscal year ended March 31, 2007 to 1.32% for the fiscal year ended March 31, 2008. For the fiscal year ended March 31, 2007, the average rate on interest-earning assets increased partly due to an increase in the expected cash flows from impaired loans acquired in the merger with UFJ Bank, which cash flows are accounted for as adjustments to accretable yields under Statement of Position 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer.” For the fiscal year ended March 31, 2008, the increase in the expected cash flows from such impaired loans was smaller than that for the previous fiscal year. The average interest rate spread on total funds decreased, showing a decrease of four basis points from 1.54% for the fiscal year ended March 31, 2007 to 1.50% for the fiscal year ended March 31, 2008.

 

Average interest-earning assets for the fiscal year ended March 31, 2008 were ¥141,312.8 billion, an increase of ¥581.1 billion, from ¥140,731.7 billion for the fiscal year ended March 31, 2007. The increase was primarily

 

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attributable to an increase of ¥3,388.9 billion in foreign loans, an increase of ¥1,474.3 billion in foreign interest-earning deposits in other banks, an increase of ¥1,241.7 billion in foreign investment securities and an increase of ¥872.8 billion in domestic call loans, funds sold, and receivables under resale agreements and securities borrowing transactions. These increases were partially offset by a decrease of ¥4,714.8 billion in domestic investment securities and a decrease of ¥1,674.6 billion in domestic loans. The increase in foreign loans was mainly due to the growth in lending to Japanese and non-Japanese customers in Asia, the United States and Europe.

 

Average interest-bearing funds for the fiscal year ended March 31, 2008 were ¥122,819.9 billion, an increase of ¥3,742.6 billion, from ¥119,077.3 billion for the fiscal year ended March 31, 2007. The increase was primarily attributable to an increase of ¥3,468.4 billion in foreign interest-bearing deposits. The increase in foreign interest-bearing deposits was mainly due to the fact that large deposits from foreign central banks and government sponsored investment corporations increased in response to the recent difficult market conditions.

 

Fiscal Year Ended March 31, 2007 Compared to Fiscal Year Ended March 31, 2006

 

Net interest income for the fiscal year ended March 31, 2007 was ¥2,165.1 billion, an increase of ¥644.6 billion, from ¥1,520.5 billion for the fiscal year ended March 31, 2006. This increase was mainly due to the fact that net interest income for the fiscal year ended March 31, 2006 reflected only that of the post-merger BTMU Group for six months (with the first half of the fiscal year reflecting that of the pre-merger BTM Group only), while net interest income for the fiscal year ended March 31, 2007 reflected that of the post-merger BTMU Group for the full twelve-month period. For the fiscal year ended March 31, 2007, interest rates in Japan, the United States and Europe generally increased. In the rising interest rate environment in Japan during the fiscal year ended March 31, 2007, the increase in average rates on domestic interest-earning assets, such as loans, was larger than the increase in average rates on domestic interest-bearing funds, such as deposits. This increase in interest rate spread contributed to the increase in our net interest income.

 

The average interest rate spread on interest-bearing funds increased, showing an increase of 11 basis points from 1.27% for the fiscal year ended March 31, 2006 to 1.38% for the fiscal year ended March 31, 2007. The average interest rate spread on total funds also increased, showing an increase of 18 basis points from 1.36% for the fiscal year ended March 31, 2006 to 1.54% for the fiscal year ended March 31, 2007.

 

Average interest-earning assets for the fiscal year ended March 31, 2007 were ¥140,731.7 billion, an increase of ¥28,708.3 billion, from ¥112,023.4 billion for the fiscal year ended March 31, 2006. The increase was primarily attributable to an increase of ¥17,946.8 billion in domestic loans, and an increase of ¥4,574.2 billion in domestic investment securities. These increases were mainly due to the fact that the fiscal year ended March 31, 2006 reflected only six months of the post-merger BTMU Group (with the first half of the fiscal year reflecting the pre-merger BTM Group only), while the fiscal year ended March 31, 2007 reflected the post-merger BTMU Group for the full twelve-month period.

 

Average interest-bearing funds for the fiscal year ended March 31, 2007 were ¥119,077.3 billion, an increase of ¥21,003.4 billion, from ¥98,073.9 billion for the fiscal year ended March 31, 2006. The increase was primarily attributable to an increase of ¥19,641.7 billion in domestic interest-bearing deposits. The increase in domestic interest-bearing deposits was mainly due to the fact that the fiscal year ended March 31, 2006 reflected only six months of the post-merger BTMU Group (with the first half of the fiscal year reflecting the pre-merger BTM Group only), while the fiscal year ended March 31, 2007 reflected the post-merger BTMU Group for the full twelve-month period.

 

Provision for Credit Losses

 

Provision for credit losses is charged to operations to maintain the allowance for credit losses at a level deemed appropriate by management. For a description of the approach and methodology used to establish the allowance for credit losses, see “—B. Liquidity and Capital Resources—Financial Condition—Allowance for Credit Losses, Nonperforming and Past Due Loans.”

 

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Fiscal Year Ended March 31, 2008 Compared to Fiscal Year Ended March 31, 2007

 

Provision for credit losses for the fiscal year ended March 31, 2008 was ¥407.2 billion, an increase of ¥65.6 billion from ¥341.6 billion for the fiscal year ended March 31, 2007. The increase in provision for credit losses was mainly due to the downgrade in credit rating of certain overseas borrowers.

 

Fiscal Year Ended March 31, 2007 Compared to Fiscal Year Ended March 31, 2006

 

Provision for credit losses for the fiscal year ended March 31, 2007 was ¥341.6 billion, an increase of ¥178.2 billion from ¥163.4 billion for the fiscal year ended March 31, 2006. The increase in provision for credit losses was mainly due to the downgrade in credit rating of a large borrower in the transportation industry. Additionally, provision for credit losses increased in the consumer finance industry.

 

Non-Interest Income

 

The following table is a summary of our non-interest income for the fiscal years ended March 31, 2006, 2007 and 2008:

 

     Fiscal years ended March 31,  
     2006     2007     2008  
     (in billions)  

Fees and commissions:

      

Trust fees

   ¥ 20.3     ¥ 24.4     ¥ 26.8  

Fees on funds transfer and service charges for collections

     103.9       149.0       150.6  

Fees and commissions on international business

     61.6       69.5       69.4  

Fees and commissions on credit card business

     109.6       163.8       138.0  

Service charges on deposits

     35.7       37.2       35.9  

Fees and commissions on securities business

     31.7       16.8       32.4  

Insurance commissions

     36.5       40.4       33.4  

Guarantee fees

     51.6       86.5       84.6  

Fees on investment funds business

     13.9       23.1       23.0  

Other fees and commissions

     176.7       237.0       209.7  
                        

Total

     641.5       847.7       803.8  

Foreign exchange gains (losses)—net

     (281.4 )     (163.6 )     1,211.7  

Trading account profits (losses)—net:

      

Net profits (losses) on interest rate and other derivative contracts

     (212.7 )     171.0       318.1  

Net profits (losses) on trading account securities, excluding derivatives

     121.5       82.4       (45.7 )
                        

Total

     (91.2 )     253.4       272.4  

Investment securities gains (losses)—net:

      

Net gains (losses) on sales of securities available for sale:

      

Debt securities

     122.5       163.5       (11.2 )

Marketable equity securities

     158.4       54.0       67.2  

Impairment losses on securities available for sale:

      

Debt securities

     (250.8 )     (36.2 )     (1,025.0 )

Marketable equity securities

     (4.2 )     (54.6 )     (249.8 )

Other

     14.9       44.3       40.4  
                        

Total

     40.8       171.0       (1,178.4 )

Equity in earnings (losses) of equity method investees

     28.8       5.4       (35.7 )

Government grant for transfer of substitutional portion of Employees’ Pension Fund Plans

     103.0       —         —    

Gains on sales of loans

     34.6       13.6       10.0  

Other non-interest income

     80.7       93.0       129.8  
                        

Total non-interest income

   ¥ 556.8     ¥ 1,220.5     ¥ 1,213.6  
                        

 

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Net foreign exchange gains (losses) primarily include transaction gains (losses) on the translation into Japanese yen of monetary assets and liabilities denominated in foreign currencies and net gains (losses) on currency derivative instruments entered into for trading purposes. The transaction gains (losses) on the translation into Japanese yen fluctuate from period to period depending upon the spot rates at the end of each fiscal year. In principle, all transaction gains (losses) on translation of monetary liabilities denominated in foreign currencies are included in current earnings. Transaction gains (losses) on translation into Japanese yen of securities available for sale, such as bonds denominated in foreign currencies, are not included in current earnings, but are reflected in other changes in equity from nonowner sources. However, if we recognize an impairment loss on foreign currency-denominated securities available for sale due to the appreciation of the Japanese yen against the relevant foreign currency, such impairment loss is included in current earnings as part of investment securities losses.

 

Net trading account profits (losses) primarily include net gains (losses) on trading account securities and interest rate and other derivative instruments entered into for trading purposes. Trading account assets or liabilities are carried at fair value and any changes in the value of trading account assets or liabilities, including interest rate derivatives, are recorded in net trading account profits (losses). Derivative instruments for trading purposes also include those used as hedges of net exposures rather than for specifically identified assets or liabilities, which do not meet the specific criteria for hedge accounting.

 

Net investment securities gains (losses) primarily include net gains on sales of marketable securities, particularly debt securities and marketable equity securities that are classified as securities available for sale. In addition, impairment losses are recognized as an offset of net investment securities gains (losses) when management concludes that declines in fair value of investment securities are other than temporary.

 

Fiscal Year Ended March 31, 2008 Compared to Fiscal Year Ended March 31, 2007

 

Non-interest income for the fiscal year ended March 31, 2008 was ¥1,213.6 billion, a decrease of ¥6.9 billion, from ¥1,220.5 billion for the fiscal year ended March 31, 2007. This decrease was primarily due to a deterioration of ¥1,349.4 billion in net investment securities losses and a decrease of ¥43.9 billion in fees and commissions, which was almost offset by an improvement of ¥1,375.3 billion in net foreign exchange gains.

 

Fees and commissions

 

Fees and commissions for the fiscal year ended March 31, 2008 were ¥803.8 billion, a decrease of ¥43.9 billion, from ¥847.7 billion for the fiscal year ended March 31, 2007. The decrease was primarily attributable to a decrease of ¥25.8 billion in fees and commissions on credit card business and a decrease of ¥27.3 billion in other fees and commissions, due to a decrease in business volume. These decreases were partially offset by an increase of ¥15.6 billion in fees and commissions on securities business due to the inclusion of fees and commissions generated by a securities business company as a result of it becoming our consolidated subsidiary.

 

Net foreign exchange gains (losses)

 

Net foreign exchange gains for the fiscal year ended March 31, 2008 were ¥1,211.7 billion, compared to net foreign exchange losses of ¥163.6 billion for the fiscal year ended March 31, 2007. The improvement in foreign exchange gains (losses) was mainly due to the larger appreciation of the Japanese yen against the US dollar in the fiscal year ended March 31, 2008, compared to the fiscal year ended March 31, 2007. For reference, the foreign exchange rate expressed in Japanese yen per US$1.00 was ¥117.47 at March 31, 2006, ¥118.05 at March 30, 2007, and ¥100.19 at March 31, 2008. All transaction gains or losses on translation of monetary liabilities denominated in foreign currencies are included in current earnings. As we maintain monetary liabilities denominated in foreign currencies for our asset liability management, net foreign exchange gains (losses) fluctuate with the appreciation (depreciation) of the Japanese yen.

