A U.S. Private Equity Flop in Japan

With their big-name U.S. private equity backers and imported Western managers, Shinsei and Aozora were Japanese banks with bright prospects a few years back. They emerged, respectively, from the remnants of Long-Term Credit Bank and Nippon Credit Bank, two failed lenders that were nationalized in 1998 during Japan's own banking sector implosion. Tokyo officialdom eventually let gaijin investors run both banks—a rarity in Japan—figuring some foreign competition would help revitalize Japan's financial sector.

So far, though, this East-meets-West experiment in banking liberalization has been a flop. The duo lost a pile of money chasing the same high-risk investment strategies that had sunk their Japanese predecessors—and would later unhinge Wall Street firms.

The Japanese government, which still has ownership stakes in both banks, is trying to orchestrate a merger to clean up the mess. Aozora, which is majority-owned by private equity firm Cerberus, lost $2.5 billion in the year through Mar. 31. Last year, Aozora wrote off about $930 million after running up losses in investments in hedge funds and other toxic assets. The bank also booked a $136 million loss related to Lehman Brothers' collapse last fall.

More disturbingly, Aozora took an additional $372 million hit on a stock investment in General Motor's (GM) GMAC financing unit. That may seem like an odd investment for a Japanese bank, until you consider that Cerberus is also a major shareholder in GMAC, a fact that has drawn public criticism from Japan's top financial regulator. If all this weren't enough, Aozora had a $120 million exposure to a fund run by convicted financier Bernard L. Madoff. "It's been a terrible year for our industry and for Aozora Bank," acting CEO Brian Prince, an ex-Wall Streeter and former Shinsei banker, said in a statement on May 15. Cerberus declined to comment.


The performance at Shinsei, which is one-third owned by U.S. buyout fund J.C. Flowers, has been just as dismal. On May 13 the bank revealed losses of $1.5 billion after taking an $809 million write-off tied to European asset-backed securities and other investments. The failure at Lehman wiped out an additional $303 million.

Neither bank has managed to build up a big and highly profitable retail banking business. Shinsei and Aozora remain middling players in a country dominated by megabanks such as Mitsubishi UFJ and Mizuho. So to drive earnings, executives at both banks bet aggressively overseas. Shinsei CEO Masamoto Yashiro, who replaced his predecessor and ex-Morgan Stanley (MS) banker, Thierry PortÉ, last November, told analysts in mid-May that the Shinsei's risk managers failed to safeguard a $260 million loan the bank had made to a Lehman unit. All this despite worries about Lehman's financial health that surfaced back in mid-2007. "We just took [Lehman's] word that they were O.K.," Yashiro said.

Will a quick merger save both banks? Neither lender will comment, but Japanese Finance Minister Kaoru Yosano in late April urged both "parties to bring the talks to a successful end." A combined Shinsei-Aozora would create Japan's sixth-largest bank. But both "offer almost identical services," so new business opportunities would be scant, says Keiichi Omura, a Waseda University professor and a former banker with Long-Term Credit Bank. A merger would also be a deflating outcome for two institutions that were supposed to be shining beacons of Western financial savvy in Japan.

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