No Floor Under Japan's Banks?

Could a pair of little-known, busted Tokyo credit cooperatives, similar to U.S. credit unions, threaten Japan's financial system? That's the warning Bank of Japan officials have been peddling ever since the central bank proposed a $1.98 billion, taxpayer-funded bailout of the Tokyo Kyowa Credit Assn. and Anzen Credit Assn. three months ago. On Mar. 17, BOJ Governor Yasuo Matsushita told a business group that letting the duo go under would unleash a "systemic risk" to the Japanese financial system.

It's tempting to dismiss such alarmist talk as justification for a rescue mission. This is not the first time that BOJ officials have forecast a financial meltdown, trying to scare banks into putting their houses in order. And the government has vast powers to prevent Japanese financial institutions from cascading into an abyss. Yet the system is particularly vulnerable now (tables). Many of Japan's other financial institutions are neck-deep in bad loans, at a time when bankruptcies keep mounting, loan growth has been negative for eight months, the yen is at worrisome highs, and a slumping stock market is pounding the banks' large equity holdings.

DUD LOANS. Although they have worked through some of their bad debts, Japan's top 21 banks are still carrying an estimated $300 billion in dud and restructured loans. Housing loan companies are probably stuck with $68 billion in soured debt. And $200 billion-plus in credit cooperative deposits are now at risk at a time when the nation's anemic deposit insurance fund is inadequate to shore them up.

The BOJ had hoped that rescuing the two credit unions would move smoothly and serve as a model for tackling bigger pieces of Japan's bad debt mess. Instead, the bailout has been endangered by scandal, with deep embarrassment to the government. Says Goldman Sachs (Japan) Corp. Vice-President David Atkinson: "There is without question a crisis in leadership."

The crisis was precipitated by the discovery that Tokyo Kyowa and Anzen had extended easy credit to top members of the opposition New Frontier Party. Relatives of one party leader received a $45 million loan to build golf courses. He resigned in early February amid speculation that politically connected depositors and borrowers had been influenced to engineer a rescue package. Outraged at the cronyism, Tokyo's metropolitan government shelved its planned bailout contribution of $340 million in taxpayers' money, leaving the BOJ to pick up the tab. If further revelations surface, some major private banks, which are expected to contribute a total of $568 million to the bailout, could jump ship, too.

The scandal has pummeled banking stocks, which make up a hefty portion of Japan's major stock indexes. The benchmark Nikkei 225 is down 19.2% so far this year, while the Topix leading share index has declined 18.5%. That hurts the big money-center banks, which have a thinner cushion of hidden stock reserves to deal with bad loans.

In retrospect, it should not have been a surprise that Tokyo Kyowa and Anzen might stir up trouble. Harunori Takahashi, chairman of Tokyo Kyowa and a top executive at Anzen, used depositor money to bankroll his acquisitive and privately held real estate group, EIE International. Tokyo investigators have alleged that Takahashi diverted 25% of the cooperatives' combined assets into EIE. If so, that exceeds a regulatory limit of 20%. Takahashi and EIE also got billions of dollars in loans from the Long-Term Credit Bank of Japan Ltd.--money that is unlikely to be repaid anytime soon.

The crisis erupted late last year. EIE went belly-up, and rumors that Tokyo Kyowa and Anzen were next had depositors pulling money out in droves. Since March, 1994, deposits have fallen by 30%. The run alarmed Yasushi Mieno, then BOJ governor, whose tight credit regime punctured Japan's late 1980s asset bubble. He once suggested that a bankruptcy or two in the banking sector wouldn't be such a bad thing.

Now, though, he moved in the opposite direction. Just days before leaving office in mid-December, Mieno announced that the BOJ and private banks would set up a new bank to take over Tokyo Kyowa and Anzen. Why? BOJ bureaucrats started to realize that if even a handful of Japan's 200-odd credit cooperatives went under, it might set off a trip wire and endanger the whole system. From January to February, deposits among the 50 or so credit cooperatives in Tokyo shrank by 1.7%.