 

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Net trading account profits (losses)

 

Net trading account profits of ¥272.4 billion were recorded for the fiscal year ended March 31, 2008, compared to net trading account profits of ¥253.4 billion for the fiscal year ended March 31, 2007.

 

Net profits (losses) on interest rate and other derivative contracts were largely affected by the impact of the decrease (increase) in Japanese long-term interest rates on interest rate swaps principally held for risk management purposes. Although such contracts are generally entered into for risk management purposes, a majority of them did not meet the conditions to qualify for hedge accounting under US GAAP and thus are accounted for as trading positions.

 

Though Japanese yen short-term interest rates generally rose during the fiscal year ended March 31, 2008 compared to the previous fiscal year, long-term interest rates generally declined. This decline in long-term interest rates had a favorable impact on our interest rate swap portfolios, in which we generally maintained net receive-fix and pay-variable positions, for managing interest rate risks on domestic deposits. The increase in net profits on interest rate and other derivative contracts of ¥147.1 billion was partially offset by a decrease in net profits on trading account securities, excluding derivatives of ¥128.1 billion, primarily reflecting the increase in loss on sales and revaluation from trading in debt and equity securities primarily due to unfavorable market conditions.

 

Net investment securities gains (losses)

 

Net investment securities losses for the fiscal year ended March 31, 2008 were ¥1,178.4 billion, compared to net investment securities gains of ¥171.0 billion for the fiscal year ended March 31, 2007.

 

The net investment securities losses for the fiscal year ended March 31, 2008 mainly reflected the impairment losses of ¥1,025.0 billion on debt securities available for sale and of ¥249.8 billion on marketable equity securities available for sale. The increase in impairment losses on debt securities was mainly due to the appreciation of the Japanese yen against US dollars in the fiscal year ended March 31, 2008, compared to the fiscal year ended March 31, 2007. The amount of impairment losses attributable to the appreciation of the Japanese yen against foreign currencies was ¥758.0 billion. The increase in impairment losses on marketable equity securities was due to a decline in Japanese stock prices in the fiscal year 2008. The Nikkei Stock Average, which is an average of 225 blue chip stocks listed on the Tokyo Stock Exchange, was ¥17,287.65 at March 30, 2007 and ¥12,525.54 at March 31, 2008.

 

Fiscal Year Ended March 31, 2007 Compared to Fiscal Year Ended March 31, 2006

 

Non-interest income for the fiscal year ended March 31, 2007 was ¥1,220.5 billion, an increase of ¥663.7 billion, from ¥556.8 billion for the fiscal year ended March 31, 2006. This increase was primarily due to the increases of ¥344.6 billion in net trading account profits, ¥206.2 billion in fees and commissions, ¥130.2 billion in net investment securities gains and an improvement of ¥117.8 billion in net foreign exchange losses. These increases and improvement were partially offset by a decrease of ¥103.0 billion in government grant for transfer of substitutional portion of employees’ pension fund plans, as there were no such transfers for the fiscal year ended March 31, 2007.

 

Fees and commissions

 

Fees and commissions for the fiscal year ended March 31, 2007 were ¥847.7 billion, an increase of ¥206.2 billion, from ¥641.5 billion for the fiscal year ended March 31, 2006. This increase was mainly due to the fact that the fiscal year ended March 31, 2006 reflected only six months of the post-merger BTMU Group (with the first half of the fiscal year reflecting the pre-merger BTM Group only), while the results for the fiscal year ended March 31, 2007 reflected the post-merger BTMU Group for the full twelve-month period.

 

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Net foreign exchange gains (losses)

 

Net foreign exchange losses for the fiscal year ended March 31, 2007 were ¥163.6 billion, compared to net foreign exchange losses of ¥281.4 billion for the fiscal year ended March 31, 2006. The improvement in foreign exchange losses was mainly due to the smaller depreciation of the Japanese yen against foreign currencies in the fiscal year ended March 31, 2007, compared to the fiscal year ended March 31, 2006. For reference, the foreign exchange rate expressed in Japanese yen per US$1.00 was ¥107.39 at March 31, 2005, ¥117.47 at March 31, 2006, and ¥118.05 at March 30, 2007. The foreign exchange rate expressed in Japanese yen per €1.00 was ¥138.87 at March 31, 2005, ¥142.81 at March 31, 2006 and ¥157.33 at March 30, 2007. All transaction gains or losses on translation of monetary liabilities denominated in foreign currencies are included in current earnings. However, the transaction gains or losses on translation of securities available for sale, such as bonds denominated in foreign currencies, are not included in current earnings but are reflected in other changes in equity from nonowner sources. As we maintain monetary liabilities denominated in foreign currencies for our asset liability management, net foreign exchange gains (losses) fluctuate with the appreciation (depreciation) of the Japanese yen.

 

Net trading account profits (losses)

 

Net trading account profits of ¥253.4 billion were recorded for the fiscal year ended March 31, 2007, compared to net trading account losses of ¥91.2 billion for the fiscal year ended March 31, 2006.

 

Net profits (losses) on interest rate and other derivative contracts were largely affected by the impact of the decrease (increase) in Japanese long-term interest rates on interest rate swaps principally held for risk management purposes. Although such contracts are generally entered into for risk management purposes, the majority of them did not meet the conditions to qualify for hedge accounting under US GAAP and thus are accounted for as trading positions.

 

Though Japanese yen short-term interest rates generally rose during the fiscal year ended March 31, 2007 compared to the previous fiscal year, long-term interest rates generally declined. This decline in long-term interest rates had a favorable impact on our interest rate swap portfolios, in which we generally maintained net receive-fix and pay-variable positions, for managing interest rate risks on domestic deposits. The increase in net profits on interest rate and other derivative contracts of ¥383.7 billion was partially offset by a decrease in net profits on trading account securities, excluding derivatives of ¥39.1 billion, primarily reflecting the decline in profits from trading in debt and equity securities at our consolidated VIEs primarily due to unfavorable market conditions.

 

Net investment securities gains (losses)

 

Net investment securities gains for the fiscal year ended March 31, 2007 were ¥171.0 billion, an increase of ¥130.2 billion, from ¥40.8 billion for the fiscal year ended March 31, 2006.

 

The increase in net investment securities gains for the fiscal year ended March 31, 2007 mainly reflected the fact that net gains on sales of Japanese government bonds increased as the book value of such bonds declined, due to impairment losses recorded during the fiscal year ended March 31, 2006. The increase was partially offset by a decrease in net gains on sales of marketable equity securities and an increase in impairment losses on marketable equity securities. The decrease in net gains on sales of marketable equity securities for the fiscal year ended March 31, 2007 was partly due to a one-time adjustment to the book value of some of our marketable equity securities in connection with the merger with UFJ Bank. The increase in impairment losses on marketable equity securities was due to the fact that a larger number of our marketable equity securities were trading at depressed prices in a stagnant Japanese stock market in the fiscal year 2007, compared to a generally rising stock market in the previous fiscal year. The Nikkei Stock Average, which is an average of 225 blue chip stocks listed on the Tokyo Stock Exchange, was ¥11,668.95 at March 31, 2005, ¥17,059.66 at March 31, 2006 and ¥17,287.65 at March 30, 2007.

 

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Non-Interest Expense

 

The following table shows a summary of our non-interest expense for the fiscal years ended March 31, 2006, 2007 and 2008:

 

     Fiscal years ended March 31,
         2006            2007             2008    
     (in billions)

Salaries and employee benefits

   ¥ 585.6    ¥ 643.2     ¥ 699.5

Occupancy expenses—net

     95.8      123.4       115.8

Fees and commission expenses

     179.6      168.1       151.2

Outsourcing expenses, including data processing

     118.2      195.8       191.2

Depreciation of premises and equipment

     66.4      96.3       153.7

Amortization of intangible assets

     125.1      198.0       184.1

Impairment of intangible assets

     0.2      184.8       0.5

Insurance premiums, including deposit insurance

     78.8      101.3       101.9

Minority interest in income (loss) of consolidated subsidiaries

     108.9      (7.8 )     19.6

Communications

     33.0      45.3       46.4

Taxes and public charges

     47.8      68.3       72.4

Provision for repayment of excess interest

     12.9      106.2       2.8

Impairment of goodwill

     —        —         816.3

Other non-interest expenses

     164.5      249.1       331.5
                     

Total non-interest expense

   ¥ 1,616.8    ¥ 2,172.0     ¥ 2,886.9
                     

 

Fiscal Year Ended March 31, 2008 Compared to Fiscal Year Ended March 31, 2007

 

Non-interest expense for the fiscal year ended March 31, 2008 was ¥2,886.9 billion, an increase of ¥714.9 billion from the previous fiscal year. This increase was primarily due to the impairment of goodwill which we recorded during the fiscal year ended March 31, 2008 in the amount of ¥816.3 billion, but for which we did not record any amount for the previous fiscal year. The increase in non-interest expenses was partially offset by decreases in impairment of intangible assets and provision for repayment of excess interest.

 

Salaries and employee benefits

 

Salaries and employee benefits for the fiscal year ended March 31, 2008 were ¥699.5 billion, an increase of ¥56.3 billion from ¥643.2 billion for the previous fiscal year. This increase was mainly due to an increase in the one-time severance payments related to an early retirement program, totaling approximately ¥37 billion, made by a consumer finance subsidiary.

 

Depreciation of premises and equipment

 

Depreciation of premises and equipment for the fiscal year ended March 31, 2008 was ¥153.7 billion, an increase of ¥57.4 billion from ¥96.3 billion for the previous fiscal year. This increase primarily reflected the fact that we reviewed the salvage values of premises and equipment and decided to change the estimated salvage values of these assets to ¥1 during the fiscal year ended March 31, 2008. This change had an adverse impact on our income from continuing operations before income tax expense and net loss of ¥47 billion and ¥28 billion, respectively, for the fiscal year ended March 31, 2008. For further information, see Note 1 to our consolidated financial statements included elsewhere in this Annual Report.

 

Impairment of intangible assets

 

Impairment of intangible assets for the fiscal year ended March 31, 2008 was ¥0.5 billion, a decrease of ¥184.3 billion, from ¥184.8 billion for the previous fiscal year. The decrease was mainly due to our having no impairment of intangible assets related to a subsidiary in the consumer finance business whereas a significant amount was provided during the previous fiscal year.

 

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Provision for repayment of excess interest

 

Provision for repayment of excess interest for the fiscal year ended March 31, 2008 was ¥2.8 billion, a decrease of ¥103.4 billion from ¥106.2 billion for the previous fiscal year. The decrease was mainly due to a decrease in the provision for repayment of excess interest at our consumer finance subsidiaries.

 

Impairment of goodwill

 

In the fiscal year ended March 31, 2008, we recorded an impairment of goodwill of ¥816.3 billion. We recorded an impairment in goodwill due to, among other factors, the recent global financial market instability which negatively impacted the fair value of our reporting units for purposes of our periodic testing of goodwill for impairment. We did not record an impairment of goodwill for the fiscal year ended March 31, 2007. For further information, see Note 10 to our consolidated financial statements included elsewhere in this Annual Report.

