Japanese economy: A revitalizing influence

FOR THE PAST 10 years investors have looked on with incredulity at the inaction of those charged with directing the Japanese economy, particularly the banking sector. For while it is plain that it needs comprehensive restructuring, nothing seems to get done. And as long as fighting between political factions of the ruling Liberal Democratic Party persists, and decisions and plans in the banking system are driven by self-interest, nothing will change.

Those in the upper echelons of power in Japan do understand the need to restructure and repair severely damaged banks reeling under a mountain of bad debt estimated at ¥44 trillion ($371 billion). And those in the banks themselves understand this. But they still fail to act, unable to reach agreement between themselves and with the government on just about every topic. For as long as there is a state of paralysis, bad borrowers, primarily in the retail and property sectors, remain in a state of limbo, like the living dead. Too sick to restructure themselves, they survive on a mix of government injections and yet more loans from banks that feel they have no choice but to continue throwing good money after bad. That’s because in Japan banks are often shareholders in the clients they lend to. And any company that collapses not only adds to the banks’ tally of non-performing loans but also erodes their equity portfolios.

The government has said that it will get tougher with the banks – but that’s hardly a new threat. Understandably such warnings are met with a large measure of scepticism.

But the banks have indeed been set deadlines by the reform-minded and often outspoken Heizo Takanaka, the minister in charge of the Financial Services Agency (FSA). The banks have to sort themselves out and clean up their balance sheets by reducing non-performing loans by 50% by 2005.

It’s a target that few market observers believe the banks will be able to hit by themselves. However, there could be help at hand.

In May the government launched an organization that it believes will help the process along. Under its CEO, Atsushi Saito, the Industrial Revitalization Corporation of Japan (IRCJ) is mandated to help cure some of the ills afflicting the Japanese banking system. It is hoped that the corporation will help reignite bad loan disposal, a process that has stalled.

Richard Gitlin of Gitlin and Company, a Nomura consultant, says: “No-one was taking leadership in making restructuring happen. There was a need for a new ingredient to facilitate the fixing of companies as opposed to relieving debt just to keep companies alive. A funded vehicle was also necessary so as to allow it to buy out minority positions when there was a sensible restructuring plan for the company.”

In short, Japan needed to create a structure to overcome the disagreements and stimulate real restructuring. The question that many in Japan’s financial district are asking, though, is whether the IRCJ is the right ingredient. Can it succeed or has it perhaps caused more problems?

Beset with disagreements The IRCJ is plainly finding the going tough. It appears to many bank analysts that the corporation has got caught up in the problems that it was set up to solve. It is in constant disagreement with the banks and the problem debtors. It has announced only four cases that it will be working on. And these – a bus company, a mining house, a small construction company and a department store – have not set the Japanese financial world all of a buzz. Instead, many analysts have become more depressed. As Yukari Sato of JPMorgan’s economic and rates research department says: “On the basis of these four cases it looks possible that the IRCJ will be nothing to do with industrial revitalization, it looks more like the revitalization of individual companies.”

Less sceptical observers reckon that the IRCJ hasn’t been given a chance. They argue that for it to be able to take on larger, more economically important corporates, it has to prove that it can offer solutions and carry them out successfully.

That’s all very well, but there can be no denying that the organization is viewed with suspicion from all sides. As one analyst explains: “It has no political power and it doesn’t have the banks behind it. It was set up because of the turmoil caused by minister Takanka when he wanted to force banks to sell loans more aggressively to the Resolution and Collection Company.”

Many conservatives wanted Takanka out, but as a compromise some of the old factions came up with the idea of the IRCJ. The analyst continues: “In other words, by the very existence of the IRCJ banks can loosely sell bad assets at a higher price to the IRCJ rather than the RCC.”

As Sato adds, this may well be the case but it hasn’t made much difference: “It’s stalemate again. Even though they announce these four cases the purchasing price will still have to be worked out. And that is the toughest part.” It seems that the IRCJ could be just another false dawn feebly punctuating the long darkness that has shrouded the Japanese economy for the past 12 years.

What is the Industrial Revitalization Corporation of Japan?

We are a kind of a mediator between the banks and borrowers. The relationship between main banks and non-main banks in Japan has for a long time been very tough. And one of the reasons why the economy has been ailing for so long can be ascribed to this.

When the borrowers got into trouble the non-main banks claimed that because the main banks had introduced clients to the non-main banks and made loans to problem companies it meant that the non-main banks did not have to take any responsibility. And while the main banks still had some money in their pockets they were making additional loans to the borrowers. And the borrowers were using that money for the interest payments on the smaller loans from the non-main banks. From the viewpoint of the non-main banks the interest rate payments are coming in so they can classify these assets as healthy assets. So no matter how the FSA inspects them they are not non-performing loans, despite the fact that the actual businesses themselves were deteriorating. That was one of the reasons why deflation has lasted for 12 years.

However, now the main banks no longer have the space or the money to make additional loans and they can’t resolve this balance-sheet problem. In addition, because of excessive competition banks asked businessmen to borrow money blindly. So the borrowers now don’t feel any guilt even though they can’t pay back the money. So there needs to be a judge between the groups. The IRCJ has been set up to resolve these disputes between banks and borrowers.

How much money do you have at your disposal?

We have ¥10 trillion [$8.9 billion].

That’s a lot for a mediator. Are you sure the IRCJ isn’t an economic controller?

We are not holding this in cash – ¥10 trillion in funding in the short-term markets is guaranteed by the government. We can take advantage of this ¥10 trillion backed by the government guarantee.

