October 22, 2008 8:35 pm

Second blossom

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Not so long ago, when Japan was mired in a deep and protracted banking crisis, it was swashbuckling US bankers and private equity firms that saw gold in the debris. Many picked up bargains, bringing fresh ideas and capital to a system on its knees.

Now, as the credit crisis drives western banks up against the wall, the roles have been reversed. Japanese financial groups have moved swiftly to snap up prized assets in the US and Europe, sending a strong message that they are back on the international stage. With western rivals shell-shocked, Japanese banks have sniffed a once-in-a-generation opportunity to grab market share and remould the international financial landscape to their advantage.

Takumi Shibata, the internationally minded chief operating officer of Nomura, the Japanese broker that scooped up the Asian and European operations of the failed Lehman Brothers for a knockdown $227m (£139m, €177m) last month, can hardly hide his glee. “It would have taken about 10 years for us to build these platforms which became available overnight,” he says. It would have been foolish for us not to jump on it.”

Mitsubishi UFJ Financial Group (MUFG) evidently felt the same. This month Japan’s biggest bank delivered a $9bn cheque to Morgan Stanley as payment for a 21 per cent stake in the venerable US investment bank. Despite a reputation for being conservative even by Japanese standards, it took MUFG just two days to stump up a sum approaching 11 per cent of its shareholders’ equity.

That is not all. Earlier in the year Mizuho, Japan’s second largest bank, spent $1.2bn on a stake in Merrill Lynch, while Sumitomo Mitsui Financial Group invested about $1bn in the UK’s Barclays. “It’s proof that Japanese financial institutions have returned to health,” says Tom Ito, co-head of investment banking at UBS in Tokyo. They “are now going to aggressively expand overseas”.

Their re-emergence brings back memories of the 1980s – seemingly golden years when Japanese financial powerhouses, backed by the country’s massive savings, seemed set to conquer the world. Equally, it marks a striking change from just a few years ago, when many of the banks were weighed down by non-performing loans and the government was forced to inject funds to save the financial system from collapse. As recently as 2003, without the government’s preference shares and the generous use of deferred tax assets to boost their capital, the main banks were in effect bankrupt.

In the so-called “lost decade” that followed the bursting in 1990 of Japan’s asset bubble, its banks had retreated from overseas markets and hunkered down at home to rebuild their capital bases. But with the domestic crisis finally behind them, Japanese financial groups have started eyeing international markets again as a solution to their remaining problems. Not least among those is the shrinking domestic market banks face.

Despite a mild economic recovery, lending has failed to recover, as companies have turned more to the capital markets for funding. Last year, lending by the top three banks fell 2.5 per cent, says Naoko Nemoto, analyst at Standard & Poor’s in Tokyo. “There is overbanking in Japan and profitability is low,” she says.

The story is the same throughout Japan’s financial sector, from stockbrokers to insurance companies. Nomura, for example, found its dominance at home increasingly threatened by foreign investment banks and the securities subsidiaries of Japan’s megabanks. Until its demise, Lehman Brothers rather than Nomura was the top broker on the Tokyo Stock Exchange in terms of trading volume. That, says Mr Shibata, is one reason “why we were not that happy with the status quo”.

Japan’s non-life insurers meanwhile face a decline in premium income this year and next, largely because of a fall in car sales and hence in the need for automotive insurance. That helps to explain why Tokio, the industry leader, this year splashed out $4.7bn to acquire Philadelphia, a specialised insurance group in the US, and £442m ($726m, €564m) to acquire Kiln, the Lloyd’s of London agent.

A second reason Japanese financial institutions need to expand overseas is because their main clients, Japanese corporations, are becoming increasingly global. In the wake of exporters such as Toyota and Panasonic, more domestically focused companies including Japan Tobacco and Asahi Glass are being driven to overseas markets by Japan’s declining population.

But to compete in overseas markets, even those involving Japanese clients, Japan’s banks and brokers need to match their western rivals’ expertise, no matter some elements of that are now tarnished. Lehman overtook Nomura on the TSE three years ago because of its ability to provide high-frequency trading for clients such as hedge funds.

The discipline imposed on the banks during their time of seclusion has given them the wherewithal again to pursue global ambitions. “Their assets are more transparent and their reserve policy is much stricter, so there is considerable confidence in their financial health,” says Mr Nozaki. The retreat also helped them to avoid the worst of the excesses that landed their western counterparts in such dire straits.