 

Fiscal Year Ended March 31, 2007 Compared to Fiscal Year Ended March 31, 2006

 

Non-interest expense for the fiscal year ended March 31, 2007 was ¥2,172.0 billion, an increase of ¥555.2 billion from the previous fiscal year. This increase was primarily due to increases in most types of expenses, especially salaries and employee benefits, outsourcing expenses, including data processing, amortization of intangible assets, impairment of intangible assets and provision for repayment of excess interest. These increases were partially offset by the decrease in minority interest income (loss) of consolidated subsidiaries.

 

Salaries and employee benefits

 

Salaries and employee benefits for the fiscal year ended March 31, 2007 were ¥643.2 billion, an increase of ¥57.6 billion, from ¥585.6 billion for the previous fiscal year. Outsourcing expenses, including data processing, for the fiscal year ended March 31, 2007 was ¥195.8 billion, an increase of ¥77.6 billion, from ¥118.2 billion for the previous fiscal year. These increases primarily reflected the fact that the fiscal year ended March 31, 2006 reflected only six months of the post-merger BTMU Group (with the first half of the fiscal year reflecting the non-interest expense of the pre-merger BTM Group only), while the results for the fiscal year ended March 31, 2007 reflected the post-merger BTMU Group for the full twelve-month period.

 

Amortization of intangible assets

 

Amortization of intangible assets for the fiscal year ended March 31, 2007 was ¥198.0 billion, an increase of ¥72.9 billion, from ¥125.1 billion for the previous fiscal year. This increase was mainly due to the amortization of core deposit intangibles recognized in the merger with UFJ Bank, as well as the amortization of IT systems-related software, which also increased due to the merger.

 

Impairment of intangible assets

 

Impairment of intangible assets for the fiscal year ended March 31, 2007 was ¥184.8 billion, an increase of ¥184.6 billion, from ¥0.2 billion for the previous fiscal year. The increase was mainly due to the impairment of intangible assets related to our subsidiary in the consumer finance business caused by the downward revision of projected earnings of the subsidiary due to adverse changes in the consumer finance business environment.

 

Minority interest in income (loss) of consolidated subsidiaries

 

Minority interest in income (loss) of consolidated subsidiaries for the fiscal year ended March 31, 2007 was a loss of ¥7.8 billion, a decrease of ¥116.7 billion, from an income of ¥108.9 billion for the previous fiscal year.

 

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The decrease mainly reflects decrease in income from our consolidated subsidiaries and VIEs, including, in particular, losses recorded at a consumer finance subsidiary.

 

Provision for repayment of excess interest

 

Provision for repayment of excess interest for the fiscal year ended March 31, 2007 was ¥106.2 billion, an increase of ¥93.3 billion from ¥12.9 billion for the previous fiscal year. The increase was mainly due to an increase in allowance for repayment at our consumer finance subsidiaries which reflected a rise in borrowers’ claims for reimbursement of excess interest payments.

 

Income Tax Expense

 

The following table presents a summary of our income tax expense:

 

     Fiscal years ended March 31,  
         2006             2007             2008      
     (in billions, except percentages)  

Income from continuing operations before income tax expense and cumulative effect of a change in accounting principle

   ¥ 297.1     ¥ 872.0     ¥ 34.0  

Income tax expense

   ¥ 68.9     ¥ 410.3     ¥ 490.3  

Effective income tax rate

     23.2 %     47.1 %     1,442.6 %

Combined normal effective statutory tax rate

     40.6 %     40.6 %     40.6 %

 

Reconciling items between the combined normal effective statutory tax rates and the effective income tax rates for the fiscal years ended March 31, 2006, 2007 and 2008 are summarized as follows:

 

     Fiscal years ended March 31,  
         2006             2007             2008      

Combined normal effective statutory tax rate

   40.6 %   40.6 %   40.6 %

Increase (decrease) in taxes resulting from:

      

Nondeductible expenses

   1.1     0.1     5.8  

Dividends from foreign subsidiaries

   2.9     1.1     37.0  

Foreign tax credit and payments

   2.0     0.9     3.7  

Lower tax rates applicable to income of subsidiaries

   (12.2 )   (0.7 )   (30.7 )

Minority interests

   14.5     (0.3 )   22.6  

Change in valuation allowance

   1.3     8.2     418.1  

Realization of previously unrecognized tax effects of subsidiaries

   (29.1 )   —       2.2  

Nontaxable dividends received

   (2.1 )   (1.3 )   (34.0 )

Tax expense on capital transactions by a subsidiary

   8.0     —       —    

Impairment of goodwill

   —       —       975.2  

Other—net

   (3.8 )   (1.5 )   2.1  
                  

Effective income tax rate

   23.2 %   47.1 %   1,442.6 %
                  

 

The effective income tax rate of 1,442.6% for the fiscal year ended March 31, 2008 was 1,402.0 percentage points higher than the combined normal effective statutory tax rate of 40.6%. This higher tax rate was primarily due to the fact that an impairment of goodwill was recorded under US GAAP, decreasing our income from continuing operations before income tax expense and cumulative effect of a change in accounting principle to ¥34.0 billion for the fiscal year ended March 31, 2008. Under Japanese tax law, such impairment of goodwill was not deductible in computing our taxable income and, accordingly, our income tax expense was significantly higher in comparison to our income from continuing operations before income tax expense and cumulative effect

 

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of a change in accounting principle reported under US GAAP. In addition, the higher effective income tax rate reflected an additional valuation allowance related to operating loss carryforwards that were no longer deemed to be “more likely than not” to be realized, due to a decline in estimated future taxable income resulting from the downturn in financial and banking businesses caused by disruptions in the global financial markets.

 

The effective income tax rate of 47.1% for the fiscal year ended March 31, 2007 was 6.5 percentage points higher than the combined normal effective statutory tax rate of 40.6%. This higher tax rate primarily reflected an additional valuation allowance for certain companies, including a subsidiary in the consumer finance business.

 

The effective income tax rate of 23.2% for the fiscal year ended March 31, 2006 was 17.4 percentage points lower than the combined normal effective statutory tax rate of 40.6%. This lower tax rate primarily reflected realization of previously unrecognized tax effects in conjunction with the liquidation of certain subsidiaries and recognition of tax benefits through the reorganization of business within the BTMU Group, which were partly offset by certain items, including minority interests and tax expense on capital transactions by a subsidiary.

 

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Business Segment Analysis

 

We measure the performance of each of our business segments primarily in terms of “operating profit.” Operating profit and other segment information are based on the financial information prepared in accordance with Japanese GAAP as adjusted in accordance with internal management accounting rules and practices. Accordingly, the format and information is not consistent with our consolidated financial statements prepared on the basis of US GAAP. For example, operating profit does not reflect items such as a part of provision (credit) for credit losses (primarily an equivalent of formula allowance under US GAAP), foreign exchange gains (losses) and equity investment securities gains (losses).

 

The following is a brief explanation of our business segments:

 

   

Retail Banking, which provides banking products and services to individual customers in Japan;

 

   

Corporate Banking, which provides banking products and services, investment banking advisory, and other services to large corporations and some small- and medium-sized companies in Japan;

 

   

Global Banking, which consists of:

 

   

Global Banking (Other than UNBC), which provides banking products and services, investment banking advisory services, and other services to the overseas operations of both large- and medium-sized Japanese corporations as well as non-Japanese corporations who do business on a global basis, excluding UNBC’s customers;

 

   

UNBC, which includes our subsidiaries in California, UnionBanCal Corporation and Union Bank of California, N.A.;

 

   

Global Markets, which conducts its asset and liability management, liquidity management, and sales and trading of foreign exchange and interest-rate-related derivatives; and

 

   

Other, which consists of:

 

   

systems services, which is responsible for our computer systems;

 

   

trust and asset management business promotion for companies, including defined contribution plans;

 

   

eBusiness & IT Initiatives, which is responsible for developing information technology business opportunities; and

 

   

the corporate center, which retains functions such as strategic planning, overall risk management, internal auditing and compliance.

 

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The following table shows the business segment information for the fiscal years ended March 31, 2006, 2007 and 2008:

 

Effective April 1, 2007, there were changes made in the managerial accounting methods, including those regarding revenue and expense distribution among BTMU’s business segments. The presentation set forth below has been reclassified to conform to the new basis of managerial accounting. For further information, see Note 28 to our consolidated financial statements included elsewhere in this Annual Report.

 

    Retail
Banking
  Corporate
Banking(2)
  Global Banking(3)   Global
Markets(2)
  Other     Total
(in billions)           Other than
UNBC
  UNBC   Total              

Fiscal year ended March 31, 2006

               

Net revenue(1)

  ¥ 743.7   ¥ 716.0   ¥ 190.1   ¥ 350.3   ¥ 558.9   ¥ 281.3   ¥ (26.6 )   ¥ 2,273.3

Operating expenses

    495.4     247.6     124.8     202.4     337.0     32.8     124.6       1,237.4
                                                 

Operating profit (loss)

  ¥ 248.3   ¥ 468.4   ¥ 65.3   ¥ 147.9   ¥ 221.9   ¥ 248.5   ¥ (151.2 )   ¥ 1,035.9
                                                 

Fiscal year ended March 31, 2007

               

Net revenue(1)

  ¥ 1,098.8   ¥ 927.7   ¥ 267.4   ¥ 324.3   ¥ 595.2   ¥ 284.3   ¥ 15.6     ¥ 2,921.6

Operating expenses

    745.5     370.0     140.6     200.9     343.4     40.8     159.7       1,659.4
                                                 

Operating profit (loss)

  ¥ 353.3   ¥ 557.7   ¥ 126.8   ¥ 123.4   ¥ 251.8   ¥ 243.5   ¥ (144.1 )   ¥ 1,262.2
                                                 

Fiscal year ended March 31, 2008

               

Net revenue(1)

  ¥ 1,124.6   ¥ 895.1   ¥ 269.6   ¥ 296.4   ¥ 566.5   ¥ 240.4   ¥ 15.8     ¥ 2,842.4

Operating expenses

    771.0     386.6     145.7     187.6     334.6     42.7     169.1       1,704.0
                                                 

Operating profit (loss)

  ¥ 353.6   ¥ 508.5   ¥ 123.9   ¥ 108.8   ¥ 231.9   ¥ 197.7   ¥ (153.3 )   ¥ 1,138.4
                                                 

 

Notes:

(1)   Net revenue does not include interest income on loans to MUFG.
(2)   In accordance with our internal management accounting policies, we allocate profit (loss) relating to securitized products between the Corporate Banking business segment and the Global Markets business segment.
(3)   Within Global Banking, results of certain liquidated subsidiaries for the fiscal years ended March 31, 2006, 2007 and 2008 are not included in the “Other than UNBC” column, while they are included in the “Total” column for internal management reporting purpose.

 

Fiscal Year Ended March 31, 2008 Compared to Fiscal Year Ended March 31, 2007

 

Total net revenue decreased ¥79.2 billion, from ¥2,921.6 billion for the fiscal year ended March 31, 2007 to ¥2,842.4 billion for the fiscal year ended March 31, 2008. Net revenue decreased ¥32.6 billion in the Corporate Banking business segment, ¥28.7 billion in the Global Banking business segment and ¥43.9 billion in the Global Markets business segment.

