Japan's High-Interest Lenders Under Fire

Aiful, the country's third largest consumer finance group, is in trouble for ham-fisted collections. But the people depend on its loans

Japan's bad-boy consumer finance companies are at it again. On Apr. 15, Japan's Financial Services Agency suspended operations at Aiful (AIFLY), the nation's third largest consumer finance group, for up to 25 days. The action was a harsh blow to the $200 billion Japanese industry and comes amid public outrage over the heavy-handed debt collection practiced by some of its companies. Aiful's shares took a beating on Apr. 17 in Tokyo trading, as did the stock prices of its three major rivals, Acom (ACMUY), Promise (PMSEY), and Takefuji. These players aren't small fry. Combined, this quartet has some $58 billion in outstanding loans on their books.

All of this could be bad news for the big global players -- Western pension funds and investment banks -- that have enjoyed stupendous stock market returns investing in Japanese consumer finance groups in recent years. With interest rates near zero, Aiful and others have raised capital at roughly 2%, then lent it out to cash-strapped Japanese salarymen and housewives at 15% to 29%.

Through much of this decade, these companies have enjoyed profit margins of about 25% or so. Their stocks have regularly delivered stellar returns as well. "They are money-making machines basically," says Jason Rogers, an analyst with Barclays Capital.


  Aiful is 30% owned by foreign investors, according to Toyo Keizai, a Japanese publisher of financial data. Takefuji, the biggest player in the market, is 55% foreign owned. In early 2004, its former chairman Yasuo Takei pleaded guilty to charges of illegally wiretapping a journalist who had written critical articles about the company. In short, these guys don't always play nice.

So is the party over? Well, short-term the industry certainly has a major public-relations exercise on its hands. The Aiful scandal comes just as the Japanese Diet is set to consider legislation capping the interest rates these companies charge, as high as 29% in some cases, and limit the total amount that individuals can borrow.

Japan may have an international image of frugality in the West, but the truth is that about 192,000 individuals declared bankruptcy in 2005, according to government figures. That's down some from levels two years ago, thanks to the Japanese economic recovery, but still twice the levels of a decade ago.

And the actual number of heavily indebted Japanese could be far higher than that. "For the last seven or eight years, there have been 1.5 million to 2 million heavily indebted individuals," says Tatsuya Kimura, a bankruptcy attorney and secretary general of Japan's National Council on Consumer-Credit Problems based in Osaka.


  Many of them have avoided filing for personal bankruptcy because of the harsh social stigma bankruptcy carries in Japan. Some Japanese in really dire straits simply drop out of sight and move to another part of the country under an alias. Japan's relatively high suicide rate has also been linked to debt pressures in recent years.

Attorney Kimura thinks the Aiful case could be a turning point in the government's efforts to rein in industry practices. To get an idea why, consider just how egregious Aiful's alleged behavior was in the eyes of Japanese regulators. Financial Services Minister Kaoru Yosano indicated at a press conference explaining the suspension that some of the breaches could "even be pursued as criminal cases."

Aiful was cited by the agency for harassing borrowers to repay debts by repeatedly calling them at home and at work, and even approaching family members. In some cases, borrowers were forced to take out new, high-interest loans from third-party lenders to pay back debts to Aiful.


  True to form in such corporate scandals in Japan, Aiful president Yoshitaka Fukuda and other top executives bowed deeply before the TV cameras last week and issued an apology to Aiful customers. "We gravely accept this action," he said. Top executives will endure 10% to 30% salary cuts for three months or so.

But don't expect Japan's consumer finance industry to fold up shop anytime soon -- or for global investors to lose interest in them. True, the big four players -- Takefuji, Promise, Aiful, and Acom -- have all downgraded their earnings estimates for the fiscal year that ended on Mar. 31.

Currently, Japan has two different laws governing interest rates. One sets the upper limit of allowable loans at between 15% and 20% -- the other allows loans as high as 29.2%. The Japanese Diet is expected to harmonize the laws when it takes up comprehensive legislation governing the industry later in the year. The result will have an impact on industry earnings.


  Even so, the industry is still enormously profitable. And though the Bank of Japan has signaled that it will gradually raise interest rates, probably in late 2006, from current near-zero levels, the increases are expected to be very gradual. That means the fat spread between borrowing and lending yen in Japan will live on for some time.

On top of that, the government is unlikely to really get radical and put these high-interest lenders out of business. The reality is, there will always be a market for this type of lending. If these regulated consumer lenders don't do it, someone else will -- namely, Japan's Yakuza criminal gangs operating on the black market. The companies may not be models of corporate governance, but they do fulfill a need. And they will be enriching themselves, and foreign investors, for some time to come.