JAPANESE BANKS PAST WORST OF NONPERFORMING-LOAN PROBLEMS

No. 6 — February 11, 2000

Weekly Review

JAPANESE BANKS PAST WORST OF NONPERFORMING-LOAN PROBLEMS
--- by Jon Choy

The Financial Supervisory Agency's latest loan portfolio survey of domestic banks, which covered the April 1, 1999-September 30, 1999 period, revealed improvements almost across the board. As a group, nationwide banks, top regional banks and their smaller counterparts clearly rid their books of problem loans in FY 1999's first half. Another unambiguous development was apparent, however: banks reduced their overall loan commitments. This result almost certainly reflected the hard lessons that bank executives learned from the nonperforming-loan crisis that has wreaked havoc with traditional banking operations in recent years. Only time will tell whether the newfound caution translates into sound lending practices that help the economy restructure or produces overly conservative decisions that could retard a sustained recovery.

Observers took with many grains of salt declarations made in early 1999 by Japanese bank executives and government regulators that the banking industry's nonperforming-loan crisis was over. Despite some qualms about its recent leadership change, the FSA has convinced skeptics that it is forcing financial institutions to provide accurate and complete information about their lending and other business activities. At best, the agency's report on bank portfolios at the end of FY 1998 showed mixed signs of improvement (see JEI Report No. 36B, September 24, 1999).

The new FSA compilation of banks' self-assessments of their September 30, 1999 loan portfolios provides clearer proof that the industry is working its way back to financial health (see Table 1). Not only did the value of unrecoverable loans (Class IV) reported by every category of bank drop, but so did the totals for loans judged as unlikely to be repaid (Class III). Moreover, the 17 largest banks as well as first-tier regional banks listed smaller amounts for loans that require monitoring (Class II), although this figure rose slightly for second-tier regional banks.

Table 1: Lenders' Internal Assessments of Their Loan Portfolios,
March 31, 1999 and September 30, 1999

(in billions of yen)

March 31, 1999
	Class I	Class II	Class III	Class IV	Total
All Banks	¥487,545	¥61,024	¥3,160	¥74	¥551,803
Top 17 Banks	316,814	39,209	2,296	71	358,391
First-Tier Regional Banks	127,669	15,442	582	3	143,695
Second-Tier Regional Banks	43,062	6,373	282	0	49,717
All Cooperative Institutions	126,174	15,608	700	2	142,483
Shinkin (Credit Associations)	70,144	10,209	358	1	80,711
Shinkumi (Credit Cooperatives)	13,723	2,278	234	1	16,237
Agricultural Institutions	24,911	1,583	67	0	26,561
All Financial Institutions	613,719	76,632	3,860	76	694,286
September 30, 1999
	Class I	Class II	Class III	Class IV	Total
All Banks	¥470,001	¥59,469	¥2,633	¥36	¥532,139
Top 17 Banks	306,651	37,654	1,914	36	346,255
First-Tier Regional Banks	122,512	15,793	518	0	138,823
Second-Tier Regional Banks	40,838	6,022	201	0	47,061
All Cooperative Institutions	n.a.	n.a.	n.a.	n.a.	n.a.
Shinkin (Credit Associations)	n.a.	n.a.	n.a.	n.a.	n.a.
Shinkumi (Credit Cooperatives)	n.a.	n.a.	n.a.	n.a.	n.a.
Agricultural Institutions	n.a.	n.a.	n.a.	n.a.	n.a.
All Financial Institutions	n.a.	n.a.	n.a.	n.a.	n.a.
Notes: Class I: Loans with no or little risk of default Class II: Loans with some risk of default that require monitoring Class III: Loans that are unlikely to be repaid Class IV: Loans that are unrecoverable "All Cooperative Institutions" includes other lenders besides the three subcategories listed. Cooperative institutions are not required by law to submit semiannual results.
Source: Financial Supervisory Agency ( http://www.fsa.go.jp/news/newse/ne_030b.html).