 

Total operating expenses increased ¥44.6 billion, from ¥1,659.4 billion for the fiscal year ended March 31, 2007 to ¥1,704.0 billion for the fiscal year ended March 31, 2008. This increase was mainly due to an increase of ¥25.5 billion in the Retail Banking business segment, ¥16.6 billion in the Corporate Banking business segment and ¥9.4 billion in the Other Business segment. These increases primarily reflected an increase in expenses related to IT systems integration and compliance related investments.

 

Net revenue of the Retail Banking business segment increased ¥25.8 billion, from ¥1,098.8 billion for the fiscal year ended March 31, 2007 to ¥1,124.6 billion for the fiscal year ended March 31, 2008. This increase was mainly due to deposit income offsetting the negative effect of the lowering of interest rates at a consumer finance subsidiary.

 

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Net revenue of the Corporate Banking business segment decreased ¥32.6 billion, from ¥927.7 billion for the fiscal year ended March 31, 2007 to ¥895.1 billion for the fiscal year ended March 31, 2008. This decrease was mainly due to a decrease in interest income from loans because of intensified competition, a decrease in the volume of currency options sales because of the recent deterioration in financial market conditions and losses relating to securitized products. These decreases were partially offset by increases in deposit income.

 

Net revenue of the Global Banking business segment (Other than UNBC) increased ¥2.2 billion, from ¥267.4 billion for the fiscal year ended March 31, 2007 to ¥269.6 billion for the fiscal year ended March 31, 2008. This increase was mainly due to revenue derived from non-Japanese corporations in Europe and the United States.

 

Net revenue of the Global Banking business segment (UNBC) decreased ¥27.9 billion, from ¥324.3 billion for the fiscal year ended March 31, 2007 to ¥296.4 billion for the fiscal year ended March 31, 2008. The decrease was principally due to a shift in the nature of deposits from non-interest-bearing and low-cost deposits into higher-cost deposits.

 

Net revenue of the Global Markets business segment decreased ¥43.9 billion, from ¥284.3 billion for the fiscal year ended March 31, 2007 to ¥240.4 billion for the fiscal year ended March 31, 2008. This decrease was mainly due to losses relating to securitized products.

 

Fiscal Year Ended March 31, 2007 Compared to Fiscal Year Ended March 31, 2006

 

The merger of BTM with UFJ Bank was the major factor in the changes in the business segment analysis between the fiscal years ended March 31, 2006 and 2007. As discussed in “—Introduction—Key Financial Figures”, although the merger of BTM with UFJ Bank occurred on January 1, 2006, the results of operations of the UFJ Bank Group have been included since October 1, 2005. The results for the fiscal year ended March 31, 2006 reflected the pre-merger results of the BTM Group for the six months ended September 30, 2005 and the post-merger results of the BTMU Group for the six months ended March 31, 2006. The results for the fiscal year ended March 31, 2007 reflected the post-merger results of the BTMU Group for the full twelve-month period.

 

Total net revenue increased ¥648.3 billion from ¥2,273.3 billion for the fiscal year ended March 31, 2006 to ¥2,921.6 billion for the fiscal year ended March 31, 2007, and total operating expenses increased ¥422.0 billion from ¥1,237.4 billion for the fiscal year ended March 31, 2006 to ¥1,659.4 billion for the fiscal year ended March 31, 2007. These increases mainly reflected the fact that the results for the fiscal year ended March 31, 2006 reflected only six months of the post-merger BTMU Group (with the first half of the fiscal year reflecting the pre-merger BTM Group only), while the results for the fiscal year ended March 31, 2007 reflected the post-merger BTMU Group for the full twelve-month period.

 

Net revenue of the Retail Banking business segment increased ¥355.1 billion, from ¥743.7 billion for the fiscal year ended March 31, 2006 to ¥1,098.8 billion for the fiscal year ended March 31, 2007. This increase primarily reflected the fact that the results for the fiscal year ended March 31, 2006 reflected only six months of the post-merger BTMU Group (with the first half of the fiscal year reflecting the pre-merger BTM Group only), while the fiscal year ended March 31, 2007 reflected the post-merger BTMU Group for the full twelve-month period. Additional factors contributing to this net revenue growth were increases in income from commercial banking operations, such as interest earned from our domestic Japanese yen deposits as a result of the increase in interest spread. These increases were partially offset by decreases in interest spread from our domestic housing loans.

 

Net revenue of the Corporate Banking business segment increased ¥211.7 billion, from ¥716.0 billion for the fiscal year ended March 31, 2006 to ¥927.7 billion for the fiscal year ended March 31, 2007. This increase primarily reflected the fact that the results for the fiscal year ended March 31, 2006 reflected only six months of

 

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the post-merger BTMU Group (with the first half of the fiscal year reflecting those of the pre-merger BTM Group only), while the results for the fiscal year ended March 31, 2007 reflected the post-merger BTMU Group for the full twelve-month period. As a result, net revenue in most areas, such as net interest income from loans, and fees related to investment banking, increased. A decrease in interest spread from our lending operations to large- and medium-sized Japanese companies, due to the improved credit of many borrowers and increased competition with other financial institutions, partially offset the increase in net revenue.

 

Net revenue of the Global Banking business segment (Other than UNBC) increased ¥77.3 billion, from ¥190.1 billion for the fiscal year ended March 31, 2006 to ¥267.4 billion for the fiscal year ended March 31, 2007. This increase primarily reflected the fact that the results for the fiscal year ended March 31, 2006 reflected only six months of the post-merger BTMU Group (with the first half of the fiscal year reflecting the pre-merger BTM Group only), while the results for the fiscal year ended March 31, 2007 reflected the post-merger BTMU Group for the full twelve-month period. Factors which increased net revenue other than the merger were incomes from commercial banking operations such as deposits and lending operations mainly consisting of loans to Japanese corporate clients situated outside Japan in Asia and Europe.

 

Net revenue of the Global Banking business segment (UNBC) decreased ¥26.0 billion, from ¥350.3 billion for the fiscal year ended March 31, 2006 to ¥324.3 billion for the fiscal year ended March 31, 2007. The decrease was principally due to the fact that profits from the sales of international correspondent banking did not occur in the fiscal year ended March 31, 2007. There were also decreases in net interest income, caused by the shift in customer deposits from non-interest bearing deposits or other investments, in response to rising short-term interest rates in the United States.

 

Net revenue of the Global Markets business segment increased ¥3.0 billion, from ¥281.3 billion for the fiscal year ended March 31, 2006 to ¥284.3 billion for the fiscal year ended March 31, 2007. This increase was also mainly due to the fact that the results for the fiscal year ended March 31, 2006 reflected only six months of the post-merger BTMU Group (with the first half of the fiscal year reflecting the pre-merger BTM Group only), while the results for the fiscal year ended March 31, 2007 reflected the post-merger BTMU Group for the full twelve-month period. These increases were partially offsets by the decrease in profits on foreign-currency ALM operations due to the increase in interest rates.

 

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Geographic Segment Analysis

 

The table immediately below sets forth our total revenue, income from continuing operations before income tax expense and cumulative effect of a change in accounting principle and net income (loss) on a geographic basis for the fiscal years ended March 31, 2006, 2007 and 2008. Assets, income and expenses attributable to foreign operations are allocated to geographical areas based on the domicile of the debtors and customers. For further information, see Note 29 to our consolidated financial statements included elsewhere in this Annual Report.

 

     Fiscal years ended March 31,  
     2006     2007    2008  
     (in billions)  

Total revenue (interest income and non-interest income):

       

Domestic

   ¥ 1,481.7     ¥ 2,697.2    ¥ 3,851.6  
                       

Foreign:

       

United States

     861.3       1,089.1      141.1  

Europe

     190.5       447.5      390.9  

Asia/Oceania excluding Japan

     174.9       264.2      434.5  

Other areas(1)

     97.8       166.8      89.3  
                       

Total foreign

     1,324.5       1,967.6      1,055.8  
                       

Total

   ¥ 2,806.2     ¥ 4,664.8    ¥ 4,907.4  
                       

Income (loss) from continuing operations before income tax expense and cumulative effect of a change in accounting principle:

       

Domestic

   ¥ (254.5 )   ¥ 5.1    ¥ 299.9  
                       

Foreign:

       

United States

     369.1       457.0      (543.9 )

Europe

     59.2       244.6      105.1  

Asia/Oceania excluding Japan

     63.9       85.0      184.3  

Other areas(1)

     59.4       80.3      (11.4 )
                       

Total foreign

     551.6       866.9      (265.9 )
                       

Total

   ¥ 297.1     ¥ 872.0    ¥ 34.0  
                       

Net income (loss):

       

Domestic

   ¥ (207.3 )   ¥ 4.0    ¥ (143.1 )
                       

Foreign:

       

United States

     288.7       241.2      (665.0 )

Europe

     45.8       130.8      134.0  

Asia/Oceania excluding Japan

     55.6       45.4      232.3  

Other areas(1)

     46.0       39.5      (16.3 )
                       

Total foreign

     436.1       456.9      (315.0 )
                       

Total

   ¥ 228.8     ¥ 460.9    ¥ (458.1 )
                       

 

Note:

(1)   Other areas primarily include Canada, Latin America and the Caribbean.

 

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Fiscal Year Ended March 31, 2008 Compared to Fiscal Year Ended March 31, 2007

 

Domestic net loss for the fiscal year ended March 31, 2008 was ¥143.1 billion, compared to net income of ¥4.0 billion for the fiscal year ended March 31, 2007. This deterioration was mainly due to our recording an impairment of goodwill for the fiscal year ended March 31, 2008.

 

Foreign net loss for the fiscal year ended March 31, 2008 was ¥315.0 billion, compared to a foreign net income of ¥456.9 billion for the fiscal year ended March 31, 2007. This deterioration primarily reflected the net loss in the United States mainly due to an increase in impairment losses on investment securities denominated in US dollars.

 

Fiscal Year Ended March 31, 2007 Compared to Fiscal Year Ended March 31, 2006

 

Domestic net income for the fiscal year ended March 31, 2007 was ¥4.0 billion, compared to net loss of ¥207.3 billion for the fiscal year ended March 31, 2006. This improvement primarily reflected the increase in non-interest income due to increases in net trading profits and net investment securities gains and a decrease in net foreign exchange losses compared to the previous fiscal year.

 

Foreign net income for the fiscal year ended March 31, 2007 was ¥456.9 billion, compared to ¥436.1 billion for the fiscal year ended March 31, 2006. This increase primarily reflected the increase in net income in Europe.

 

Effect of the Change in Exchange Rates on Foreign Currency Translation

 

Fiscal Year Ended March 31, 2008 Compared to Fiscal Year Ended March 31, 2007

 

The average exchange rate for the fiscal year ended March 31, 2008 was ¥114.29 per US$1.00, compared to the prior fiscal year’s average exchange rate of ¥117.02 per US$1.00. The average exchange rate for the conversion of the US dollar financial statements of some of our foreign subsidiaries for the fiscal year ended December 31, 2007 was ¥117.84 per US$1.00, compared to the average exchange rate for the fiscal year ended December 31, 2006 of ¥116.38 per US$1.00.

 

The change in the average exchange rate of the Japanese yen against the US dollar and other foreign currencies had the effect of increasing total revenue by ¥31.3 billion, net interest income by ¥11.4 billion and income before income taxes by ¥12.7 billion, respectively, for the fiscal year ended March 31, 2008.

