RESTRUCTURING OF JAPAN'S BANKING INDUSTRY
PICKS UP SPEED
--- by Jon Choy
Domestic and overseas observers alike agree that Japanese banks and banking practices are being revamped from top to bottom. This process never was expected to be smooth or painless. However, as several recent events demonstrate, new forces, both local and foreign in origin, are reshaping Japan's banking landscape in totally unforeseen ways.
Case in point. A group led by Internet investor Softbank Corp. completed difficult negotiations with the Financial Reconstruction Commission June 6 on terms for buying Nippon Credit Bank, Ltd., which came under Tokyo's control after it failed in December 1998 (see JEI Report No. 47B, December 18, 1998). The FRC had given the consortium which includes Japan's number-one lessor, Orix Corp., and top property and casualty underwriter Tokio Marine & Fire Insurance Co., Ltd. first rights to buy NCB earlier this year (see JEI Report No. 8B, February 25, 2000), but the talks had not concluded by the May 31 deadline. While it continued discussions with Softbank, the FRC reopened the process to other buyers. A group of foreign investors organized by Cerberus Partners, L.P., which had competed for priority rights to acquire NCB, immediately reiterated its interest in purchasing the failed investment bank. Although the U.S.-led syndicate soon withdrew from the bidding, the FRC's negotiating tactic appeared to work since the Softbank consortium rushed to close the deal by dropping demands that previously had blocked agreement.
Softbank and its partners will pay ¥1 billion ($9.1 million at ¥110=$1.00) for NCB's outstanding shares and another ¥100 billion ($909.1 million) for new equity to be issued by the revived bank. To raise the "new" NCB's capital/ asset ratio to a healthy 13 percent, the Softbank group is negotiating with at least 15 regional banks and three foreign investment banks reportedly, Lehman Brothers Holdings Inc., Chase Manhattan Corp. and Switzerland's UBS AG for another ¥20 billion ($181.8 million) in additional equity. At the conclusion of the process, Softbank expects to own 40 percent of the reborn bank; Orix and Tokio Marine & Fire each will have a 15 percent stake.
The sticking points in the earlier talks the precise condition of NCB's loan portfolio and how much of its nonperforming assets Tokyo would cover remain unsettled. Softbank had demanded that it have full access to NCB's files to evaluate for itself the quality of the bank's loans and that the government pump in at least ¥240 billion ($2.2 billion) in capital by buying preferred shares. In the end, the two sides agreed to let NCB's auditors produce a final assessment of the bank's loan portfolio and to give them the authority to determine the appropriate amount of bad-loan reserves Tokyo should provide.
Softbank founder Masayoshi Son has said that the revitalized NCB will focus on lending to venture enterprises, although it will offer a full range of banking and investment services. This strategy has taken flak from industry analysts. They doubt that the purchasers have the experience to run a major bank. The same sources also question the new bank's business plan, calling it vague and unrealistic.
Ripplewood Holdings LLC broke the mold last February by buying failed Long-Term Credit Bank of Japan, Ltd. from the FRC for ¥121 billion ($1.1 billion) and working quickly to relaunch it. The rechristened Shinsei Bank, Ltd. opened its doors June 5, becoming the first Japanese bank to operate under foreign control. Executives immediately made it clear that the tag line of the bank's advertisements "É create a new banking business by combining Japanese and foreign skills" will be the driving force. Foreigners have been integrated into nearly every level of management, and the emphasis is on rapid decisionmaking the norm in the United States. Shinsei Bank's new style, however, is ruffling the feathers of banking industry veterans.
While agreeing with financial regulators as part of the buyout arrangement not to cut off existing loans, Shinsei Bank officials have refused to extend new credit to struggling customers. Most notably, they have taken this stance in cases where Shinsei Bank's predecessor was the main or lead bank, a position that customarily has made shouldering greater responsibilities and burdens obligatory. Three inherited clients consumer financier Life Co., Ltd., general contractor Kakuei Co., Ltd. and Tokyo-based Dai-ichi Hotel, Ltd. already have been forced into bankruptcy by Shinsei Bank's refusal to participate in their bailout or rescue plans.
A key test of Shinsei Bank's policy will be how it handles loans to Sogo Co., Ltd., a department store operator on the verge of failure. Industrial Bank of Japan, Ltd., Sogo's lead bank, has agreed to forgive more than ¥18 billion ($163.6 million) worth of notes to the troubled firm. As part of the turnaround plan, IBJ asked 71 other creditors to cancel ¥639 billion ($5.8 billion) in loans, including ¥97 billion ($881.8 million) extended by LTCB.
Shinsei Bank officials are weighing the request, but many observers agree that such a write-off would not be in the bank's interest because of the terms of its agreement with Tokyo. Specifically, if the market value of loans made by LTCB falls more than 20 percent after being assumed by Shinsei Bank, the FRC is obligated to buy them back at book value. This safety net, though, does not cover notes that Shinsei Bank forgives or otherwise voluntarily reduces. Thus, the fate of Sogo rests in Shinsei Bank's hands.
The foreign-run bank also is creating waves by offering property developers nonrecourse loans. These require a lender to agree to make no direct claim against a borrower in the event of a default, limiting the claim to the collateral behind the note. To intelligently make nonrecourse loans, banks must complete complex evaluations of a borrower's financial health and the quality of the collateral. Japanese banks have been put off by this technical feat, leaving the door open to foreign competitors with the requisite expertise. The widespread use of nonrecourse loans could have a major impact on Japan's real estate market because this form of financing is based on cold, hard numbers instead of such traditional factors as the loan value and the borrower's relationship to the lender.
