Shinsei Bank, the Japanese lender 33 per cent owned by JC Flowers, on Monday said it expected to fall into a loss for the second year running, further increasing the likelihood that a planned merger with local rival Aozora Bank would be called off.

Shinsei is forecasting a Y140.1bn ($1.5bn) net loss in the year just ended, which it blamed on investments in consumer finance, real estate and asset-backed products in the US. It had previously estimated a Y10bn profit for the period.

The loss will put pressure on the bank to quickly name a new chief executive to replace Masamoto Yashiro, the bank’s 81-year old chief executive who was called back from semi-retirement in November 2008. Mr Yashiro has already expressed his intention to step down.

The two banks are expected to announce as early as this month that they are cancelling a planned merger and will replace it with a business alliance.

Shinsei and Aozora, which is controlled by US private equity firm Cerberus, announced plans last July to merge their operations this October in a deal that would, based on recent valuations, create Japan’s seventh largest bank with assets of Y18,000bn.

However, Aozora is believed to have become increasingly unhappy with the one-on-one merger ratio, given Shinsei’s weaker capital adequacy and financial performance.

Shinsei’s tier one capital adequacy ratio at the end of March 2010 is expected to have increased to 6.35 per cent from 6.02 per cent a year earlier. But it falls far short of the 14.38 per cent tier one capital adequacy ratio of Aozora as of the end of December last year.

The improving business climate, which has weakened the arguments for the merger, is believed to have convinced both sides that the deal is no longer as compelling as initially thought.

Both banks, which were acquired by US private equity firms after being nationalised amid Japan’s banking crisis, have suffered from a failure to define a profitable business model. Driven by their new shareholders, both banks had tried to build a new business model in Japan’s crowded banking sector.

Shinsei and Aozora suffered massive losses amid the subprime crisis after making large proprietary investments in asset-backed securities and other products in the US, which subsequently plunged in value.

Shinsei has been battered further by a need to write down and make reserves for its investments in Japan’s consumer finance and real estate sectors.

JC Flowers and Cerberus are nursing paper losses on their investments in Shinsei and Aozora, which have suffered huge falls in their share prices in the past several years.

The Japanese government, which owns a 23.9 per cent stake in Shinsei, cannot sell its shares unless the share price, which closed at Y116 on Monday, recovers to more than Y745.

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