 

Fiscal Year Ended March 31, 2007 Compared to Fiscal Year Ended March 31, 2006

 

The average exchange rate for the fiscal year ended March 31, 2007 was ¥117.02 per US$1.00, compared to the prior fiscal year’s average exchange rate of ¥113.31 per US$1.00. The average exchange rate for the conversion of the US dollar financial statements of some of our foreign subsidiaries for the fiscal year ended December 31, 2006 was ¥116.38 per US$1.00, compared to the average exchange rate for the fiscal year ended December 31, 2005 of ¥110.21 per US$1.00.

 

The change in the average exchange rate of the Japanese yen against the US dollar and other foreign currencies had the effect of increasing total revenue by approximately ¥88 billion, net interest income by approximately ¥35 billion and income before income taxes by approximately ¥15 billion, respectively, for the fiscal year ended March 31, 2007.

 

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B.    Liquidity and Capital Resources

 

Financial Condition

 

Total Assets

 

Our total assets at March 31, 2008 were ¥152.08 trillion, a decrease of ¥1.53 trillion from ¥153.61 trillion at March 31, 2007. The decrease in total assets mainly reflected decreases in investment securities of ¥7.55 trillion, call loans and funds sold of ¥1.12 trillion and goodwill of ¥0.80 trillion. These decreases were partially offset by increases in net loans of ¥3.60 trillion, receivables under securities borrowing transactions of ¥1.28 trillion, trading account assets of ¥1.23 trillion, cash and due from banks of ¥1.12 trillion and deferred tax assets of ¥0.35 trillion. The decrease in investment securities was mainly due to the sale of Japanese government bonds to take advantage of lower market interest rates.

 

We have allocated a substantial portion of our assets to international activities. As a result, reported amounts are affected by changes in the value of the Japanese yen against the US dollar and other foreign currencies. Foreign assets are denominated primarily in US dollars. The following table shows our total assets at March 31, 2007 and 2008 by geographic region based principally on the domicile of the obligors:

 

     At March 31,
     2007    2008
     (in trillions)

Japan

   ¥ 119.10    ¥ 111.14
             

Foreign:

     

United States of America

     17.58      17.94

Europe

     7.43      10.83

Asia/Oceania excluding Japan

     6.36      7.94

Other areas(1)

     3.14      4.23
             

Total foreign

     34.51      40.94
             

Total

   ¥ 153.61    ¥ 152.08
             

 

Note:

(1)   Other areas primarily include Canada, Latin America and the Caribbean.

 

At March 31, 2008, the foreign exchange rate expressed in Japanese yen per US$1.00 was ¥100.19, as compared with ¥118.05 at March 30, 2007. The Japanese yen amount of foreign currency-denominated assets and liabilities decreases as the relevant exchange rates resulted in an increase in the value of the Japanese yen relative to such foreign currencies. The appreciation of the Japanese yen against the US dollar and other foreign currencies during the fiscal year ended March 31, 2008 decreased the Japanese yen amount of our total assets by ¥9.92 trillion.

 

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Loan Portfolio

 

The following table sets forth our loans outstanding, before deduction of allowance for credit losses, at March 31, 2007 and 2008, based on classification by industry segment as defined by the Bank of Japan for regulatory reporting purposes, which is not necessarily based on use of proceeds. Classification of loans by industry at March 31, 2007 has been restated. For further information, see Note 7 to our consolidated financial statements included elsewhere in this Annual Report.

 

     At March 31,  
     2007 (Restated)     2008  
     (in billions)  

Domestic(1):

    

Manufacturing

   ¥ 9,600.7     ¥ 9,906.4  

Construction

     1,689.8       1,601.7  

Real estate

     6,676.0       6,605.0  

Services

     6,063.2       5,725.7  

Wholesale and retail

     8,545.5       8,547.3  

Banks and other financial institutions(2)

     3,309.9       3,548.5  

Communication and information services

     1,002.5       962.8  

Other industries

     9,183.1       9,390.3  

Consumer

     22,490.4       22,650.8  
                

Total domestic

     68,561.1       68,938.5  
                

Foreign:

    

Governments and official institutions

     371.6       315.4  

Banks and other financial institutions(2)

     1,618.8       2,021.0  

Commercial and industrial

     13,256.5       15,998.8  

Other

     2,363.8       2,586.8  
                

Total foreign

     17,610.7       20,922.0  
                

Total

     86,171.8       89,860.5  
                

Unearned income, unamortized premiums—net and deferred loan fees—net

     (47.7 )     (80.7 )
                

Total(3)

   ¥ 86,124.1     ¥ 89,779.8  
                

 

Notes:

(1)   Since the credit administration system was upgraded, a precise breakdown of the balance of consumer loans by the type of proprietor business became available. As a result, the consumer balances at March 31, 2007 and 2008 do not include those loans to individuals who utilize loan proceeds to finance their proprietor activities and not for their personal financing needs. The balances at March 31, 2007 were reclassified accordingly.
(2)   Loans to the so-called non-bank finance companies are generally included in the “Banks and other financial institutions” category. Non-bank finance companies are primarily engaged in consumer lending, factoring and credit card businesses.
(3)   The above table includes loans held for sale of ¥87.1 billion at March 31, 2007 and ¥469.8 billion at March 31, 2008, which are carried at the lower of cost or estimated fair value.

 

Loans are our primary use of funds. The average loan balance accounted for 61.3% of total interest-earning assets for the fiscal year ended March 31, 2007 and 62.2% for the fiscal year ended March 31, 2008.

 

At March 31, 2008, our total loans were ¥89.78 trillion, representing an increase of ¥3.66 trillion from ¥86.12 trillion at March 31, 2007. Before unearned income, unamortized premiums—net and deferred loan fees—net, our loan balance at March 31, 2008 consisted of ¥68.94 trillion of domestic loans and ¥20.92 trillion of foreign loans, while the loan balance at March 31, 2007 consisted of ¥68.56 trillion of domestic loans and ¥17.61 trillion of foreign loans. Between March 31, 2007 and March 31, 2008, domestic loans increased ¥0.38 trillion and foreign loans increased ¥3.31 trillion.

 

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Domestic loans outstanding at March 31, 2008 remained approximately at the same level as those at March 31, 2007. Breaking down the domestic portfolio by industry segment, the loan balance for manufacturing increased ¥0.31 trillion and the loan balance for banks and other financial institutions increased ¥0.24 trillion, while the loan balance for services decreased ¥0.33 trillion.

 

Despite foreign corporations’ increasing need for funds, the ability of corporations to obtain funds from the capital markets mainly in the United States and Europe was affected by the recent disruptions in the financial markets. The recent disruptions in the financial markets also caused US and European banks to reduce lending activity. As a result, loans to our customers increased mainly in the United States and Europe during the fiscal year ended March 31, 2008.

 

Allowance for Credit Losses, Nonperforming and Past Due Loans

 

The following table shows a summary of the changes in the allowance for credit losses for the fiscal years ended March 31, 2006, 2007 and 2008:

 

     Fiscal years ended March 31,  
     2006     2007     2008  
     (in billions)  

Balance at beginning of fiscal year

   ¥ 567.7     ¥ 913.0     ¥ 993.5  

Additions resulting from the merger with UFJ Bank(1)

     279.2       —         —    

Provision for credit losses

     163.4       341.6       407.2  

Charge-offs:

      

Domestic

     (116.7 )     (284.4 )     (363.5 )

Foreign

     (10.4 )     (13.9 )     (6.3 )
                        

Total

     (127.1 )     (298.3 )     (369.8 )

Recoveries:

      

Domestic

     3.2       28.2       23.8  

Foreign

     16.2       4.8       2.0  
                        

Total

     19.4       33.0       25.8  
                        

Net charge-offs

     (107.7 )     (265.3 )     (344.0 )

Others(2)

     10.4       4.2       (6.0 )
                        

Balance at end of fiscal year

   ¥ 913.0     ¥ 993.5     ¥ 1,050.7  
                        

 

Notes:

(1)   Additions resulting from the merger with UFJ Bank represent the allowance for credit losses for acquired loans outside the scope of SOP 03-3. The allowance for credit losses on loans within the scope of SOP 03-3 was not carried over.
(2)   “Others” principally include foreign exchange translation adjustments.

 

As previously discussed, the provision for credit losses for the fiscal year ended March 31, 2008 was ¥407.2 billion, an increase of ¥65.6 billion from ¥341.6 billion for the fiscal year ended March 31, 2007. The increase in the provision for credit losses was mainly due to the downgrade in credit rating of certain overseas borrowers.

 

For the fiscal year ended March 31, 2008, the ratio of the provision for credit losses of ¥407.2 billion to the average loan balance of ¥87.95 trillion was 0.46%, and that to the total average interest-earning assets of ¥141.31 trillion was 0.29%.

 

Charge-offs for the fiscal year ended March 31, 2008 were ¥369.8 billion, an increase of ¥71.5 billion from ¥298.3 billion for the fiscal year ended March 31, 2007. The increase in the charge-offs was mainly due to increases in the charge-offs for the domestic wholesale and retail, services, and manufacturing segments.

 

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The total allowance at March 31, 2008 was ¥1,050.7 billion, an increase of ¥57.2 billion from ¥993.5 billion at March 31, 2007 as we recorded a provision for credit losses of ¥407.2 billion, whereas we had net charge-offs of ¥344.0 billion.

 

The following table presents comparative data in relation to the principal amount of nonperforming loans sold and reversal of allowance for credit losses:

 

     Principal
amount of
loans(1)
   Allowance for
credit losses(2)
   Loans,
net of
allowance
   Reversal of
allowance for
credit losses
 
     (in billions)  

For the fiscal year ended March 31, 2007

   ¥ 121.4    ¥ 35.7    ¥ 85.7    ¥ (23.9 )

For the fiscal year ended March 31, 2008

   ¥ 76.5    ¥ 19.9    ¥ 56.6    ¥ (11.8 )

 

Notes:

(1)   Represents principal amount after the deduction of charge-offs made before the sales of nonperforming loans.
(2)   Represents allowance for credit losses at the latest balance-sheet date.

 

Through the sale of nonperforming loans to third parties, additional provisions or gains may arise from factors such as a change in the credit quality of the borrowers or the value of the underlying collateral subsequent to the prior reporting date, and the risk appetite and investment policy of the purchasers.

 

Due to the inherent uncertainty of factors that may affect negotiated prices which reflect the borrowers’ financial condition and the value of underlying collateral, the fact that we recorded no additional cost during the reported periods is not necessarily indicative of the results that we may record in the future.

 

In connection with the sale of loans including performing loans, we recorded net gains of ¥22.7 billion and ¥12.7 billion for the fiscal years ended March 31, 2007 and 2008, respectively.

 

The following table summarizes the allowance for credit losses by component at March 31, 2007 and 2008:

 

     At March 31,
     2007    2008
     (in billions)

Allocated allowance:

     

Specific—specifically identified problem loans

   ¥ 511.9    ¥ 544.6

Large groups of smaller balance homogeneous loans

     129.5      129.1

Loans exposed to specific country risk

     0.1      0.1

Formula—substandard, special mention and other loans

     345.0      367.2

Unallocated allowance

     7.0      9.7
             

Total allowance

   ¥ 993.5    ¥ 1,050.7
             

 

Allowance policy

 

Our credit rating system is closely linked to the risk grading standards set by the Japanese regulatory authorities for asset evaluation and assessment, and is used as a basis for establishing the allowance for credit losses and charge-offs. The categorization is based on conditions that may affect the ability of borrowers to service their debt, such as current financial condition and results of operations, historical payment experience, credit documentation, other public information and current trends. For a discussion of our credit rating system, see “Item 11. Quantitative and Qualitative Disclosures about Credit, Market and Other Risk—Credit Risk Management—Credit Rating System.”

