By Brian Bremner
I recently spent an afternoon over at Japan's Resolution & Collection Corp. The taxpayer-funded RCC, like the former U.S. Resolution Trust Corp., goes after failed banks, takes over their nonperforming loans, and tries to recoup as much as it can by selling the furniture, drapes, and all manner of assets backing that debt.
Now headed by an amiable Osaka attorney named Akio Kioi, the RCC recently has been given a broader mandate to buy loans not only from fallen lenders but from big mainstream ones. The idea is to help the major banks improve their capital base by selling off some of their weaker loans to the RCC, which will then service them and deal with the corporate deadbeat borrowers.
Anyway, I jawboned with Kioi about this unpleasant task and other issues regarding the nation's current banking mess (see BW, 2/25/02, "The Toughest Job in Japan"). What surprised me was his willingness -- indeed, eagerness -- to team up with local and foreign private-investment banks to explore ways of bundling bank loans, good and not so good, into marketable securities called asset-backed bonds, which could be sold off to investors at home and abroad.
A BRIGHT SPOT.
Plenty of financial sharpies have been arguing for years that this kind of securitization could be a very elegant, albeit partial, solution to fix Japan's crippled banking system, which is saddled with $600 billion to $1 trillion in questionable loans, depending on whose figures you believe. Securitizing those loans and selling them to institutional investors in the $2.5 trillion-plus asset-backed market is a great way to spread risk across a very broad base.
Now the idea appears to be gaining some momentum. A recent report on credit trends by Standard & Poor's concludes that one of the few bright spots right now in the Japanese economy is the growth of such transactions. It amounted to a $22.5 billion market last year -- and could jump 40% in 2002.
Banks are unburdening their books of nonperforming loans, replenishing their anemic capital bases. That gets them back into the business of lending again, ending a credit crunch that has been the bane of the Japanese economy for years. And investment banks are salivating over the prospect of picking up distressed real estate for a song, then pulling down big fees and profits selling off asset-backed investments.
WHO OWNS WHAT?
Back in the mid-1990s, the asset-backed market was pretty much a joke in Japan, owing to general lack of familiarity with financial exotica and some uniquely Japanese legal hassles. For one thing, some real estate properties have multiple claims on them from lenders. So, if the RCC bought a loan from a bank, sorting out ownership issues would have to be resolved before a property could be grouped with others into an asset-backed bond.
Also, banks were generally reluctant to sell chunks of their loan portfolios. Doing so could harm key lending relationships going back decades. (Yes, this sort of stuff really matters in Japan.) Also, loans are usually backed by land and would need to be sold at a steep discount, triggering an earnings hit to reflect that loss, given that land prices have been tumbling for a decade. And some bankers had hoped -- however fancifully -- that Japan's real estate market would come roaring back sometime down the road.
Well, the economy has pretty much been stagnant since then, and the pressure is hotter and heavier than ever for banks to clean up their balance sheets, which off-loading loans would accomplish. Shinsei Bank, formerly the giant Long Term Credit Bank of Japan, has freed capital by rebundling and selling off part of its loan portfolio. And the latest to get into the act is Asahi Bank, which has plans to sell off $1.5 billion of its loans.
NEEDED: FAT RETURNS.
Most of the new, asset-backed bonds coming out of Japan involve fairly sound corporate loans that have a low-default risk. The trick will be moving the really wretched nonperforming loans without upsetting the apple cart. Those bonds will need to be priced very generously, offering up fat returns to entice investors with cast-iron stomachs. That job will probably fall to the RCC's Kioi, who plans to buy dud loans worth billions of yen from the banks.
The $2.5 trillion-plus asset-backed market will never be a magic bullet in and of itself. But it sure could help. Plenty of observers think Japan could easily support a $100 billion market for such investments. Other financial products, such as real estate investment trusts (REITs), have been introduced here, the hope being that they'll attract enough investors to create a vibrant market capable of lighting a fire under Japan's moribund real estate market.
One of the biggest problems facing Japan has always been the gross misallocation of capital. Banks lent with little regard for risk. Sophisticated financial products used in other markets to channel money more efficiently didn't exist in Tokyo a decade ago. They do now -- and could make a critical difference as they become more widespread. Best of luck, Kioi-san.
Bremner, Tokyo bureau chief for BusinessWeek, offers his views every week in Eye on Japan, only for BusinessWeek Online
Edited by Beth Belton