. . .

Until the credit crisis struck, few foreign banks were available to buy. Those that were up for grabs were prohibitively expensive. “Lehman one year ago was a $20bn market cap company and, since Asia-Pacific comprises 40 per cent, it would have cost [Nomura] $8bn,” estimates one Japanese investment banker – more than 30 times what it actually paid.

Consequently, when the opportunities arose, even the most cautious Japanese bankers were tempted, notwithstanding the uncertainty still clouding the outlook for international investment banks. MUFG even cut short its due diligence on Morgan Stanley from an initially forecast one month to just a week, partly to stop its target’s shares from falling further.

But having made these uncharacteristically bold moves, Japan’s banks face two big questions. First, should they be buying into investment banks at a time when the sector’s business model is being scrutinised and when profitability is shot to pieces?

Analysts say profitable proprietary investments and primary brokerage operations are likely to shrink, forcing investment banks to go back to their roots as more stable – but less lucrative – fee-based businesses. Yet from the Japanese perspective, even the regular fees western investment banks earn from mergers and acquisitions advice, securities underwriting and trading look attractive. These would help diversify profits and cushion the impact of a dwindling home market.

“The landscape has changed quite dramatically. The profitability, longer term, is likely to be less than it was until this year. But while the returns may not be as good, there will still be a need for expertise to raise money,” says Brian Waterhouse at Japaninvest, an equity research company.

Second, will Japanese financial institutions be able to manage their investments and transform themselves from predominantly domestic institutions to serious global players? “You can acquire expertise but can you manage expertise? That is the crucial question,” says Mr Waterhouse.

Nomura’s success hinges on whether it is able to retain talented Lehman bankers and ensure that the positive aspects of the Lehman culture, which underpinned the US bank’s successful divisions, survive in the new environment. To that end, Nomura has moved quickly to boost morale among Lehman staff through bonus guarantees. It has also appointed three non-Japanese directors to the Nomura board to infuse international thinking into its top management team.

Some warn that the bureaucratic, inward-looking culture typical of Japan’s financial institutions is an obstacle to a close partnership with aggressive western bankers. “They are not the potential saviours of western capitalism,” Mr Waterhouse adds. “They don’t have the fire in the belly that other financial institutions have.”

In MUFG’s case, even before it faces any cultural issues, it must agree strategic ventures with Morgan Stanley that provide new revenue streams. “There has to be a real deal that comes out of this,” says Mr Nozaki. One fillip has been that, as soon as the investment was sealed, MUFG received US financial holding company status – a licence to underwrite bonds and conduct other investment banking services, which had been denied the Japanese bank for years.

But in order to take full advantage of its new powers, MUFG will want to tap Morgan Stanley’s expertise in deal-structuring and complex services and become the provider of funds to back deals. MUFG will also want to gain access through its new partner to US customers. It and Morgan Stanley are giving themselves until next June to come up with strategic initiatives.

As Katsuhito Sasajima, banking analyst at JPMorgan in Tokyo, says: “The plan that is unveiled in June will show whether Japanese banks have really changed from being lenders of last resort to being able to make strategic alliances.” Given the speed of change in financial markets and the potential for western financial groups to reinvent themselves, they will have a limited time to make their mark.


Japanese officials have been quietly warning for months that big capital injections would be needed to keep western financial institutions afloat, writes David Pilling. Having gone through their own slow-motion banking catastrophe lasting 10 years from 1995, many were convinced the faster-paced US subprime developments would end in massive government intervention.

Now this has come to pass, some observers are looking to recent Japanese history to see what may come next. Although Japan’s experience was different in important respects – not least in that it was played out over a long period against a background of deflation – the country provides a case study of how bank bail-outs work in practice.

The 1990 collapse of an asset bubble provoked a sharp fall in the value of property and equity that underpinned banks’ balance sheets. But banks ignored their problems until 1997 when Sanyo Securities, Yamaichi Securities and Hokkaido Takushoku Bank all failed.

Even then, the government had a hard time convincing banks to accept state funds, senior officials involved in the subsequent bail-outs recall. “They didn’t want the government meddling in their management and setting conditions,” says one former executive at the Bank of Japan, the central bank.