 

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Change in total allowance and provision for credit losses

 

At March 31, 2008, the total allowance for credit losses was ¥1,050.7 billion, representing 1.17% of our total loan portfolio. At March 31, 2007, the total allowance for credit losses was ¥993.5 billion, representing 1.15% of our total loan portfolio.

 

The total allowance increased from ¥993.5 billion at March 31, 2007 to ¥1,050.7 billion at March 31, 2008 primarily as a result of the downgrade in credit rating of certain borrowers.

 

The provision for credit losses for the fiscal year ended March 31, 2008 was ¥407.2 billion, a increase of ¥65.6 billion from ¥341.6 billion for the fiscal year ended March 31, 2007. The increase in the provision for credit losses was mainly due to the downgrade in credit rating of certain overseas borrowers.

 

During the fiscal year ended March 31, 2008, there were no significant changes in our general allowance policy, which affected our allowance for credit losses for the period, resulting from directives, advice or counsel from governmental or regulatory bodies.

 

Allocated allowance for specifically identified problem loans

 

The allocated credit loss allowance for specifically identified problem loans represents the allowance against impaired loans required under SFAS No. 114, “Accounting by Creditors for Impairment of a Loan.” Impaired loans primarily include nonaccrual loans and restructured loans. We generally discontinue the accrual of interest income on loans when substantial doubt exists as to the full and timely collection of either principal or interest, or when principal or interest is contractually past due one month or more with respect to loans made by us or by certain domestic subsidiaries, and 90 days or more with respect to loans of certain foreign subsidiaries. Loans are classified as restructured loans when we grant a concession to borrowers for economic or legal reasons related to the borrowers’ financial difficulties.

 

Detailed reviews of impaired loans are performed after a borrower’s annual or semi-annual financial statements first become available. In addition, as part of an ongoing credit review process, our credit officers monitor changes in all customers’ creditworthiness, including bankruptcy, past due principal or interest, downgrading of external credit ratings, declines in the stock price, business restructuring and other events, and reassess our ratings of borrowers in response to such events. This credit monitoring process forms an integral part of our overall risk management process. An impaired loan is evaluated individually based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s estimated market price or the fair value of the collateral at the annual and semi-annual balance-sheet date, if the loan is collateral-dependent as of a balance-sheet date.

 

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The following table summarizes nonaccrual and restructured loans, and accruing loans that are contractually past due 90 days or more as to principal or interest payments, at March 31, 2007 and 2008:

 

     At March 31,  
     2007     2008  
     (in billions, except
percentages)
 

Nonaccrual loans:

    

Domestic(1):

    

Manufacturing

   ¥ 80.9     ¥ 108.3  

Construction

     43.2       44.2  

Real estate

     138.7       161.6  

Services

     134.0       135.9  

Wholesale and retail

     126.5       152.9  

Banks and other financial institutions

     10.2       4.3  

Communication and information services

     22.0       43.2  

Other industries

     120.4       33.0  

Consumer

     284.0       303.6  
                

Total domestic

     959.9       987.0  

Foreign

     39.0       116.1  
                

Total nonaccrual loans

     998.9       1,103.1  
                

Restructured loans:

    

Domestic(1):

    

Manufacturing

     80.8       63.5  

Construction

     13.0       14.8  

Real estate

     96.6       118.4  

Services

     48.1       32.3  

Wholesale and retail

     107.6       30.9  

Banks and other financial institutions

     0.6       2.0  

Communication and information services

     2.9       2.6  

Other industries

     58.6       112.3  

Consumer

     63.1       54.6  
                

Total domestic

     471.3       431.4  

Foreign

     40.3       22.8  
                

Total restructured loans

     511.6       454.2  
                

Accruing loans contractually past due 90 days or more:

    

Domestic

     19.5       13.5  

Foreign

     1.8       3.0  
                

Total accruing loans contractually past due 90 days or more

     21.3       16.5  
                

Total

   ¥ 1,531.8     ¥ 1,573.8  
                

Total loans

   ¥ 86,124.1     ¥ 89,779.8  
                

Nonaccrual and restructured loans, and accruing loans contractually past due 90 days or more as a percentage of total loans

     1.78 %     1.75 %
                

 

Note:

(1)   Since the credit administration system was upgraded, a precise breakdown of the balance of consumer loans by the type of proprietor business became available. As a result, the consumer balance at March 31, 2007 and 2008 do not include those loans to individuals who utilize loan proceeds to finance their proprietor activities and for their personal financing needs. The balance at March 31, 2007 were reclassified accordingly.

 

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Nonaccrual and restructured loans and accruing loans contractually past due 90 days or more increased ¥42.0 billion from ¥1,531.8 billion at March 31, 2007 to ¥1,573.8 billion at March 31, 2008. The percentage of nonperforming loans to the total loans decreased to 1.75% at March 31, 2008 from 1.78% at March 31, 2007.

 

Total nonaccrual loans were ¥1,103.1 billion at March 31, 2008, an increase of ¥104.2 billion from ¥998.9 billion at March 31, 2007. This increase was mainly due to an increase of ¥27.1 billion in domestic nonaccrual loans, and an increase of ¥77.1 billion in foreign nonaccrual loans, mainly due to the downgrade in credit rating of certain overseas borrowers. Domestic nonaccrual loans in domestic other industries decreased ¥87.4 billion mainly due to the upgrade in credit rating of certain borrowers.

 

Total restructured loans were ¥454.2 billion at March 31, 2008, a decrease of ¥57.4 billion from ¥511.6 billion at March 31, 2007. Domestic restructured loans decreased ¥39.9 billion to ¥431.4 billion at March 31, 2008 from ¥471.3 billion at March 31, 2007 mainly due to the upgrade in credit rating of certain large borrowers. While the restructured loans in the wholesale and retail segments decreased ¥76.7 billion, those in the other industries increased ¥53.7 billion.

 

The following table summarizes the balances of impaired loans and related impairment allowances at March 31, 2007 and 2008, excluding smaller-balance homogeneous loans:

 

     At March 31,
     2007    2008
     Loan
balance
    Impairment
allowance
   Loan
balance
    Impairment
allowance
     (in billions)

Requiring an impairment allowance

   ¥ 987.2     ¥ 511.9    ¥ 1,079.2     ¥ 544.6

Not requiring an impairment allowance(1)

     239.3       —        300.4       —  
                             

Total(2)

   ¥ 1,226.5     ¥ 511.9    ¥ 1,379.6     ¥ 544.6
                             

Percentage of the allocated allowance to total impaired loans

     41.7 %        39.5 %  
                     

 

Notes:

(1)   These loans do not require an allowance for credit losses under SFAS No. 114 since the fair values of the impaired loans equal or exceed the recorded investments in the loans.
(2)   In addition to impaired loans presented in the above table, there were loans held for sale that were impaired in the amount of ¥0.8 billion and ¥11.9 billion at March 31, 2007 and 2008, respectively.

 

Impaired loans increased ¥153.1 billion from ¥1,226.5 billion at March 31, 2007 to ¥1,379.6 billion at March 31, 2008, reflecting the increase in restructured loans.

 

The percentage of the allocated allowance to total impaired loans decreased 2.2 percentage points to 39.5% at March 31, 2008 from 41.7% at March 31, 2007.

 

Based upon a review of the financial status of borrowers, we may grant various concessions (modification of loan terms) to troubled borrowers at the borrowers’ request, including reductions in the stated interest rates, debt write-offs, and extensions of the maturity date. According to our policies, such modifications are made to mitigate the near-term burden of the loans to the borrowers and to better match the payment terms with the borrowers’ expected future cash flows or, in cooperation with other creditors, to reduce the overall debt burden of the borrowers so that they may normalize their operations, in each case to improve the likelihood that the loans will be repaid in accordance with the revised terms. The nature and amount of the concessions depend on the particular financial condition of each borrower. In principle, however, we do not modify the terms of loans to borrowers that are considered “Likely to Become Bankrupt,” “Virtually Bankrupt” or “Bankrupt” under the self-assessment categories established by Japanese banking regulations because in these cases there is little likelihood that the modification of loan terms would enhance recovery of the loans.

 

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Allocated allowance for large groups of smaller-balance homogeneous loans

 

The allocated credit loss allowance for large groups of smaller-balance homogeneous loans is focused on loss experience for the pools of loans rather than on an analysis of individual loans. Large groups of smaller-balance homogeneous loans primarily consist of first mortgage housing loans to individuals. The allowance for groups of performing loans is based on historical loss experience over a period. In determining the level of the allowance for delinquent groups of loans, we classify groups of homogeneous loans based on the risk rating and/or the number of delinquencies. We determine the credit loss allowance for delinquent groups of loans based on the probability of insolvency by the number of actual delinquencies and actual loss experience.

 

The allocated credit loss allowance for large groups of smaller-balance homogeneous loans was ¥129.1 billion at March 31, 2008, a decrease of ¥0.4 billion from ¥129.5 billion at March 31, 2007.

 

Allocated allowance for country risk exposure

 

The allocated credit loss allowance for country risk exposure is based on an estimate of probable losses relating to the exposure to countries that we identify as having a high degree of transfer risk. The countries to which the allowance for country risk exposure are decided based on a country risk grading system used to assess and rate the transfer risk to individual countries. The allowance is generally determined based on a function of default probability and expected recovery ratios, taking external credit ratings into account.

 

The allocated allowance for country risk exposure was approximately ¥0.1 billion at March 31, 2007 and 2008.

 

Formula allowance for substandard, special mention and unclassified loans

 

The formula allowance is calculated by applying estimated loss factors to outstanding substandard, special mention and unclassified loans. In evaluating the inherent loss for these loans, we rely on a statistical analysis that incorporates a percentage of total loans based on historical loss experience.

 

The formula allowance increased ¥22.2 billion from 345.0 billion at March 31, 2007 to ¥367.2 billion at March 31, 2008. The main reason for this increase was downgrades of loans to some borrowers to substandard loans or special mention loans.

 

We have computed the formula allowance based on estimated credit losses using a methodology defined by the credit rating system. Estimated losses inherent in the loan portfolio at the balance sheet date are calculated by multiplying the default ratio by the nonrecoverable ratio (determined as a complement of the recovery ratio). The default ratio is determined by each credit risk rating, taking into account the historical number of defaults of borrowers within each credit risk rating divided by the total number of borrowers within that credit risk rating existing at the beginning of the three-year observation period. The recovery ratio is mainly determined by the historical experience of collections against loans in default. The default ratio, the recovery ratio and other indicators are continually reviewed and improved to compute the formula allowance and the allowance for off-balance-sheet instruments. In addition, an appropriate adjustment to the formula allowance and the allowance for off-balance-sheet instruments, considering the risk of losses from large obligors and other credit risks, is examined and made by analyzing the difference between the allowance computed by multiplying the default ratio by nonrecoverable ratio and the allowance calculated based on the loss experience ratio.