In another first for Japan's banking industry, Sakura Bank, Ltd. has launched a friendly takeover of Minato Bank, Ltd., a troubled second-tier regional institution. In the past, stronger banks often signed deals to merge with or buy smaller institutions that were failing. Never before, however, has a public tender offer been the takeover vehicle. Sakura Bank executives chose this method not only because the price was attractive but also because it was quicker and more transparent than the usual way of arranging a private issue of new shares.
Change also is apparent in the agreement by Wilbur L. Ross & Co., LLC and its partners to buy Kofuku Bank, Ltd., a regional lender that passed into Tokyo's control in May 1999 because of nonperforming-loan problems. An investor group Sawayaka Partners LP will be created by two of the American company's funds and the California Public Employees Retirement System, better known as CALPERS, to launch a new financial institution in January 2001. The proposed bank, which plans to operate 81 of Kofuku Bank's 123 branches and hire 1,027 of its 2,000 or so employees, will focus on lending to small businesses in central Japan. This business strategy as well as the fact that the Ross-led bid required the government to put up less money persuaded the Deposit Insurance Corp., Kofuku's caretaker, to chose the American offer over one submitted by Daiwa Bank, Ltd. The reborn Kofuku Bank will be Japan's first foreign-owned regional lender.
Old-line Japanese banks soon will face another unprecedented competitive challenge since major convenience store chains are going into the banking business. Seven-Eleven Japan Co., Ltd., FamilyMart Co., Ltd. and Lawson Inc. are moving ahead with plans to install automated teller machines in their nationwide networks of stores. Within two years, consumers will have access to a full range of banking services 24 hours a day, seven days a week at more than 10,000 locations across Japan.
Seven-Eleven Japan plans to go one step further, offering customers of Nomura Securities Co., Ltd., Daiwa Securities Group Inc. and Nikko Securities Co., Ltd. access to their brokerage accounts via its in-store ATMs. While Japan's three largest securities firms have struck deals to offer their clients service through bank-run ATMs, investors cannot deposit funds into their brokerage accounts through these machines and only have access to the bank ATMs during limited hours. Seven-Eleven Japan's computerized tellers will not have these drawbacks.
More industry-reshaping changes are in the works. Sony Corp. and Seven-Eleven Japan's owner, Ito-Yokado Co., Ltd., have prepared applications for full banking licenses. The Financial Supervisory Agency recently drafted rules for banks owned by nonfinancial companies so formal submission of the plans should occur in the near future. Sony wants to integrate its proposed financial services with its electronic commerce and home Internet initiatives. Supermarket operator Ito-Yokado expects to offer a full spectrum of financial services through its large and diversified network of retail outlets. Industry experts predict that these entrants will inject fresh competition and innovation into the banking business.
Not surprisingly given the unprecedented events taking place in the industry, traditional Japanese banks are having trouble setting a course. Over the past year, the nation's top banks have announced a series of pacts that would led to the formation of four gigantic competitors: the Mizuho Financial Group (Industrial Bank of Japan, Dai-Ichi Kangyo Bank, Ltd. and Fuji Bank, Ltd.), Sumitomo Mitsui Banking Corp. (Sumitomo Bank, Ltd., Sakura Bank and Sumitomo Trust & Banking Co., Ltd.), the Mitsubishi Tokyo Financial Group (Bank of Tokyo-Mitsubishi, Ltd., now Japan's biggest bank, Mitsubishi Trust & Banking Corp. and Nippon Trust Bank, Ltd.) and the Sanwa Bank/Tokai Bank/Asahi Bank Group (Sanwa Bank, Ltd., Tokai Bank, Ltd., Asahi Bank, Ltd. and Toyo Trust & Banking Co., Ltd.) (see JEI Report No. 17B, April 28, 2000). While the proposed tie-ups have generated considerable debate as to whether bigger really is better, analysts applauded the Sanwa Bank/Tokai Bank/Asahi Bank alliance. It not only would create the world's second-largest financial entity with assets of ¥102.5 trillion ($931.8 billion), but, in the expert view, the planned merger represented a sensible combination of three strong banks based in different regions of the country.
Underscoring the difficulties of realizing such grand plans, however, Asahi Bank pulled out of the proposed alliance in mid-June. Although Sanwa Bank was the latecomer to the deal Asahi Bank and Tokai Bank had announced a comprehensive business cooperation agreement in September 1998 that turned into a more formal alliance when Sanwa Bank decided to come on board this past March (see JEI Report No. 12B, March 24, 2000) the changed partnership convinced Asahi Bank to rethink its plans.
Asahi Bank and Tokai Bank executives originally had envisioned a holding company structure under which the two lenders would pursue local banking markets. Sanwa Bank, which is about twice as large as either Asahi Bank or Tokai Bank, had bigger ideas. It wanted the trio to compete nationwide as a full-service, merged financial institution, eventually integrating securities and insurance products into the portfolio. Asahi Bank leaders apparently could not see themselves in this grand picture. They feared as well that the bank would lose clout under Sanwa Bank's proposed merger. For these reasons alone, Asahi Bank quit the alliance to pursue its own strategy, which could involve the establishment of relationships with regional banks in areas around its Tokyo stronghold.
Investors reacted positively to Asahi Bank's about-face, apparently reasoning that executives had carefully reexamined the merger deal and found it not to be in the lender's interests. The fact that the four proposed banking blocs had coalesced in such rapid succession had led observers to wonder if the deals were just the latest banking fad rather than the result of sound business thinking. Asahi Bank's surprising move partly answered that question. Whether its decision will encourage other bank executives to reconsider their reorganization plans is not clear. Certainly, however, Asahi Bank's flip-flop is another piece of evidence that Japan's banking industry is undergoing fundamental changes.