Fitch Ratings has affirmed the 'A-' Long-Term Issuer Default Ratings (IDRs) on Mitsubishi UFJ Financial Group, Inc. (MUFG) and its subsidiaries - MUFG Bank, Ltd. and Mitsubishi UFJ Trust and Banking Corporation (MUTB) - together referred to as MUFG group.

Fitch has also affirmed the Long-Term IDRs on MUFG's affiliated companies - Mitsubishi UFJ Morgan Stanley Securities Co., Ltd. (MUMSS) at 'A-' and ACOM CO., LTD. at 'BBB+'. The Outlooks on their Long-Term IDRs are Stable.

At the same time, Fitch has affirmed the ratings on the senior notes issued by MUFG and MUFG Bank.

Fitch has also withdrawn MUFG group's Support Ratings (SRs) of '1' and Support Rating Floors (SRFs) of 'A-' because they are no longer relevant to the agency's coverage following the publication of our updated Bank Rating Criteria on 12 November 2021. We have also withdrawn MUMSS's and ACOM's SRs of '1' and '2', respectively, because they are no longer relevant to the agency's coverage following the publication of our updated Non-Bank Financial Institutions Rating Criteria on 31 January 2022.

In line with the updated criteria, we have assigned MUFG group a Government Support Rating (GSR) of 'a-', and MUMSS and ACOM a Shareholder Support Rating (SSR) of 'a-' and 'bbb+', respectively.

Key Rating Drivers

IDRs, GSRs and VIABILITY RATINGs

The MUFG group's Long-Term IDRs are at the same level as its 'a-' group Viability Rating (VR) and GSR. The GSR reflects Fitch's view of a very high likelihood of support from the Japanese sovereign (A/Stable) for MUFG, should it be required. Our affirmation of the VRs, in line with its implied group VR, factors in MUFG's strong business profile, which underpins its sound funding base, stable asset quality and capitalisation, and modest profitability.

Consolidated Group VR: We assess MUFG group's VR on a consolidated group basis, reflecting the functional interconnectedness between the group and its core banks, MUFG Bank and MUTB, and the regulator's group-level focus, which makes government support equally likely for MUFG, MUFG Bank and MUTB. We assign the group VR to MUFG Bank and MUTB as we believe they have substantially the same failure risk as the group. The group VR is also assigned to the holding company, reflecting low double leverage and prudent liquidity management.

Stable Operating Environment: We expect a slow but sound economic recovery in Japan over 2022 and 2023, underpinning the stable outlook on our 'a-' operating environment factor score. The pressure on growth from structural challenges and global uncertainties is factored into our assessment.

Sound Franchise: MUFG's strong business profile is characterised by a solid franchise in the domestic market, geographical diversification and the most diversified business model among domestic major bank peers. However, its franchise strength has not resulted in a stronger financial profile relative to mega-bank peers, which, in conjunction with Fitch now incorporating our assessment of management and strategy in the business profile, has resulted in our lowering of the factor score to 'a' with a stable outlook, from 'a+' with a negative outlook.

Profitability Recovery: MUFG's profitability remains a weakness although the operating profit/risk-weighted asset (RWA) ratio, the core metric for profitability, improved to 1.0% in the nine months ended December 2021 from 0.6% at end-March 2021, primarily due to reduced credit costs and operating expenses. We believe an improvement in the risk-return profile of MUFG's business portfolio in addition to a more cost-efficient operation would lead to a sustainable improvement in profitability.

Solid Capitalisation: Fitch expects MUFG's capitalisation to remain stable. We believe MUFG will maintain its capital-management policy target of a common equity Tier 1 (CET1) ratio of 9.5%-10% on a finalised Basel III basis, excluding unrealised gains on securities. Any capital above this target range is likely to prompt the bank to consider investments and/or additional shareholder returns.

Stable Asset Quality: We expect MUFG's impaired-loan ratio (1.3% at end-December 2021) to remain broadly at the current level with reduced downside risks given the economic recovery from the pandemic.

Funding and Liquidity Remain Stable: MUFG's funding and liquidity score of 'a' is below the 'aa' category implied score given the bank's foreign-currency liquidity, with a foreign-currency loan-to-deposit ratio above 100% despite recent improvements due to a reduction in loans. Domestically, we expect MUFG to maintain its sound liquidity and funding profile with a strong deposit base.

Disciplined Risk Management: We think MUFG has robust risk management and control. Fitch believes that MUFG retains its appetite for growth, although we expect its inorganic growth to be aligned with the group's capital policy, which reflects regulatory capital considerations.

'Very High' Likelihood of Support: MUFG group's GSR reflects our assessment that, like other systemically important banks in Japan, there is a 'Very High' probability the group will receive government support in case of need. The government can pre-emptively provide financial assistance to a solvent bank holding company when a serious system disruption is anticipated under Japan's Deposit Insurance Act.