 

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UNBC, our largest overseas subsidiary, calculates the formula allowance by applying loss factors to outstanding loans and certain unused commitments, in each case based on the internal risk grade of such loans, leases and commitments. Changes in risk grades affect the amount of the formula allowance. Loss factors are based on their historical loss experience and may be adjusted for significant factors that, in management’s judgment, affect the collectibility of the portfolio as of the evaluation date. Loss factors are developed in the following ways:

 

   

loss factors for individually graded credits are derived from a migration model that tracks historical losses over a period, which we believe captures the inherent losses in our loan portfolio; and

 

   

pooled loan loss factors (not individually graded loans) are based on expected net charge-offs. Pooled loans are loans that are homogeneous in nature, such as consumer installment, home equity, residential mortgage loans and certain small commercial and commercial real estate loans.

 

Though there are a few technical differences in the methodology used for the formula allowance for credit losses as mentioned above, we examine overall sufficiency of the formula allowance periodically by back-test comparison with the actual loss experience subsequent to the balance sheet date.

 

Unallocated allowance

 

The unallocated allowance is based on management’s evaluation of conditions that are not directly reflected in the determination of the formula and specific allowances. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they may not be identified with specific problem credits or portfolio segments. The conditions evaluated in connection with the unallocated allowance include the following, which were considered to exist at the balance sheet date:

 

   

general economic and business conditions affecting our key lending areas;

 

   

credit quality trends (including trends in nonperforming loans expected to result from existing conditions);

 

   

collateral values;

 

   

loan volumes and concentrations;

 

   

specific industry conditions within portfolio segments;

 

   

recent loss experience in particular segments of the portfolio;

 

   

duration of the current economic cycle;

 

   

bank regulatory examination results; and

 

   

findings of internal credit examination.

 

Executive management reviews these conditions quarterly in discussion with our senior credit officers. To the extent that any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s estimate of the effect of such condition may be reflected as a specific allowance, applicable to such credit or portfolio segment. Where any of these conditions is not evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s evaluation of the probable loss related to such condition is reflected in the unallocated allowance.

 

The unallocated allowance increased ¥2.7 billion from ¥7.0 billion at March 31, 2007 to ¥9.7 billion at March 31, 2008. This increase resulted mainly from management’s negative outlook of economic and specific industry conditions.

 

Allowance for Off-balance-sheet Credit Instruments

 

In addition to the allowance for credit losses on the loan portfolio, we maintain an allowance for credit losses on off-balance-sheet credit instruments, including commitments of credit, guarantees and standby letters of

 

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credit. This allowance is included in other liabilities. With regard to the specific allocated allowance for specifically identified credit exposure and the allocated formula allowance, we apply the same methodology that we use in determining the allowance for loan credit losses. The allowance for credit losses on off-balance-sheet credit instruments was ¥94.0 billion at March 31, 2008, an increase of ¥17.4 billion from ¥76.6 billion at March 31, 2007. The increase in the allowance for credit losses on off-balance-sheet credit instruments was mainly due to the downgrade in the credit rating of certain overseas borrowers.

 

Investment Portfolio

 

Our investment securities are primarily comprised of marketable equity securities and Japanese government and Japanese government agency bonds, which are mostly classified as available-for-sale securities. We also hold Japanese government bonds which are classified as securities being held to maturity.

 

Historically, we have held equity securities of some of our customers for strategic purposes, in particular, to maintain long-term relationships with these customers. However, we have been reducing the aggregate value of our equity securities because we believe that from a risk management perspective reducing the price fluctuation risk in our equity portfolio is imperative. As of March 31, 2007 and 2008, the aggregate value of marketable equity securities under Japanese GAAP satisfies the requirements of the legislation prohibiting banks from holding equity securities in excess of their Tier I capital.

 

Investment securities decreased ¥7.55 trillion, from ¥42.26 trillion at March 31, 2007 to ¥34.71 trillion at March 31, 2008 due primarily to the sale of Japanese government bonds to take advantage of lower market interest rates and to a lesser extent due to the decrease in net unrealized gain in marketable equity securities relevant to the decline in the Japanese stock market.

 

The following table shows information as to the amortized costs and estimated fair values of our investment securities available for sale and being held to maturity at March 31, 2007 and 2008:

 

    At March 31,  
    2007     2008  
    Amortized
cost
  Estimated
fair value
  Net
unrealized
gains (losses)
    Amortized
cost
  Estimated
fair value
  Net
unrealized
gains (losses)
 
    (in billions)  

Securities available for sale:

           

Debt securities:

           

Japanese national government and Japanese government agency bonds

  ¥ 18,583.3   ¥ 18,615.4   ¥ 32.1     ¥ 13,453.5   ¥ 13,482.9   ¥ 29.4  

Japanese prefectural and municipal bonds

    228.9     230.5     1.6       192.7     197.7     5.0  

Foreign governments and official institutions bonds

    3,124.8     3,192.5     67.7       2,528.8     2,557.3     28.5  

Corporate bonds

    5,305.2     5,438.7     133.5       4,711.8     4,824.2     112.4  

Mortgage-backed securities

    2,614.6     2,677.1     62.5       3,366.2     3,365.1     (1.1 )

Asset-backed securities, excluding mortgage-backed securities

    2,503.7     2,560.4     56.7       2,932.2     2,839.0     (93.2 )

Other debt securities

    11.0     11.5     0.5       12.2     11.9     (0.3 )

Marketable equity securities

    3,683.6     6,864.0     3,180.4       3,475.3     5,098.8     1,623.5  
                                       

Total securities available for sale

  ¥ 36,055.1   ¥ 39,590.1   ¥ 3,535.0     ¥ 30,672.7   ¥ 32,376.9   ¥ 1,704.2  
                                       

Securities being held to maturity:

           

Debt securities, principally Japanese government bonds

  ¥ 2,106.9   ¥ 2,100.7   ¥ (6.2 )   ¥ 1,858.0   ¥ 1,860.6   ¥ 2.6  
                                       

 

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The estimated fair value of available-for-sale securities decreased ¥7.21 trillion from ¥39.59 trillion at March 31, 2007 to ¥32.38 trillion at March 31, 2008. This decrease was primarily due to a decrease in our holdings of Japanese government bonds. As part of our asset-liability management operations, we decreased our Japanese government bond holdings, considering the interest rate market conditions and possible tightening of liquidity condition resulting from the effects of the market disruptions starting in the latter half of 2007.

 

Net unrealized gains on available-for-sale securities decreased ¥1.84 trillion from ¥3.54 trillion at March 31, 2007 to ¥1.70 trillion at March 31, 2008. This decrease consisted of a ¥1.56 trillion decrease in net unrealized gains on marketable equity securities and a ¥0.28 trillion decrease in net unrealized gains on debt securities. The decrease in net unrealized gains of ¥1.56 trillion on marketable equity securities was mainly due to the decrease in stock prices which negatively affected our holdings of Japanese equity securities. The decrease in net unrealized gains on debt securities was mainly due to the appreciation of the Japanese yen against the US dollar that negatively affected the yen value of our foreign mortgage-backed securities and asset-backed securities. The decline in market prices of asset-backed securitization products due to the deterioration in credit markets was also a factor resulting in our reporting net unrealized losses on mortgage-backed securities and asset-backed securities.

 

The amortized cost of securities being held to maturity decreased ¥0.25 trillion compared to the previous fiscal year. The decrease was mainly due to the redemption of Japanese government bonds.

 

Cash and Due from Banks

 

Cash and due from banks at March 31, 2008 was ¥3.55 trillion, an increase of ¥1.12 trillion from ¥2.43 trillion at March 31, 2007. The increase was primarily due to an increase in our deposit balance with the Bank of Japan, resulting from an increase in our total balance of time deposits.

 

Interest-earning Deposits in Other Banks

 

Interest-earning deposits in other banks fluctuate significantly from day to day depending upon financial market conditions. Interest-earning deposits in other banks at March 31, 2008 were ¥5.80 trillion, an increase of ¥0.28 trillion from ¥5.52 trillion at March 31, 2007. This increase primarily reflected an increase in released funds in Euro-yen markets.

 

Goodwill

 

Goodwill at March 31, 2008 was ¥0.97 trillion, a decrease of ¥0.80 trillion from ¥1.77 trillion at March 31, 2007. This decrease was mainly because goodwill impairment loss of ¥816.3 billion was recognized for the fiscal year ended March 31, 2008, compared to no impairment for the previous fiscal year. For further information, see “—A. Operating Results—Impairment of goodwill.”

 

Deferred Tax Assets

 

Deferred tax assets increased ¥0.35 trillion, from ¥0.51 trillion at March 31, 2007 to ¥0.86 trillion at March 31, 2008. This increase was primarily due to a decrease in deferred tax liabilities related to a decline in net unrealized gains on investment securities, which was partly offset by a decrease in deferred tax assets for utilized operating loss carryforwards and an additional valuation allowance related to operating loss carryforwards that were no longer deemed to be “ more likely than not” to be realized due to a decline in estimated future taxable income resulting from the downturn in financial and banking businesses caused by disruptions in the global financial markets.

 

Total Liabilities

 

At March 31, 2008, total liabilities were ¥145.41 trillion, an increase of ¥0.49 trillion from ¥144.92 trillion at March 31, 2007. This increase primarily reflected increases of ¥2.01 trillion in total deposits and ¥0.73 trillion

 

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in payables under repurchase agreements which offset decreases of ¥0.81 trillion in payables under securities lending transactions, ¥0.73 trillion in other short-term borrowings and ¥0.61 trillion in long-term debt.

 

The appreciation of the Japanese yen against the US dollar and other foreign currencies during the fiscal year ended March 31, 2008 decreased the Japanese yen amount of foreign currency-denominated liabilities by ¥8.71 trillion.

 

Deposits

 

Deposits are our primary source of funds. Total average balance of deposits increased ¥2.78 trillion from ¥110.71 trillion for the fiscal year ended March 31, 2007 to ¥113.49 trillion for the fiscal year ended March 31, 2008, reflecting an increase of ¥3.47 trillion in average foreign interest-bearing deposits and an increase of ¥1.77 trillion in average domestic interest-bearing deposits, partially offset by a decrease of ¥2.10 trillion in average domestic non-interest-bearing deposits and a decrease of ¥0.37 trillion in average foreign non-interest-bearing deposits.

 

Domestic deposits decreased ¥0.03 trillion from ¥96.57 trillion at March 31, 2007 to ¥96.54 trillion at March 31, 2008, while foreign deposits increased ¥2.05 trillion from ¥16.81 trillion at March 31, 2007 to ¥18.86 trillion at March 31, 2008. As for domestic deposits, the balance of non-interest bearing deposits decreased while interest-bearing deposits increased, partially in response to the rising short-term interest rates that made interest-bearing deposits more attractive. The increase in foreign interest-bearing deposits was mainly due to the fact that large deposits from foreign central banks and government sponsored investment corporations increased in response to the recent difficult market conditions.

 

Short-term Borrowings

 

We use short-term borrowings as a funding source and in our management of interest rate risk. For management of interest rate risk, short-term borrowings are used in asset-liability management operations to match interest rate risk exposure resulting from loans and other interest-earning assets and to manage funding costs of various financial instruments at an appropriate level, based on our forecast of future interest rate levels. Short-term borrowings consist of call money and funds purchased, payables under repurchase agreements, payables under securities lending transactions and other short-term borrowings.

