No. 32 — August 18, 2000


Weekly Review

--- by Jon Choy

Despite the fact that Japanese banks traditionally have eased the terms of their loans to troubled companies as part of the borrower's restructuring process, the practice of forgiving part or all of the principal has become a sensitive topic. Bank executives are being squeezed on one side by regulators and investors who want lenders to clean up their books and show a profit and on the other side by strapped corporate borrowers that warn that without the cancellation of significant amounts of their debts, bankruptcy may be their only option. The government and the public, both keenly interested in this exchange, are conflicted over the subject because the policies that might speed up resolution of the problem also carry a high political and social cost. The consequences of inaction, however, may be dire for Japan's banks and economy.

Japanese banks often have extended payback periods or reduced interest rates on notes in order to help weak borrowers get back on their feet. This approach avoided the legal morass of bankruptcy proceedings (see JEI Report No. 25A, July 2, 1999) and allowed banks to continue to carry the loans on their books at full face value. However, the economy's decade-long slowdown has forced some borrowers — particularly in the politically influential real estate, construction and retail industries — past the point at which these traditional remedies are effective. In the late 1990s, executives at some hard-hit companies began to believe that the only solution was to ask creditors to forgo a portion of their loan repayments.

As it happened, banks' resistance to loan forgiveness was eroding at this time, mainly because they were employing the same tactic to rescue their troubled subsidiaries and affiliates. In 1998, for example, Long-Term Credit Bank of Japan, Ltd. was planning to cancel loans worth several billion yen made to its Japan Leasing Corp. subsidiary. Although never implemented, the scheme opened the door for other problem borrowers — including midsize general contractors, real estate developers and leasing firms — to successfully negotiate loan forgiveness with their lenders (see JEI Report No. 16B, April 21, 2000).

Department store operator Sogo Co., Ltd., however, was the first major firm to include this wrinkle in a big way in its restructuring proposal. Sogo asked its banks to slash ¥639 billion ($5.8 billion at ¥110=$1.00) off its ¥1.7 trillion ($15.5 billion) debt load and to reschedule payment on the remainder over as long as 30 years. The retailer's main bank — Industrial Bank of Japan, Ltd. — was not eager to take such a "haircut" but nevertheless rounded up the support of nearly all of Sogo's lenders. The exception was the former LTCB, which recently had been relaunched as Shinsei Bank, Ltd.

Reflecting the hard-nosed approach of its American backers, Shinsei Bank executives were not willing to participate in the restructuring plan because they thought that it would fail. Instead, Shinsei Bank activated a clause in its sale contract, asking the Deposit Insurance Corp. to buy at face value the ¥197.6 billion ($1.8 billion) worth of loans to Sogo that it had inherited from LTCB. The DIC complied. Financial regulators subsequently agreed to join in Sogo's restructuring at the taxpayer's expense. This ignited a fire storm of public anger and caused Tokyo to reverse its position on the debt workout. Eventually, the department store chain had to file for bankruptcy (see JEI Report No. 28B, July 21, 2000).

In the aftermath of the Sogo debacle, positions on loan forgiveness are being reassessed across the board. Public opinion has shaped the debate to an unusual extent and, as a result, has become a major consideration in formulating policies and making business decisions. Voter discontent first surfaced when the big banks that had received capital infusions from the government in both 1998 and 1999 began to give debt relief to their subsidiaries and affiliates. The grumbling grew louder during the Sogo affair. Public opinion now solidly opposes any use of taxpayer funds to cancel or reduce business loans.

This hardened position is echoed by the Financial Reconstruction Commission, Japan's top financial regulator, and the DIC, the agency that actually handles bad loans bought from banks. For three years from the date of purchase, the buyers of LTCB and Nippon Credit Bank, Ltd., which also was nationalized in late 1998, have the right to ask the DIC to pay face value for inherited loans whose collateral has fallen in value by 20 percent or more. DIC sources expect that Shinsei Bank eventually will ask the agency to buy ¥500 billion to ¥600 billion ($4.5 billion to $5.5 billion) of its approximately ¥1 trillion ($9.1 billion) pool of nonperforming loans. Agency executives also anticipate that Softbank Corp. and the other new owners of defunct NCB will seek to have the DIC purchase some portion of the bank's soured loans once its sale is completed September 1. Prime Minister Yoshiro Mori has said that he will instruct the FRC and the DIC to take a tough stand on forgiving loans assumed by the DIC. At the moment, it appears unlikely that nonfinancial firms will be able to win debt relief if taxpayer money is required.

Several analysts as well as a number of policymakers have warned that the government's growing reluctance to participate in debt workouts could cost the public more in the long run. Mr. Mori has been cited for a lack of leadership in the Sogo debacle by members of his own Liberal Democratic Party as well as by outsiders. Chief Cabinet Secretary Hidenao Nakagawa has admitted to reporters that "the government should have better informed the public" about the cost to taxpayers of not participating in the Sogo bailout. Tokyo's about-face on the department store's workout has eliminated — at least for the short term — a potentially important way in which the government can help industry restructure and solve its bad-loan problems.

Despite hostile public opinion and Tokyo's negative stand, banks and their clients continue to consider debt relief an option. Hazama Corp., a major contractor teetering under its own massive debts and those accumulated by its affiliates and subcontractors, has convinced three of its lenders to cancel ¥100 billion ($909.1 million) out of loans totaling ¥420 billion ($3.8 billion). Dai-Ichi Kangyo Bank, Ltd. will forgive ¥55 billion ($500 million), Mitsubishi Trust & Banking Corp. about ¥35 billion ($318.2 million) and Shinsei Bank ¥10 billion ($90.9 million).

Shinsei Bank consented to the haircut because the other two financial institutions agreed to buy its remaining loans to Hazama. Moreover, the bank did not want to further irritate a public that already blamed it for triggering Sogo's downfall. Shinsei Bank officials also have hinted that they might consider participating in a debt-relief program for Kumagai Gumi Co., Ltd., another major contractor in trouble.

Perhaps the success of these workouts will help begin to reverse the negative opinion toward loan forgiveness harbored by the public and some of the political leadership. With many analysts predicting that nonperforming loans will plague Japan's economy for at least another decade, policymakers and corporate executives can ill afford the loss of the powerful debt-relief tool.

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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