Bank stocks were among the hardest hit in the Japanese market tumble. The shock may make investors and lenders much more risk-averse
Investors in Tokyo had an extra day to digest the news about Lehman Brothers' (LEH) bankruptcy thanks to a three-day holiday weekend. But that didn't make them any less unhappy about it. On Sept. 16, the Nikkei 225 Stock Average fell 5% to its lowest level in more than three years, closing at 11,609.72, a number not seen since July 2005. Hardest-hit were the banks, with Aozora Bank, the Japanese financial institution controlled by Cerberus Capital that was left holding the highest amount of publicly disclosed Lehman debt, falling 16% from Sept. 12. Other Asian markets plunged, too, with South Korea down 6.1% and Hong Kong down 5.4%.
When Lehman's Japan unit, which manages about $11.5 billion in assets for investors, finally filed for bankruptcy protection at a court in Tokyo on Sept. 16, it had debt totaling $38 billion, making it Japan's second-largest bankruptcy in the postwar period. Japan's Financial Services Agency had already ordered Lehman's Japan unit to halt operations until Sept. 26 and ensure that it had assets equivalent to its debts owed to local institutions. Separately, the Tokyo Stock Exchange ordered Lehman to stop all trading at the bourse.
There are plenty of out-of-luck Lehman creditors in Tokyo. Aozora Bank was listed in Lehman's filing as the largest bank lender to Lehman Brothers Japan, with $463 million in loans. Shinsei Bank had $363 million, and Mizuho Bank had $289 million.
The Japanese banks on Sept. 16 tried to reassure investors that the losses would not be as large as they might appear. Shinsei confirmed that it had $239 million in unsecured loans, $86 million in bonds, and $9.6 million in counterparty risk. A spokesman called this the "maximum possible loss at this point in time" and added, "Various elements, including the recovery process, still remain uncertain, so [the loss] may be less." In a statement, the bank said its strong financials should allow it to deal with the debts. "Shinsei is taking prompt action to manage its exposure and maximize recovery," it said.
Other creditors said Lehman's bankruptcy filing didn't tell the whole story. Aozora Bank said it "believes that its net exposure is materially less, and its projected recoveries are greater, than suggested in the Lehman Chapter 11 filing and some initial media reports." Despite being listed in Lehman's filing as its largest creditor, with $463 million in loans to Lehman, Aozora estimated that its projected exposure could be less than $25 million, crediting hedging instruments and other "risk-management" actions.
Mizuho Corporate Bank also played down its Lehman exposure. The bank has $93 million in loans to Lehman, all of them involving uncollateralized derivatives trades, says Gaku Deguchi, a spokesman for the bank. "We believe that the losses will be limited," says Deguchi. Nippon Life Insurance has $95.2 million worth of exposure, half in unsecured corporate bonds to the parent company and half for a loan to Sunrise Finance, a subsidiary of Lehman's Japan unit.
Analysts said the figures weren't huge. "It's equivalent to the size of a bankruptcy of a midsize Japanese real estate company," says Masanobu Kaizu, head of Nomura Securities Financial Economic Research Center. He considers that "relatively small."
But what's worrisome for credit-starved banks and other corporate borrowers, the Lehman collapse could make it more expensive to raise capital in Japan. Since the subprime meltdown began last summer, Japan has become a haven of funding for many global financial institutions that have raised money by issuing Samurai bonds, or yen bonds issued in Japan by non-Japanese companies. With interest rates so low in Japan, investors here have been eager to buy higher-yielding securities. The low-rate environment makes Samurai bonds a cheaper way to raise capital than other markets, such as Europe and the U.S. where the credit crunch has made lenders stingy. That explains why in June, companies sold more than $8.1 billion in Samurai bonds.
For now, raising money in Japan is still a steal compared with trying to raise money from investors in Western markets. For a 10-year Samurai bond, the rate might be 2.5%; to issue a similar bond in the U.S. a company would have to offer well over 5%, according to traders. Last week, Citigroup's (C) three-year-bond issuance was the biggest ever, totaling 315 billion yen, more than $3 billion. Credit Suisse (CS) and Australia & New Zealand Bank announced issuances, as did Daimler (DAI). Société Générale, Deutsche Bank (DB), and a unit of British utility National Grid had all been planning their own Samurai sales this week. Merrill Lynch (MER) had previously predicted that Samurai bond sales could amount to near $29 billion this year, the highest total since 1996.
But funding costs on Samurai bonds have shot up—spreads over Libor are more than three times what they were in early 2007. And some analysts think Lehman's collapse might now make Japanese investors more risk-averse. Lehman tapped the market last May, when it sold 22 billion yen ($210 million at current conversion rates) worth of 10-year Samurai bonds. "When Lehman issued Samurais last year, many Japanese investors didn't think twice about risk and just bought them," says Yutaka Ban, chief credit analyst at Shinko Securities. "They are now becoming aware of the risks."