The Gaijin Stumble in Japanese Banking

The scenario may sound familiar. A Japanese bank announces another net loss and the chief executive resigns to take responsibility. His successor, a 79-year-old Japanese in a gray suit, pledges a return “to the basics of the banking business” and to pay more attention to risk.

But there is nothing commonplace about either the bank or its departing CEO. Shinsei, which means ‘new life,’ was famously formed in 2000 from the rubble of the Long-Term Credit Bank, which collapsed under the weight of huge debts run up during the Japanese ‘bubble’ of the late 1980s and had to be nationalised. It was supposed to become the showpiece for Wall Street bankers who came to Tokyo to bring western methods to what had been criticized as a feudal banking system.

Indeed, the bankers who bought LTCB from the Japanese government promised that Shinsei would be a new beginning for Japan. They had powerful supporters. David Rockefeller invested a few million dollars in the buyout consortium to promote “free enterprise.” Paul Volcker, former head of the Federal Reserve Board and now a key economic adviser to U.S. President-elect Barack Obama, agreed to serve as a senior adviser out of a desire to reform the Japanese financial system.

Shinsei had no shortage of cheerleaders in the Western business press. The notion of Wall Street private equity riding to the aid of a sinking Japan Inc lay behind Saving the Sun – Shinsei and the Battle for Japan’s Future, a book by journalist Gillian Tett of the Financial Times. Published in 2004, the subtitle was: “A Wall Street gamble to rescue Japan from its trillion-dollar meltdown.”

Thierry Porté, whose resignation from Shinsei was triggered by last month’s announcement of a ¥19.2 billion net loss for the six months to September 30, is one of the most senior Americans in Tokyo. Previously head of Morgan Stanley in Japan, Porté is chairman of the Japan-U.S. Friendship Commission (overseen by the U.S. Congress) and the American School in Japan, as well as president of the Harvard Club of Japan.

Shinsei replaced Porté with his predecessor Masamoto Yashiro, who was Shinsei’s first CEO from 2000 to 2005. Yashiro was hauled out of retirement in June after Porté was forced to sell the Tokyo headquarters building to avoid posting a loss for the last fiscal year.

Before joining Shinsei, Yashiro built up Citigroup’s retail bank in Japan, and in recent interviews he has made veiled criticism of Porté’s leadership by blaming an excessive focus on investment banking for Shinsei’s current woes.

(Shinsei’s interim report of December 10 struck a more diplomatic note. Yashiro attributed Porté’s exit to “unforeseeable events, including changes in the regulatory environment and the recent global financial turmoil.”)

A sense of crisis also envelops Aozora, another Japanese bank controlled by U.S. private equity, and of similar provenance to Shinsei. Aozora, which translates as ‘blue sky,’ lost ¥28 billion in the first half of the fiscal year ending March 31, 2009. Federico Sacasa, a native of Nicaragua who used to work for Bank of America, so far has managed to keep his job as CEO. However, there has been a dense blizzard of executive and board changes – 12 appointments, 25 reassignments, six resignations and three retirements – since he took the helm.

The dismal performance of Shinsei and Aozora is striking in light of the extravagant claims that were made for both banks. After the orgy of property lending that nearly bankrupted the Japanese banking system, they were hailed as paragons of prudence and probity who would teach Japanese the meaning of risk management while maximising profits to the benefit of shareholders. Not least, they would display a mastery of complex financial products that were quite beyond the plodding comprehension of Japanese bankers.

The main voices of dissent came from Japanese taxpayers, angry that trillions of yen in public money were spent on making the two banks attractive to foreign investors, who then pocketed billions of dollars when they were floated on the stock market. In addition to injecting capital through buying preferred shares, the government also cleaned out the Augean stables of bad loans to the old LTCB and Nippon Credit Bank. This was thanks to a controversial put option obliging the Deposit Insurance Corp. to buy loans from Shinsei and Aozora at book value should they decline by 20 percent or more within three years.

