BANKS RETHINK LOAN
--- by Jon Choy
Despite the many fund-raising options created over the past 15 years by a steady stream of changes in financial market rules and structures, bank loans continue to play a leading role in financing corporate operations in Japan. This enduring reality explains why the nonperforming-loan crisis of the 1990s posed such a threat to the entire economy and why new factors that affect bank lending policies are analyzed exhaustively.
Bank executives and financial authorities in Japan are treading a delicate line between two conflicting goals. One is for banks to rehabilitate their loan portfolios and balance sheets as quickly as possible so that they can resume lending in the volume required for a sustained economic recovery. To accomplish this, however, bank loan officers must take a more coldly calculating approach to processing applications. Even longtime, major clients may be denied new credit if their financial health is not up to snuff. The sudden withdrawal of bank support has been cited as the key factor in several recent high-profile corporate failures and in a new survey of bankruptcies by a private economic research company.
These divergent forces are clearly illustrated by recent exchanges between the government and the country's top banks over the issue of increased lending to small and midsize enterprises. Such firms, in particular, depend on bank loans for operating and investment funds because they may not qualify to issue shares on established exchanges or are unable to sell bonds and other instruments in domestic or international markets. Although higher interest rates can be demanded of these borrowers, they present a greater risk of default. One result of the nonperforming-loan crisis was a dearth of credit for smaller ventures, a shortage that boosted their bankruptcy rates and led to political pressure for change. When Japan's biggest banks accepted capital infusions from Tokyo in March 1999 (see JEI Report No. 11B, March 19, 1999), they agreed in part to increase lending to small and midsize businesses by a net ¥3 trillion ($27.3 billion at ¥110=$1.00).
According to the Ministry of Finance and the Federation of Bankers' Associations of Japan, the country's 17 largest commercial banks had boosted net credit to this group by only ¥680 billion ($6.2 billion) as of September 1999. This modest increase raised some eyebrows and alarms among bureaucrats and politicians that banks were reneging on their commitments. With the March 31, 2000 close of FY 1999, however, both MOF insiders and business executives agreed that big banks certainly had met their obligations and likely had exceeded them by a significant margin. Japanese press reports citing government and private sources estimated that lending by the 17 top banks to midsize and smaller commercial borrowers had increased by a net ¥4.1 trillion to ¥4.6 trillion ($37.3 billion to $41.8 billion) over the past fiscal year.
That reported gain, however, has not been the lifesaver for smaller firms that politicians had anticipated. According to Teikoku Databank, Ltd.'s most recent survey, 1,770 companies filed for bankruptcy in March, a figure that was 40 percent higher than the year-earlier level and up 23 percent from February. At the same time, however, the value of liabilities involved in the March filings fell by 80 percent from March 1999 to ¥646.8 billion ($5.9 billion). Together, these developments indicate that smaller firms continue to fold at record rates. In fact, Teikoku Databank reported that only 54 of the firms asking for protection from creditors in March had assets greater than ¥50 million ($454,500). The private credit firm's research did indicate one bright point: the number of companies reporting that they had failed because they were unable to obtain loans fell to 22, the first decline in four months.
In the past, banks usually took steps to help troubled corporate customers return to financial health. Loans were renegotiated on terms more favorable to the borrower, bank employees were stationed in key positions within the firm to aid the development and the implementation of a restructuring plan, and fresh credit was provided to keep the operation going during rehabilitation. In addition, the bigger the client, the more concessions a bank would be willing to make.
In the post-"bubble," 21st-century economy, however, the patience of bankers definitely is shorter when it comes to troubled borrowers. The management of nationwide chain store operator Nagasakiya Co., Ltd. experienced this new reality in February, when it filed for bankruptcy after Dai-Ichi Kangyo Bank, Ltd. officers refused to extend new loans. The cutoff was especially surprising because DKB earlier had seconded executives to the retailer to help the longtime customer with its restructuring. Analysts cite two reasons for DKB's decision. First, even with a restructuring plan, Nagasakiya's prospects remained poor and, second, DKB's merger agreement with Fuji Bank, Ltd. and Industrial Bank of Japan, Ltd. (see JEI Report No. 33B, August 27, 1999) obligated it to pare poor quality assets before their April 2002 consolidation.
