Japan's Battered Banks Need Bigger Bailouts

To residents of Kobe, "Port Island," an artificial island studded with amusement parks, means fun in the sun. But to the 10 finance companies that bankrolled the project, the island is anything but a happy place. During the bubble years, the companies lent some $15 billion to get the development going. But now that the bubble has burst, 70% of the loans have gone bad--and the commercial banks that funded the finance companies are beginning to get desperate.

To try to get some money back, the seven banks are putting together a rescue plan. The banks hope to win lucrative tax breaks by transferring the bad loans, at deep discounts, from the finance companies to a new entity called Port Island Acceptance Co. If the real estate market recovers, the new company and the banks may see the loans repaid. But they may have a long wait. Bankers say the workout may take a decade and even then may never realize the loans' full value.

LURCHING ALONG. So goes the tedious task of rebuilding Japan's sagging lenders. With the nation's banking crisis now in its third year, progress is being made in restructuring the industry's $400 billion in bad debts. But it is painfully slow. The debts are keeping banks from making the loans that would spur the recovery now getting under way. New loans by the 11 largest commercial banks were actually down 1.1% in June from their year-earlier level. And the bad-loan mess is raising speculation that the Ministry of Finance (MOF), which has pledged to buy $26 billion in real estate, soon will have to come up with much more cash. MOF may even have to create something resembling the Resolution Trust Corp., which managed the $1 trillion bailout of the U.S. thrift industry.

For now, however, bankers and regulators alike are lurching from crisis to crisis. To help the industry slim down, MOF is urging banks to merge. For example, the ministry recently shepherded through a merger of three small banks in northern Japan. But the plan came unglued in June, when customers and employees of one of the institutions, Kita-Nippon Bank, rebelled. The bank's union, fearing job losses after the consolidation, wanted no part in bailing out the weaker Tokuyo City Bank, which is stuck with $100 million in nonperforming loans.

Or take Nippon Mortgage, a real estate finance company set up by Sumitomo Trust & Banking Ltd. and others in 1982. The bursting of the bubble left an incredible 97% of its $4.7 billion of loans in arrears. Sumitomo Trust now plans to let Nippon Mortgage go to court to seek liquidation. Other major shareholders and lenders are expected to follow. But regulators may thwart the move. Japanese banks must review each charge against earnings with tax authorities, and Sumitomo says there's no guarantee it will be permitted to claim the losses it's seeking.

NO HUM. Some banks have set up "special-purpose" companies to buy their bad loans. The Kobe island venture is one of them, but the granddaddy of them all so far is the Cooperative Credit Purchasing Co., which was established in 1993 amid much fanfare. The company, which is backed by Industrial Bank of Japan Ltd., Sakura Bank Ltd., and others, has taken over some $47 billion in shaky loans. But it has only sold $490 million worth of collateral.

Even if the auctions were humming along, they probably would raise less money than the banks want. Commercial real estate prices are now falling at an annual rate of 15% to 20% in urban centers, and courts are slow to get property auctions going. Moreover, capital-gains taxes as steep as 73% on short-term land sales are scaring off foreign investors who might otherwise be ready to sweep up prime properties on the cheap.

With the domestic property market ailing, selling overseas property remains one of the few ways Japanese bankers have to raise cash. Dai-Ichi Kangyo Bank Ltd., for example, is selling the posh Ritz-Carlton Huntington Hotel in Pasadena, Calif., which most recently served as headquarters for the World Cup. But that won't solve DKB's even bigger problems at home. Banks, the property market, and perhaps even the economy may face some more painful summers if lenders and their regulators can't cobble together a more comprehensive solution to Japan's financial mess.

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