The government has made consistent and strong statements of its intention to support the financial system, backed by its long history of support. We expect the government to maintain its support position to avoid financial market disruption. The Short-Term IDRs of 'F1', which is at the higher of the two options mapped to the Long-Term IDR of 'A-', reflect Fitch's expectation of government support, which is more certain in the short term.

SENIOR DEBT

The ratings on the senior unsecured debt issued by MUFG and MUFG Bank are at the same level as the entities' IDRs, in line with Fitch's criteria. MUFG's senior bonds, eligible as total loss-absorbing capacity, are also rated at the same level as its Long-Term IDR, as we believe the holding company's failure and senior-level default risk are similar to that of wholly owned operating banks, despite the notes' structural subordination features.

Rating Sensitivities

Factors that could, individually or collectively, lead to negative rating action/downgrade:

IDRs, SENIOR DEBT, GSRs

Any weakening of our assumptions about the propensity or ability of the sovereign to provide timely support to MUFG could lead to negative rating action on the GSRs. However, there would not be negative rating action on the Long-Term IDRs or senior debt ratings unless there is concurrent negative rating action on the VRs.

VRs

MUFG's VRs are most sensitive to a resurgence of challenges in the operating environment, such as a contraction in GDP with a substantial delay in recovery to pre-crisis GDP levels, which could prompt us to revise the operating environment factor score to 'bbb+'. This would likely lead to a downgrade of the group VR. However, this is not our base case as reflected in our stable outlook on the operating environment score.

MUFG's VR could come under pressure should multiple key rating drivers deteriorate while the operating environment score remains unchanged. A downgrade of the VR could be prompted by a combination of a sharp deterioration in profitability or lack of prospects for sustainable earnings improvement, measured by an operating profit/RWA ratio of less than 0.9% for a prolonged period, weaker asset quality, such as an elevated non-performing loan ratio consistently above 1.5%, deterioration in capitalisation, with the CET1 ratio consistently below 12%, and material weakening of its strong domestic market position and franchise values.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

IDRs, SENIOR DEBT, GSRs

An upgrade of the sovereign ratings could lead to upgrades of the GSRs, IDRs and senior debt ratings.

An upgrade of the VRs would lead to upgrades on the Long-Term IDRs and long-term senior debt ratings.

MUFG group's Short-Term IDRs would be upgraded if its Long-Term IDRs are upgraded to 'A' and our funding and liquidity score is raised to 'aa-'; however, this is not likely in the near term.

VRs

An upgrade of the VR appears unlikely. It would require a sustainable improvement in profitability with the operating profit/RWA ratio consistently above 1.4%, supported by successful execution of management's strategy, and strengthened capitalisation, reflected by the CET1 ratio sustained above 14%, while other financial metrics and the operating environment remain unchanged.

SUBSIDIARIES & AFFILIATES: KEY RATING DRIVERS

The Long-Term IDRs on MUMSS and ACOM are driven by their SSRs.

MUMSS's SSR of 'a-' is in line with the Long-Term IDR of its ultimate parent, MUFG, reflecting MUMSS's key and integral role in the group's securities business. The company engages in retail, investment banking, sales, trading and research. MUMSS is 60% indirectly owned by MUFG and 40% by US-based Morgan Stanley (A/Positive).

The SSR of ACOM, a 40%-owned subsidiary of MUFG, is one notch below the Long-Term IDR of MUFG. It reflects the company's strong synergies with the parent and its strategic role as one of the core entities in MUFG's consumer-finance service business.

SUBSIDIARIES AND AFFILIATES: RATING SENSITIVITIES

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Any negative rating action on MUFG would likely result in similar rating action on MUMSS and ACOM.

A weakening in MUFG's propensity to support MUMSS or ACOM, including a decline in ownership or their strategic importance to the group, could lead to negative rating action on MUMSS or ACOM.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Any positive rating action on MUFG would lead to similar rating action on MUMSS and ACOM.

VR ADJUSTMENTS

The operating environment score of 'a-' has been assigned below the 'aa' category implied score due to the following adjustment reason: economic performance (negative).

The funding and liquidity score of 'a' has been assigned below the 'aa' category implied score due to the following adjustment reason: foreign-currency liquidity (negative).

Best/Worst Case Rating Scenario

International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579

Summary of Financial Adjustments

Total assets and total liabilities exclude acceptances and guarantees from Japan's generally accepted accounting principles balance sheet to be globally comparable.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

Public Ratings with Credit Linkage to other ratings

The ratings on MUMSS and ACOM are based on our view of support from the parent and therefore linked to the parent's IDRs.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

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