Shinsei’s shares closed at ¥158 on December 11, less than a fifth of their ¥827 price when first listed in 2004. Aozora’s share price has slid even more steeply than that of Shinsei, down almost 75 percent in the past 12 months.


Much of the damage to both banks has come from risky overseas investments.

Yashiro now says risk management needs strengthening at Shinsei. He also wants the bank to concentrate on growing its domestic business. No mention is made of the money Shinsei invested in June in Germany’s Hypo Real Estate Holdings, a company which had to be bailed out four months later by the German government and the country’s financial institutions. JC Flowers, the private equity group that now controls Shinsei, led the group of investors in Hypo. Also quietly forgotten is the USUS$3.7 billion Shinsei invested in a portfolio of corporate bonds, including WorldCom, soon after Yashiro became Shinsei’s first CEO in 2000. In its 2004 annual report, Shinsei acknowledged that the portfolio’s value had shrivelled to USUS$900 million. Further discussion of the bond portfolio was omitted from subsequent annual reports.

More than half of Aozora’s shares now belong to Cerberus, the private equity firm that last year bought most of money-losing Chrysler for USUS$7.4 billion. The car maker has bled cash ever since and is now seeking a bail-out by the U.S. taxpayer.

In 2006 Aozora unwisely put USUS$500 million into a Cerberus-led purchase of 51 percent of GMAC, the finance arm of General Motors. All but 30 percent, or US$150 million, of this investment has since been written off. The bank has also had to write off more than 90 percent of its US$484 million of collaterized debt obligations (CDOs). No surprises therefore that Aozora’s chief financial officer and chief market risk officer both resigned in November.

While Porté was in charge, analysts castigated him for lacking strategic focus. Shinsei’s retail bank won consumer plaudits for innovation but for most of the time failed to make any money. Perhaps out of frustration, Porté decided on a major foray into consumer finance, an industry long tainted in Japan by the activity of loan sharks. The timing of Shinsei’s first acquisitions was disastrous, coming just before a clampdown on usurious rates of interest. Porté’s response was to massively increase the bank’s bet by buying GE’s consumer finance division in Japan for ¥580 billion in cash. Moody’s Investor Services last month cut Shinsei’s long-term credit rating, citing uncertainty over the outlook for consumer finance.

Moody’s also worries whether Aozora’s wholesale banking model is sustainable. Aozora has only 18 retail branches in Japan to collect deposits. Almost one-third of its funding comes from selling fixed-rate debentures to 500 of the 700 regional banks in Japan.

This a legacy of the old Nippon Credit Bank, one of only three banks specially chartered by the government to provide long-term credit to industry. (The other two were LTCB and the Industrial Bank of Japan.) Forbidden from accepting short-term deposits, like the city banks, NCB instead was permitted to issue three-and five-year debentures.

The publicly owned forerunner of NCB, Nippon Fudosan Bank, was created in 1957 out of the Japanese assets of the Bank of Chosen, the central bank of Korea during Japanese colonial rule from 1910 to 1945.

Some analysts wonder whether in a banking market as crowded as Japan’s the two foreign-controlled banks are even necessary. Liberalisation deprived the old long-term banks of their raison d’être and ability to compete when the commercial banks began using their deposit bases to offer cheaper long-term funding than their debenture-issuing counterparts.

The chief equity analyst at a Wall Street bank in Tokyo said in an interview that the Japanese government “should have wound up LTCB and NCB in an orderly manner ... because they’re not needed any more.”

Privatisation of the Development Bank of Japan over the next five to seven years begs similar questions about looming obsolescence. At present large Japanese companies are turning increasingly to the bank for policy loans as other sources of credit dry up. The Development Bank is able to meet this surge in demand simply by asking the government for more funds.

Without any depositors or government backing for its bonds, a wholly independent Development Bank may find the funding environment far more hostile to its chances of survival.