LEAKY BOATS. The credit coops account for only about 4% of total private deposits. But a run on them could easily exhaust the resources of Japan's Deposit Insurance Corp., which is funded by private banks and insures up to about $113,000 per depositor. It has a paltry balance of about $9.3 billion, or 0.1% of all insured deposits, and is already committed to pumping $454 million into the BOJ-led bailout. If other credit cooperatives come running for help, the central bank would be forced to shore up the fund, probably with public money.

But the credit coops aren't the only leaky boats in the banking fleet. Officials haven't even started to address the woes afflicting seven troubled housing loan companies, or jusen, whose shareholders include Sanwa, Sumitomo, Daiichi Kangyo, and LTCB. The jusen, similar to U.S. S&Ls, were set up in the early 1970s to supply credit to homeowners. They did--but also started lending to real estate developers, financing everything from golf courses to condos until real estate prices collapsed.

The result: Roughly 50% of their $136.6 billion loan portfolio is now underwater, figures J. Brian Waterhouse, a senior analyst with James Capel Pacific Ltd. The jusen's major shareholders--big city banks, trust banks, and life insurance companies--could be left holding the bag, and any jusen bailout will certainly require some taxpayer contribution. Because of the close link between the home loan companies and Japan's first-tier financial institutions, says Standard & Poor's Corp. credit analyst Shinano Morita, "this is a much more serious problem for the Japanese financial system" than the credit coop mess.

Taking on the jusen's bad loans would increase the already considerable pressure on the big banks' balance sheets. By the end of March, they are expected to write off half of their $150 billion in disclosed nonperforming loans--notes to defunct companies or those that haven't paid interest in more than six months. But they aren't required to say how many loans have been restructured with interest-rate breaks and other concessions. Whatever that figure is now, it's likely to grow. Bankruptcies in Japan jumped 10.9% in February year-over-year, because of the Kobe quake.

Worse, falling share prices are battering the large banks' stock portfolios, which have allowed them to write off bad loans. The market is not just likely to crimp future write-offs. It's also starting to undermine the banks' capital reserve ratios. Should the Topix index, now at around 1,260, decline below 1,200, the capital reserves of LTCB, Daiwa Bank, and Chuo Trust & Banking may fall below the 8% international reserve requirement, says Barclays de Zoete Wedd analyst Quinn Riordan. And their earnings picture isn't bright. According to Barclays estimates, the top 11 city banks will report lower average earnings for the year ending Mar. 31, with Sumitomo Bank Ltd. posting a $3.12 billion loss.

The big banks probably face years of balance-sheet repair work and will have difficulty unloading their real estate collateral until the commercial property market, down 50% from its early 1991 peak, recovers. And while Matsushita promises to keep a "soft grip" on interest rates, already at historic lows, slow loan growth will continue to dampen their profits.

Analysts doubt the BOJ and Finance Ministry will opt for a U.S.-style clean-up that relies on big public funding and ruthless bank examiners willing to push weaker players into bankruptcy. Yet without a comprehensive plan to undo some of the damage from years of speculation and abuses, Japan's banking system is in for a tough stretch. "I think they have only scratched the surface," muses L. William Seidman, former head of the U.S. Federal Deposit Insurance Corp. And for Matsushita, the prospect of a teetering financial system could turn out to be more than an empty threat.


-- At least $151.2 billion at Japan's 11 commercial banks, 7 trust banks, and 3 long-term credit banks

-- An estimated $68.2 billion at the housing loan companies

-- Some $1.2 billion at two credit cooperatives bailed out by BOJ,

with 20 more under supervision


-- Spooked by BOJ's bailout of two failed credit unions in Tokyo, depositors might yank their money out of other troubled CUs

-- A run on deposits could pull more credit unions under, and Japan's Deposit Insurance Corp. would quickly begin burning through its paltry $9.3 billion

-- BOJ would step in to shore up the deposit insurance fund with public money, but public confidence in the banking sector would be shaken


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