So you are not economic controllers then?

We will buy the assets after adjustments. We will ask the lenders to forgive, 30%, 60% or 80% of their portions. And the remaining portions we will buy. Non-main banks do not have to sell the portions if they agree with our plan and use our figures on their own assets. But we don’t have to buy the assets from the banks.

But buying the assets could cause problems because of the gap in valuations between you and the banks. Do you have a standardized criteria for pricing?

We have a couple of numerical criteria to apply, in addition to the international accounting standards. On the active asset – active means any asset that is to do with the actual generation of cashflow – we are applying the discount cashflow basis of calculations. And any asset that has nothing to do with the business or the actual business or generation of the cashflow, we apply the valuation price of real market price – the price at which we can sell immediately on the market. So for the active asset normally the banks do not have serious objections. But the point is that with non-active assets, particularly property, the banks don’t like mark-to-market valuations. However, we have to squeeze these corporations. The law requires the IRCJ to shrink overcapacity, shrink the size of the balance sheet and sell any asset that is not generating any cashflow.

Also banks are not necessarily repeating the mark-to-market valuation on their collateral. So if they put valuation on the ¥10 billion loan they might put ¥6 billion of their collateral against it and fix it at ¥6 billion no matter how much the ¥10 billion changes. However, we are always calculating the worst case using legal and private procedures. If our price is worse than if legal procedures are used they will not accept it. We have tried to keep value up, above the level if legal redress is used. So if the banks do not agree with us we can cancel our dealings on the assets and it will have to go back to court, which would force bankruptcy and then the actual fund return would be much less than if we dealt with it. They have to agree with us. Naturally, the banks will say it’s terrible.

The IRCJ is not popular with banks is it?

Well we mustn’t be popular with anyone. If we are popular then we are twisted. We must be neutral. Although everyone will attack us it means that we are doing perfect business.

How do you choose companies? There was high expectation and you ended up choosing a bus company, a mining company, a small department store and a small construction company. What message do you think that sent?

Very honestly, we didn’t choose. When we started in April a lot of cases came here. We started with six or seven teams and did due diligence. And after three or four months these were the cases that came out. The selection [of cases that came to the IRCJ] was handled by the banks, not by us.

Why banks brought these cases I don’t know. There is some reason. They are classifying the quality of the loan. Depending on the classification of the loan there is a provision ratio, so if the asset is healthy then it requires less than 5% provisioning. Assets needing attention require 35% provision and assets close to bankruptcy require 70% to 80% provisioning. So basically bankers thought that assets needing attention should be handled here. If their analysis was reasonable we would have followed their calculations and shortened the time for due diligence.

However, we have a strong requirement from taxpayers to use their money carefully. We must find third-party buyers for the asset that we buy from the banks, so naturally I have to be conservative. If I buy any asset in line with their calculations then I might make a loss in three years. I don’t want to be axed. I asked our people to investigate the assets very carefully. We might have to ask banks to use another 20% provisions. If these banks are rich enough, it won’t be a problem but others may have a problem. Banks will bring cases where they have enough provisions. With the large companies they are lacking this kind of classification and their loans are appearing healthier. So there is no need to bring these kinds of cases to us.

Do you think the rebound in the Nikkei and optimism about the Japanese economy will help or hinder your work?

I think that the more we see higher prices for the valuation of the stock and higher prices for real estate, banks will find it easier to use the incremental increases for the additional provisions so they will find it easier to bring cases to us. On the other hand some lazy managers in banks might feel that they don’t have to do anything and will wait and see if some companies might turn around.

Some suggest that the IRCJ’s name was chosen for political reasons. It gives the impression that it will transform industries, whereas actually it’s just transforming individual companies.

Individual companies make up an industry. If we feel restructuring an individual company is good for an industry we will look at it.

So you think that companies you have chosen are good for their respective industries?

I think so. For example, take the local bus company – there are lots of ways to think of the rescue of this company. One is that we are thinking of the population and demographic composition.

Any local bus will face difficulty, bus routes that are servicing parts of the society and local structure. If we wipe them out through legal procedures, people in villages and towns will lose the transport.

This company has 5,000 employees. And in the local area this is one of the largest industries. The negative impact would spill over. Rather than wiping out these inefficient industries I thought that this was a good chance for administrators to think about what sort of transport network they should install for the future. We have 400 bus companies and most of them are running a deficit so if we can be confident and successful with this company we can probably employ a similar strategy with others.

But what about the companies that are fundamentally important to the Japanese economy. Wouldn’t they have been the more obvious choice?

Yes, there may that kind of thinking. But the point is whether we should approach these cases from the view of the total national economy or only efficiency of the economy, or put more weight on society.

It’s a difficult question. Although I don’t like keeping the zombie companies alive we cannot ignore these types of cases.

So will you move on to the larger companies?

We are waiting and wish to handle them but we don’t have legislative powers to pick them. The banks have to come forward.

What is more important, the number of companies or the profitability of the IRCJ?

The IRCJ does not have to make a profit. But we want to keep the total cost down. Size and number of cases is much more important than profitability. Our first priority is how we can send a message to society and how we can really revitalize the industries.

What else is in the pipeline alongside these four companies?

It’s a secret.

Will the process of choosing companies get quicker? You were set up in May but only have four companies.

We have a couple of companies in our pocket and we are investigating them. When we have finished we will announce them. But I don’t know what will come or in what industries. We may have problems and it will push us back.

So you don’t know if you will become quicker?

We don’t know.