A reluctance to admit the scale of the problem meant capital injections took place in three main tranches. The first came in the spring of 1998, when the government injected Y1,800bn ($18bn, £11bn, €14bn) into 21 institutions. The money, which came in the form of preference shares, had few strings attached. The second followed the collapse in 1998 of Nippon Credit Bank and Long Term Credit Bank. A tightening of rules forced 32 institutions to raise capital and in 1999 to accept government funds totalling Y8,600bn.

Conditions grew stricter. “The first time, the government injections were very generous, depending on the banks’ own will. The second time was more forcible,” says the former BoJ official. “The first priority was that in a certain period they had to return from red to black, second was to lend to SMEs [small and medium-sized enterprises] and third was a host of conditions, such as cutting their payroll,” he says. But banks struggled to comply, particularly when it came to SME lending.

Most had massively overextended their loan books and were intent on shrinking their balance sheets to reduce risk and repair capital adequacy. Their struggle was made harder by two big recessions, in 1998 and 2001, and by chronic deflation, which hurt borrowers by increasing the relative value of past debts.

As a result, as fast as banks wrote off non-performing loans, new ones appeared on their books, forcing them into a new round of balance sheet reduction. According to Teizo Taya, special counsellor to Daiwa Institute of Research and a former BoJ board member, total bank lending fell from Y600,000bn in 1995 to Y400,000bn a decade later. “Japanese banks could not maintain capital adequacy ratios without that [injected] money. But even so, bank loans declined by more than Y200,000bn over 10 years,” says Mr Taya.

Kiichi Murashima, chief economist at Nikko Citigroup, says some banks resorted to “window dressing” to convince regulators that they were complying with instructions to lend to SMEs. Officials close to the bail-out admit those instructions were largely ineffective. Some argue that the more conditions are set, the longer it takes banks to recover and resume lending.

Richard Jerram, chief economist at Macquarie Securities, who followed the bank bail-outs blow by blow, says: “Japan never injected sufficient funds to overcapitalise banks. There is no incentive for properly capitalised banks to sit on risk-free assets.” In other words, only by injecting more money than banks actually need will they regain the risk appetite required to fulfil their macroeconomic function of creating credit.

The third capital injection came in May 2003, when Y2,000bn was injected into Resona, Japan’s fifth biggest bank. Management was fired and tough targets were set for regaining profitability. Government also engineered a merger of two of the remaining top four banks – Mitsubishi and UFJ – and set stiff goals for banks to improve capital adequacy levels. Meeting those goals was helped by a much improved economic background that enabled formerly struggling companies to start servicing their debts.

By March 2005, non-performing loans were at 2.9 per cent of banks’ total assets from 8.4 per cent at the height of the crisis. Of the Y12,200bn injected, Y9,200bn has now been paid back. Yet the story was long and painful and, even now, banks are barely increasing their lending.

The lesson of Japan’s experience, says Teizo Taya, is that financial institutions generally need more money than originally envisaged. He also says highly stringent conditions can be counterproductive, merely delaying necessary adjustment.

“I don’t think we can expect banks to lend,” he says of US and European institutions. “They are going to be too busy writing off bad loans. Depending on the size of the bubble, what has to happen will happen.”


Mitsubishi UFJ Financial Group President Nobuo Kuroyanagi

Nobuo Kuroyanagi The straight-talking, football player was instrumental in creating Mitsubishi UFJ Financial Group in 2005. He has since taken the group into new areas, such as consumer finance.

Mizuho Financial Group Inc. President Terunobu Maeda

Terunobu Maeda is credited with making Mizuho the first Japanese bank to receive financial holding company status in the US. A keen gardener, he values independence and self-reliance.

Sumitomo Mitsui Financial Group, Inc. President designate Teisuke Kitayama

Teisuke Kitayama The cosmopolitan banker began his career at the blue-chip Mitsui Bank. He has aggressively diversified Sumitomo Mitsui Financial Group into consumer loans and credit cards.

Nomura Holdings president Kenichi Watanabe

Kenichi Watanabe took charge at Nomura Holdings, Japan’s largest broker, in April. Drawing on his experience of the 1997 Asian crisis, he was quick to raise $6bn to help finance the acquisition of Lehman’s Asian and European operations.

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