They're not much bigger than shoe boxes, but the tiny studio apartments Shoji Kanazawa once peddled were the biggest thing going in Japan's overheated real estate market of the 1980s. Kanazawa's company, Maruko Inc., moved 31,000 of them, and the more it sold, the more its bankers wanted to lend. Mitsubishi Trust & Banking Corp., Kanazawa's lead bank, funneled $418 million into Maruko. Others kicked in $1.8 billion more, allowing Kanazawa to branch out into Tokyo office towers, Hawaiian property, and even fine art.
Then, in 1989, Bank of Japan Governor Yasushi Mieno clamped down on easy money to curb inflationary speculation in real estate and stocks. As interest rates soared from 4.9% to 8.9%, condo sales and Kanazawa's fortunes nose-dived. Kanazawa pleaded with his lenders for more cash, but none would accede. By last summer, Maruko was bankrupt. Says Masayuki Sagawa, a Mitsubishi senior manager: "The situation was much worse than we expected."
'BASKET CASES.' Sagawa isn't the only Japanese banker expressing shock and dismay these days. As a record-breaking wave of real estate-related corporate failures sweeps the country (charts), one bank after another is being forced to shoulder unprecedented quantities of bad debts. Indeed, with the banks now holding some $600 billion worth of property loans at home and tens of billions more abroad, these mammoth lenders "seem to have turned into financial basket cases overnight," says analyst David Marshall of London's IBCA Ltd. "You're going to see much higher problem loans and the potential for large losses," adds Akio Mikuni, owner of a Tokyo credit-rating agency.
Analysts believe most big Japanese banks still have more than enough capital and staying power to see them through their problems. Their near-monopoly on domestic consumer banking alone will probably ensure that. Nonetheless, the rising tide of bad loans marks a stunning comedown for the banks, which in recent years muscled major U. S. and European lenders aside to dominate global finance. Worldwide, Japanese bankers are now retrenching while they try to nurse troubled projects back to health or sell them off. "Any Japanese firm that owns real estate overseas is being forced by its banks to reduce its debt," says Gary Pinkston, president of San Francisco-based developer Meridian Pacific Ltd. "They're calling loans and reducing commitments."
The pullback could mean even worse news for the slowing Japanese economy. Just like their hard-hit U. S. competitors, Japan's banks are becoming increasingly reluctant to lend. And while central banker Mieno has been cutting interest rates to bolster the economy, the banks' problems won't disappear soon. Just the cost of carrying billions in bad loans will deliver "a body blow to profits," concedes a Bank of Japan official. Salomon Brothers Asia Ltd. analyst David M. Atkinson estimates that $154 billion worth of loans -- 7% of total lending -- will be producing no income by the time the current fiscal year ends next Mar. 31. That alone could cost the banks as much as $11 billion annually, half of what big commercial banks earned in the last fiscal year.
With deregulation of interest rates on deposits also eating away at income, some lenders, including the $409 billion Mitsui Taiyo Kobe Bank Ltd., may even post losses. But what's troubling the banks even more than deregulation is something that never was supposed to happen: a slide in property prices.
The value of land in Japan soared in the late 1980s to $17.3 trillion, nearly six times Japan's gross national product. Now, the figures are going the other way. James Capel Pacific Ltd. analyst Graeme McDonald says vacancy rates in some new gffice buildings in the Osaka and Tokyo areas are hovering at 30%. Some rents have dropped as much as 20%. And the average resale price for Tokyo-area condos has fallen 19% over the past year, to $303,000. Average home prices are also off, down 30%, to $423,000.
HAWAIIAN PUNCH. Of all the lenders swept up in the real estate bust, none has been hit harder than the long-term credit banks. Once the chief bankers to Japan's top corporations, they have had to search for new business as their clients have grown fat with export earnings and started tapping capital markets directly. So the lenders -- Industrial Bank of Japan (IBJ), Long-Term Credit Bank of Japan, and Nippon Credit Bank -- went after aggressive stock speculators and property developers. That shift is now costing the lenders dearly.
Earlier this year, for example, the Long-Term Credit Bank had to take over the management of resort developer EIE International Corp. when it was unable to pay the interest on its $5.3 billion in bank debt. Since then, the bank has put on the block some $2 billion in resort, hotel, and commercial properties scattered around the South Pacific, the U. S., and Britain. But sales are going slowly. In the meantime, Long-Term Credit and others have had to pony up $769 million to finish several projects. That may signal even bigger troubles ahead. EIE's 400-room Regent Hotel on Manhattan's swanky East 57th Street is expected to cost $300 million -- or $750,000 a room -- by the time it's completed next spring. But with interest payments of $50,000 per day, the hotel will have to keep more than half its rooms full -- at a steep $260 per night -- just to pay the bank.
The news is no better in Hawaii, where overbuilding and the U. S. recession have hit developers hard. EIE, for one, is a year behind schedule on a 350-room resort. Many other Japanese developers are in the same bind. "No one expected this severe an environment to develop so quickly," says Shigeki Matsushima, a senior manager at IBJ, which recently stretched out payment terms on part of a troubled $3 billion resort venture in Oahu. As if Hawaii weren't trouble enough, Japanese police last summer arrested IBJ's top individual borrower for bilking the bank and others out of $2.8 billion. The scandal forced Chairman Kaneo Nakamura to resign.
The U. S. mainland, where the Japanese have lent more than $25 billion to developers, is also becoming a wasteland. New York real estate circles are abuzz with rumors that builders are behind in payments on several Japanese-backed projects. And with $250 million of its $3 billion in California real estate loans listed as nonperforming, San Francisco's $17 billion Union Bank, 77%-owned by Bank of Tokyo Ltd., is hurting. In the third quarter, it took a $90 million provision against possible losses and saw earnings fall 87%, to $5 million.
WAIT AND SEE. Such problems still pale in comparison with some of the banks' difficulties with their own affiliates at home. During the '80s, many banks set up finance companies to handle risky credits they normally wouldn't touch. In short order, the banks funneled an astounding $312 billion through the affiliates to borrowers speculating on land, stocks, and even golf club memberships. Now, the banks are bailing the affiliates out. Take Japan Leasing Corp., 4.9% owned by Long-Term Credit Bank. With $1.5 billion of the company's $10.8 billion in loans gone bad, LTCB is seizing assets to raise cash. It has also lent Japan Leasing $2 billion.
Despite the growing problems, Japanese financial regulators have been surprisingly reluctant to order banks to begin a U. S.-style write-down of bad loans. In fact, the Finance Ministry actually discourages banks from taking charge-offs, thus leaving lenders free to paper over their problems. Instead, regulators are urging lenders to sell bad assets over several years to minimize their losses. "This strategy has always worked in the past," says analyst Marshall, "because land prices only fell once in the last 30 years."
But will the strategy work again? Mieno's warnings against another property boom have kept a lid on real estate. And while big banks own $446 billion in corporate equities, enough to cover as much as 10% of their loans, they are reluctant to sell. The stocks cost only $226 billion. But large-scale disposals might inflict new damage on Tokyo's shaky stock market.
For now, the banks will try to tough it out in hopes that the Japanese economy and the international property market come back to life. "Time is the greatest cure," says John Z. Bulkeley, executive vice-president at Union Bank. But this cure is likely to take a lot longer -- and be a lot more unpleasant -- than any of Japan's lenders ever dreamed.