 

Short-term borrowings decreased ¥1.08 trillion from ¥13.05 trillion at March 31, 2007 to ¥11.97 trillion at March 31, 2008. This decrease was primarily attributable to decreases of ¥0.81 trillion in payables under securities lending transactions, ¥0.74 trillion in other short-term borrowings and ¥0.26 trillion in call money and funds purchased, partially offset by an increase of ¥0.73 trillion in payables under repurchase agreements. We reduced our short-term borrowings in general to maintain liquidity in our money market operations.

 

Long-term Debt

 

Long-term debt at March 31, 2008 was ¥11.65 trillion, a decrease of ¥0.61 trillion from ¥12.26 trillion at March 31, 2007. This decrease was mainly due to a decrease of ¥0.29 trillion in the balance of certain straight bonds issued by us, a decrease of ¥0.20 trillion in the balance of subordinated bonds and borrowings payable in US dollars and a decrease of ¥0.17 trillion in obligation under loan securitization transaction accounted for as secured borrowings by our subsidiaries. For further information, see Note 15 to our consolidated financial statements included elsewhere in this Annual Report.

 

Sources of Funding and Liquidity

 

Our primary source of liquidity is from a large balance of deposits, mainly ordinary deposits, certificates of deposit and time deposits. Time deposits have shown a historically high rollover rate among our corporate customers and individual depositors. As of March 31, 2008, our deposits of ¥115.40 trillion exceeded our loans, net of allowance for credit losses of ¥88.73 trillion, by ¥26.67 trillion. These deposits provide us with a sizable

 

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source of stable and low-cost funds. While approximately 47.0% of certificates of deposit and time deposits mature within three months, we continuously monitor relevant interest rate characteristics of these funds and utilize asset and liability management techniques to manage the possible impact of the rollovers on our net interest margin and liquidity. Our average deposits, combined with average shareholder’s equity, funded 78.2% of our average total assets of ¥155.53 trillion during the fiscal year ended March 31, 2008.

 

Most of the remaining funding was provided by short-term borrowings and long-term senior and subordinated debt. Short-term borrowings consist of call money and funds purchased, payables under repurchase agreements, payables under securities lending transactions and other short-term borrowings. From time to time, we have issued long-term instruments such as straight bonds with mainly three to five years’ maturity. Liquidity may also be provided by the sale of financial assets, including securities available for sale, trading account securities and loans. Additional liquidity may be provided by the maturity of loans.

 

Total Shareholder’s Equity

 

The following table presents a summary of our total shareholder’s equity at March 31, 2007 and 2008:

 

     At March 31,  
                 2007                             2008              
     (in billions, except percentages)  

Preferred stock

   ¥ 125.0     ¥ 125.0  

Common stock

     872.0       872.0  

Capital surplus

     5,851.1       5,884.0  

Retained earnings (Accumulated deficit)

     216.3       (710.8 )

Accumulated other changes in equity from nonowner sources, net of taxes

     1,850.4       725.4  

Loan receivable for constructive capital contribution from parent company

     (228.5 )     (228.5 )

Parent company’s stock, at cost

     (0.2 )     (1.4 )
                

Total shareholder’s equity

   ¥ 8,686.1     ¥ 6,665.7  
                

Ratio of total shareholder’s equity to total assets

     5.65 %     4.38 %

 

Total shareholder’s equity decreased ¥2,020.4 billion, from ¥8,686.1 billion at March 31, 2007 to ¥6,665.7 billion at March 31, 2008. The ratio of total shareholder’s equity to total assets also showed a decrease of 1.27 percentage points from 5.65% at March 31, 2007 to 4.38% at March 31, 2008. The decrease in total shareholder’s equity, and the resulting decrease in the ratio to total assets, at March 31, 2008 were principally attributable to a decrease of ¥1,125.0 billion in accumulated other changes in equity from nonowner sources, net of taxes, and an increase of ¥927.1 billion in accumulated deficit. The decrease in accumulated other changes in equity from nonowner sources, net of taxes, was mainly due to declines in the Japanese stock market, which resulted in a decrease in net unrealized gain on investment securities available for sale. The increase in accumulated deficit was mainly due to our recording a net loss for the fiscal year ended March 31, 2008.

 

Due to our holdings of a large amount of marketable Japanese equity securities and the volatility of the equity markets in Japan, changes in the fair value of marketable equity securities have significantly affected our shareholder’s equity. The following table presents information relating to the accumulated net unrealized gains, net of taxes, in respect of investment securities classified as available for sale at March 31, 2007 and 2008:

 

     At March 31,  
                 2007                             2008              
     (in billions, except percentages)  

Accumulated net unrealized gains on investment securities available for sale

   ¥ 1,861.4     ¥ 762.8  

Accumulated net unrealized gains to total shareholder’s equity

     21.43 %     11.44 %

 

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Capital Adequacy

 

We are subject to various regulatory capital requirements promulgated by the regulatory authorities of the countries in which we operate. Failure to meet minimum capital requirements can initiate mandatory actions by regulators that, if undertaken, could have a direct material effect on our consolidated financial statements.

 

We continually monitor our risk-adjusted capital ratio closely and manage our operations in consideration of the capital ratio requirements. These ratios are affected not only by fluctuations in the value of our assets, including our credit risk assets such as loans and equity securities, the risk weights of which depend on the borrowers’ or issuers’ internal ratings, marketable securities and deferred tax assets, but also by fluctuations in the value of the Japanese yen against the US dollar and other foreign currencies and by general price levels of Japanese equity securities.

 

Capital Requirements for Banking Institutions in Japan

 

A Japanese banking institution is subject to the minimum capital adequacy requirements both on a consolidated basis and a stand-alone basis, and is required to maintain the minimum capital irrespective of whether it operates independently or as a subsidiary under the control of another company. Under the Financial Services Agency’s guidelines, capital is classified into three tiers, referred to as Tier I, Tier II and Tier III capital. Our Tier I capital generally consists of shareholder’s equity items, including common stock, non-cumulative preferred stock, capital surplus, minority interests and retained earnings (which includes deferred tax assets), but recorded goodwill and other items, such as treasury stock, are deducted from Tier I capital. Our Tier II capital generally consists of the amount (up to a maximum of 0.6% of credit risk-weighted assets) by which eligible reserves for credit losses exceeds expected losses in the Internal Ratings Based approach, or the IRB approach, and general reserves for credit losses, subject to a limit of 1.25% of modified risk-weighted assets determined by the partial use of the Standardized Approach (including a phased rollout of the IRB approach), 45% of the unrealized gains on investment securities classified as “other securities,” 45% of the land revaluation excess, the balance of perpetual subordinated debt and the balance of subordinated term debt with an original maturity of over five years subject to certain limitations, up to 50% of Tier I capital. Our Tier III capital consists of short-term subordinated debt with an original maturity of at least two years, subject to certain limitations. At least 50% of the minimum capital requirements must be maintained in the form of Tier I capital.

 

The eligible regulatory capital set forth in the Financial Services Agency’s guidelines discussed above were modified as of March 31, 2007 to reflect the “International Convergence of Capital Measurement and Capital Standards: A Revised Framework,” often referred to as “Basel II.”

 

As of March 31, 2007 and 2008, we have calculated our risk-weighted assets in accordance with Basel II. In determining capital ratios under Basel II, we adopted the Foundation Internal Ratings Based approach, or the FIRB approach, to reflect the credit risk in the risk-weighted assets. Under the FIRB approach, we generally take into account probability of default, or PD, applicable to borrower rating and PD, loss given default and exposure at default applicable to pool assignment. Market risk is reflected in the risk-weighted assets by applying the Internal Models Approach to calculate general market risk and the Standardized Methodology to calculate specific risk. Under the Internal Models Approach, we principally use a historical simulation model to calculate value-at-risk amounts by estimating the profit and loss on our portfolio by applying actual fluctuations in the market rates and prices over a fixed period in the past. Under Basel II, we newly reflected operational risk in the risk-weighted assets by applying the Standardized Approach. Specifically, operational risk capital charge is determined based on the amount of gross profit allocated to business lines multiplied by a factor ranging from 12% to 18%.

 

For additional discussion of the calculation of our capital ratios under Basel II, see Note 21 to our consolidated financial statements included elsewhere in this Annual Report.

 

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Under the Japanese regulatory capital requirements, our consolidated capital components, including Tier I, Tier II and Tier III capital, and risk-weighted assets, are calculated from our consolidated financial statements prepared under Japanese GAAP.

 

For a detailed discussion of the capital adequacy guidelines adopted by the Financial Services Agency and proposed amendments, see “Item 4.B. Information on the Company—Business Overview—Supervision and Regulation—Japan—Capital Adequacy.”

 

Capital Requirements for Banking Institutions in the United States

 

In the United States, UNBC and its banking subsidiary, Union Bank of California, N.A., or UBOC, our largest subsidiaries operating outside Japan, are subject to various regulatory capital requirements administered by US Federal banking agencies, including minimum capital requirements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, they must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under US regulatory accounting practices. Their capital amounts and prompt corrective action classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

 

For a detailed discussion of the capital adequacy guidelines applicable to our US banking subsidiaries, see “Item 4.B. Information on the Company—Business Overview—Supervision and Regulation—United States—Bank Capital Requirements and Capital Distributions.”

 

Our Capital Ratios

 

The table below presents our consolidated total capital, risk-weighted assets and risk-adjusted capital ratios at March 31, 2007 and 2008 (underlying figures are calculated in accordance with Japanese banking regulations based on information derived from our consolidated financial statements prepared in accordance with Japanese GAAP, as required by the Financial Services Agency. The percentages in the tables below are rounded down).

 

The consolidated total capital, risk-weighted assets and risk-adjusted capital ratios at March 31, 2007 have been restated. For further information, see Note 21 to our consolidated financial statements included elsewhere in this Annual Report.

 

     At March 31,     Minimum capital
ratios required
 
         2007 (Restated)             2008        
     (in billions, except percentages)        

Capital components:

      

Tier I capital

   ¥ 6,975.6     ¥ 7,037.6    

Tier II capital (qualifying capital)

     4,940.6       3,917.6    

Tier III capital (qualifying capital)

     —         —      

Deductions from total qualifying capital

     314.2       344.1    
                  

Total capital

   ¥ 11,602.0     ¥ 10,611.1    
                  

Risk-weighted assets

   ¥ 90,804.1     ¥ 94,686.9    

Capital ratios:

      

Tier I capital

     7.68 %     7.43 %   4.00 %

Total risk-adjusted capital

     12.77       11.20     8.00  

 

Our Tier I capital ratio and total risk-adjusted capital ratio at March 31, 2008 were 7.43% and 11.20%, respectively. The decrease in total risk-adjusted capital ratio was mainly due to a decrease in Tier II capital resulting from the decrease in the amount of unrealized gains on investment securities and an increase in risk-weighted assets for credit risk.

 

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Table of Contents

Capital Ratios of Our Banking Subsidiaries in the United States

 

The table below presents the risk-adjusted capital ratios of UNBC and UBOC at December 31, 2006 and 2007:

 

     At December 31,     Minimum capital
ratios required
    Ratios OCC
requires to be
“well-capitalized”
 
         2006             2007          

UNBC:

        

Tier I capital (to risk-weighted assets)

   8.68