The financial watchdog also issued data that classifies bank loans according to a slightly different scheme of "risk management groups" (see Table 2). Compiled by FSA auditors, this analysis differed from the bank self-assessment report in the details but not in the overall picture. The figures for the value of total lending diverged, for example, but both showed decreases from end-of-FY-1998 levels. The FSA evaluation underscored a nearly universal improvement in loans to bankrupt borrowers (LBB), those at least six months past due (PDL), those three months or more overdue (3PDL) and restructured loans. The exception to this pattern was the PDL number for regional banks, which surged between March 31 and September 30. Analysts will be watching carefully to see how these financial institutions and regulators deal with this bulge as the end of FY 1999 approaches.

Table 2: Assets of Japan's Banks Classified by Risk Management Groups,
March 31, 1999 and September 30, 1999

(in billions of yen)

			Nonperforming and Restructured Loans					Loan-Loss Reserves
	Total Assets	Of Which: Loans	LBB	PDL	3PDL	Restructured Loans	Total	Specific Allow ance	Total	Latent Stock Profits
March 31, 1999
Nationwide Commercial Banks	¥389,573	¥249,467	¥1,362	¥8,008	¥860	¥2,653	¥12,884	¥4,263	¥6,175	¥2,383
			(1,330)	(8,714)	(1,009)	(1,970)	(13,023)
Long-Term Credit Banks	42,089	22,872	146	1,382	8	554	2,091	936	1,116	24
			(148)	(1,307)	(9)	(555)	(2,019)
Trust Banks	90,015	47,846	774	3,532	114	856	5,275	1,614	1,967	297
			(846)	(3,502)	(118)	(863)	(5,330)
Top 17 Banks Subtotal	521,677	320,185	2,282	12,922	982	4,063	20,250	6,813	9,258	2,704
			(2,324)	(13,523)	(1,136)	(3,388)	(20,372)
First-Tier Regional Banks	200,303	138,584	1,498	1,824	439	3,007	6,769	3,254	4,117	2,355
Second-Tier Regional Banks	65,312	47,833	644	758	212	993	2,608	1,165	1,422	152
Regional Banks Subtotal	265,615	186,417	2,142	2,582	651	4,000	9,377	4,419	5,539	2,507
Total of All Banks	787,292	506,602	4,424	15,504	1,633	8,063	29,627	11,232	14,797	5,211
Total of All Financial Institutions	1,073,707	642,164	6,546	18,743	2,407	10,956	38,656	14,802	19,310	6,984
			(6,932)	(20,157)	(2,639)	(9,922)	(39,651)
September 30, 1999
Nationwide Commercial Banks	¥382,069	¥242,523	¥990	¥7,986	¥652	¥2,745	¥12,374	¥3,297	¥5,146	¥5,218
			(894)	(8,344)	(751)	(2,044)	(12,032)
Long-Term Credit Banks	39,615	22,422	153	1,407	7	439	2,006	1,027	1,208	173
			(155)	(1,419)	(8)	(439)	(2,022)
Trust Banks	81,959	46,360	601	3,364	94	778	4,837	1,292	1,659	858
			(644)	(3,407)	(104)	(784)	(4,939)
Top 17 Banks Subtotal	503,643	311,305	1,744	12,757	753	3,962	19,217	5,616	8,013	6,249
			(1,693)	(13,170)	(863)	(3,267)	(18,993)
First-Tier Regional Banks	198,386	134,059	1,374	3,725	199	2,339	7,637	2,971	3,876	3,079
Second-Tier Regional Banks	63,036	44,236	556	1,143	115	1,047	2,861	1,015	1,251	342
Regional Banks Subtotal	261,422	178,295	1,930	4,868	314	3,386	10,498	3,986	5,127	3,421
Total of All Banks	765,065	489,600	3,674	17,625	1,067	7,348	29,715	9,602	13,140	9,670
Notes: Consolidated figures in parentheses. LBB = Loans to borrowers in legal bankruptcy. PDL = Past-due loans in arrears by six months or more on which interest is not collected and does not add to earnings but excluding LBB loans with interest payments suspended as part of a restructuring of a borrower by its lender. 3PDL = Past-due loans on which principal or interest is in arrears by three to six months from the date of default on the payment of interest or principal under the terms of the loan agreement, excluding LBB and PDL. Restructured Loans = Loans on which the original interest rate or maturity terms have been eased. Latent Stock Profits = Profit or loss that would have been realized if banks' stock investment portfolios had been liquidated on that date. A total of all financial institutions is not presented for September 30, 1999 because cooperative institutions are not required by law to submit semiannual reports.
Source: Financial Supervisory Agency ( http://www.fsa.go.jp/news/newse/ne_030b.html).

