June 27 (Bloomberg) -- Aiful Corp., Japan's biggest consumer finance company by assets, said it may sue Lehman Brothers Holdings Inc. after the broker said the lender may be insolvent, triggering a 25 percent slide in its share price.

Aiful has ``no problems with funding,'' the lender said in a statement to the Tokyo Stock Exchange today. ``We will continue to protest against Lehman Brothers, and to recover our honor and trust, we are considering taking legal action.'' The report's assertions are ``false,'' Aiful spokesman Kenichi Hashimoto said separately.

Lehman analyst Walter Altherr said in a June 23 report that Aiful's parent company is ``arguably insolvent.'' About 22 percent of the company's loans are non-performing, and bad loans have risen for at least the last 19 quarters at the Kyoto-based lender, Altherr wrote. Aiful is depending on inter-company loan repayments to stay solvent, he said.

``Aiful is one of the most dangerous companies to invest in, as its main bank Sumitomo Trust may not be able to support Aiful anymore,'' said Hiromichi Tsuyukubo, a hedge-fund manager in Tokyo at Myojo Asset Management Japan Co., which oversees $200 million. ``This sector doesn't have a future,'' he said, as companies may have to write off ``much more'' loans.

Lehman Response

Kerrie Cohen, a spokeswoman for Lehman in New York, referred questions to spokesman Matthew Russell in Hong Kong, who declined to comment.

Sumitomo Trust & Banking Co. spokesman Takuya Sakamoto said the bank will continue to support Aiful.

``There is no change in our stance of providing appropriate support to Aiful as its main bank,'' Sakamoto said by phone.

Aiful dropped 6.8 percent to 1,201 yen, the lowest since the shares were first listed on the Tokyo Stock Exchange in 1998, as of 1:30 p.m. local time. Takefuji Corp., the third-largest consumer lender by market value, fell 8 percent to 1,457 yen, also a 10-year low.

Lehman said in a corrected report on Aiful dated June 26 that Sumitomo Trust is ``unlikely'' to ``provide full support for Aiful or take it over.'' The original report said Sumitomo Trust had told Lehman it had no desire to fully support or take over Aiful.

Credit-Default Swaps

Credit-default swaps on Aiful rose 45 basis points to trade at 490, the highest in more than three months, according to Credit Suisse prices. The cost to protect 10 million yen ($93,000) of Aiful debt for five years is equivalent to 490,000 yen annually. Dealers quoted Takefuji contracts, which hadn't traded yet, as much as 55 basis points higher at 465.

``One of the most worrying things is that we're seeing significantly higher CDS spreads on consumer lenders,'' said UBS AG's Fumihito Gotoh, Japan's top credit analyst in a Nikkei Veritas survey. ``Higher credit premiums mean potentially higher borrowing costs and that may squeeze their profit, raising the credit premium. It's kind of a vicious cycle.''

Japan's consumer lenders are trying to recover from record losses in the year ended March 2007 after a crackdown by Japan's government and courts forced them to cut interest rates and set aside funds for potential claims by borrowers who made excess payments.

Aya Fujiki, a Tokyo-based analyst at UBS, cut her net income estimate for Aiful this week by 16 percent to 18.6 billion yen for the year ending March 31, citing growing bad loans. The lender posted 27.4 billion yen in profit last year, after a loss of 411.3 billion yen the preceding year.

Declining Profit

Takefuji forecasts profit may fall 18 percent in the 12 months ending March 31. The company had net income of 14.1 billion yen last year, following a 481.3 billion yen loss the year before. The company said May 23 it would sell 70 billion yen of convertible bonds to UBS, which can be converted into common stock starting Oct. 1, potentially diluting shares as much as 18 percent.

The two lenders' main rivals, Promise Co. and Acom Co., are supported by two of Japan's biggest banks, Mitsubishi UFJ Financial Group Inc. and Sumitomo Mitsui Financial Group Inc., respectively, which invested in the lenders in recent years. Acom declined 1.2 percent in Tokyo trading, and Promise fell 1.8 percent.

A Japanese court ruled this month that Promise, the nation's second-largest consumer finance company by market value, has to refund excess interest charged of a borrower, in a case brought by the western city of Ashiya. At least 30 local governments are involved in similar actions, the Asahi newspaper reported.

The lawsuits may result in more loan write-offs for consumer lenders, Myojo's Tsuyukubo said.

Citigroup Inc. offered early retirement to 1,350 employees at its Japanese consumer finance unit, CFJ KK, last week after saying it will close all of its 32 consumer finance branches and 540 automated loan machines in the country.

To contact the reporter on this story: Finbarr Flynn in Tokyo at fflynn3@bloomberg.net

Last Updated: June 27, 2008 00:55 EDT