Even a bank that received significant public assistance no longer feels bound by old practices and traditions. Despite only recently taking control of Long-Term Credit Bank of Japan, Ltd. from Tokyo (see JEI Report No. 8B, February 25, 2000), managers of the "new" LTCB told longtime customer L. Kakuei Corp., a real estate firm, that its poor financial prospects made it ineligible for new loans. Believing that the bank was obligated to support the company under the sale agreement with the government, L. Kakuei's officers were shocked by the new policy. LTCB officials explained that while they would maintain existing credit lines to the property developer as per the deal with Tokyo, additional loans were out of the question. Faced with this no-confidence vote, L. Kakuei executives felt that they had no choice but to file for bankruptcy.
Banks are breaking with past lending practices for two reasons:
The Financial Supervisory Agency has begun to make unannounced inspections of financial institutions and has issued guidelines that encourage greater fiduciary diligence. The FSA and the Finance Ministry are planning additional changes in this vein. Beginning with their annual reports for FY 1999, banks and insurers will have to classify loan-loss reserves as special assets held in so-called contra accounts instead of reporting them as liabilities. The change will shrink the net value of assets on financial institutions' balance sheets, leading to an improvement in the return on assets and other measures of performance based on total assets.
Beginning with the half-year reports for FY 2000, MOF also will require financial institutions to disclose in regulatory filings the value of assets pledged as collateral to other firms, especially subsidiaries. Such assets were a hidden liability under the old rules. Finally, starting in the current fiscal year, MOF and the FSA are requiring banks to report losses if the price of a stock in their investment portfolios falls by 30 percent or more from its book value. Under accounting rules drawn up in January, the trigger point for banks was set at a 50 percent paper loss versus 30 percent for nonfinancial companies. The exception for banks drew criticism from both inside and outside the industry, and regulators moved to level the field.
Banks that participated in Tokyo's 1998 and 1999 recapitalization schemes also find that their actions are being scrutinized by taxpayers. It has become much more difficult for banks to extend unlimited support to a poorly performing borrower, even when the troubled firm is a major employer. The public is demanding that banks be accountable for their lending decisions and that they provide a complete and transparent accounting statement.
Another indication that banks are phasing out their traditional lending practices comes from recent data on debt forgiveness. According to leading business daily Nihon Keizai Shimbun, Japan's top 17 banks have announced plans to cancel ¥926 billion ($8.4 billion) in loans to specific customers (see Table). Some of the write-offs are related to corporate restructuring plans, as in the case of major trading company Tomen Corp.
Banks, however, are moving to cap this charity, especially given the large number of customers that are in trouble. Ailing department store operator Sogo Co., Ltd., for example, has floated a restructuring plan that includes canceling bank loans worth ¥639 billion ($5.8 billion). Speaking for Nippon Credit Bank, Ltd., Sogo's second-largest lender and now under state control (see JEI Report No. 47B, December 18, 1998), Financial Reconstruction Commission head Sadakazu Tanigaki said that he would not allow NCB to accept this deal. Executives at IBJ, Sogo's main bank, while not ruling it out entirely, gave the plan a chilly reception, indicating that it would be a burden.
What has critics up in arms, however, is the planned forgiveness of loans to bank subsidiaries and affiliates. Taxpayer advocates, in particular, find this practice distasteful since banks are using public money to keep ailing affiliates afloat. This special treatment also has raised questions about top banks' claims that they have boosted lending to small and midsize businesses beyond the levels they agreed to when they accepted infusions of government capital. The Finance Committee of the Diet's lower house has asked a representative of the Federation of Bankers' Associations of Japan and the president of DKB to testify whether the increase in lending is being funneled to bank affiliates or to unrelated borrowers. Whatever the case, economic and regulatory forces clearly are reshaping the lending practices of Japan's banks.