Looking beyond the close of the fiscal year, experts point to three signs that signal that the nonperforming-loan situation is well in hand:

Set-asides for loan-loss reserves generally declined during the first half of FY 1999. Only the country's single remaining long-term credit institution — Industrial Bank of Japan, Ltd. — had set aside more money as of September 30 than it had in the previous 12 months. Since the FSA and outside auditors are forcing banks to calculate potential loan losses more rigorously, the downward trend in loan-loss reserves not only means that banks expect fewer problem loans in the future but also that this drain on funds is shrinking.
Latent profits on stock portfolios were up for every category of bank. IBJ led the charge, reporting that its latent profits had jumped to ¥173 billion ($1.6 billion at ¥110=$1.00) from ¥24 billion ($218.2 million), more than a sevenfold increase. Next came trust banks, which had paper profits of ¥858 billion ($7.8 billion) as of September 30, 1999, or 189 percent more than the ¥297 billion ($2.7 billion) they reported at the start of the fiscal year. Bigger latent stock profits allow banks to claim larger capital bases; that, in turn, helps them meet international and domestic capital/asset requirements. More importantly perhaps, stronger numbers enable banks to raise funds on international markets at a better price. They also reassure customers about the financial stability of the institution that has their money.
The cost of disposing of nonperforming loans dropped like a rock (see Table 3). While the FSA survey only covered operations for the first half of FY 1999, banks of all sizes apparently are on track to report sharply lower expenses for the full business year from purging bad loans from their books. This prospect lends weight to the argument that nonperforming assets will be a smaller drain on bank balance sheets over the near term.

Table 3: All Banks' Reported Losses on the Disposal of Nonperforming Loans,
FY 1992-FY 1998 and First Half FY 1999

(in billions of yen)

			Direct Write-Offs
	Losses on Disposal of Bad Loans	Net Transfers to Specific Allowances for Loan Losses	Write-Offs of Loans	Losses on Sales to the CCPC	Total
FY 1992	¥1,640	¥945	¥204	¥219	¥424
FY 1993	3,872	1,146	235	1,855	2,090
FY 1994	5,232	1,402	706	2,103	2,809
FY 1995	13,369	7,087	1,721	2,526	5,980
	[11,067]	[5,576]	[1,568]	[2,132]	[5,490]
FY 1996	7,763	3,447	973	1,133	4,316
	[6,210]	[2,534]	[850]	[971]	[3,676]
FY 1997	13,258	8,403	851	1,043	3,993
	[10,819]	[6,552]	[791]	[921]	[3,501]
FY 1998	13,631	8,118	2,377	359	4,709
	[10,440]	[5,490]	[2,255]	[339]	[4,268]
First Half FY 1999	2,275	1,008	607	80	900
	[1,587]	[476]	[585]	[77]	[812]

Cumulative Since FY 1992
	Losses on Disposal of Bad Loans	Direct Write-Offs	Nonperforming Loans	Outstanding Amount of Specific Allowances for Loan Losses
FY 1992	¥1,640	¥424	¥12,775	¥3,698
FY 1993	5,512	2,514	13,576	4,547
FY 1994	10,744	5,322	12,546	5,536
FY 1995	24,113	11,602	28,504	13,293
	[21,811]	[10,812]	[21,868]	[10,345]
FY 1996	31,877	15,918	21,789	12,334
	[28,021]	[14,488]	[16,441]	[9,388]
FY 1997	45,135	19,911	29,758	17,815
	[38,840]	[17,988]	[21,978]	[13,601]
FY 1998	58,766	24,620	29,627	14,797
	[49,280]	[22,256]	[20,250]	[9,258]
First Half FY 1999	61,041	25,520	29,715	13,140
	[50,867]	[23,068]	[19,217]	[8,013]
Notes: 1. Losses on disposal of nonperforming loans refer to the total amount of net transfers to specific allowances for loan losses (formerly provisions in special accounts for loan-loss write-offs), write-offs of loans, losses on sales to the Cooperative Credit Purchasing Co., Ltd., disclaimer of loans and losses on support to other financial institutions.
2. Through FY 1994, disclosed nonperforming loans were composed only of loans to borrowers in legal bankruptcy (LBB) and loans past due six months or more (PDL). In both FY 1995 and FY 1996, disclosed bad loans were composed of LBB, PDL and restructured loans. Since FY 1997, nonperforming-loan figures also include loans three to six months past due.
3. Before FY 1994, the above data refer only to nationwide commercial banks, long-term credit banks and trust banks. Beginning in FY 1995, the figures cover all banks, while those in brackets refer to the same group of major banks.
4. Direct write-offs refer to the total amount of write-offs of loans, losses on sales of loans and losses on support to other financial institutions. However, before FY 1994, this figure was composed only of write-offs of loans and losses on sales of loans to the CCPC.
5. Hokkaido Takushoku Bank, Ltd., Tokuyo City Bank, Ltd., Kyoto Kyoei Bank, Ltd., Naniwa Bank, Ltd., Fukutoku Bank, Ltd. and Midori Bank, Ltd. are excluded from FY 1997 onward because these institutions failed. Long-Term Credit Bank of Japan, Ltd., Nippon Credit Bank, Ltd., Kokumin Kouhuku Bank, Ltd. and Tokyo Sowa Bank, Ltd. are excluded from FY 1998 because these institutions failed.
Source: Financial Supervisory Agency ( http://www.fsa.go.jp/newse/ne_030b.html).

Taken together, the three trends paint a much brighter picture of the financial condition of Japanese banks — a conclusion that extends beyond the bad-loan problem. As the red ink from nonperforming loans ebbs, profits, which already have shown signs of improvement (see JEI Report No. 46B, December 10, 1999), should get a boost. A more profitable banking industry could add to the positive momentum in Japan's equity markets since bank shares are important components of stock price indices. Analysts also hope that healthier banks will help to lift the economy by actively extending credit to businesses, especially small firms, for restructuring and investment. Pessimists warn, however, that loan officers — burned equally by their experiences in the go-go days of the late 1980s' "bubble economy" and by the problems associated with the "lost decade" of the 1990s — may not fulfill these expectations.

The views expressed in this report are those of the author
and do not necessarily represent those of the Japan Economic Institute

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Table 1: Lenders' Internal Assessments of Their Loan Portfolios, March 31, 1999 and September 30, 1999

Table 2: Assets of Japan's Banks Classified by Risk Management Groups, March 31, 1999 and September 30, 1999

Table 3: All Banks' Reported Losses on the Disposal of Nonperforming Loans, FY 1992-FY 1998 and First Half FY 1999

Table 1: Lenders' Internal Assessments of Their Loan Portfolios,
March 31, 1999 and September 30, 1999

Table 2: Assets of Japan's Banks Classified by Risk Management Groups,
March 31, 1999 and September 30, 1999

Table 3: All Banks' Reported Losses on the Disposal of Nonperforming Loans,
FY 1992-FY 1998 and First Half FY 1999