Daiei to Get JPY60 Billion Bailout


The poster child for Japan's bad debt problem, major retailer Daiei, will get its second bailout of the year through the Development Bank of Japan, whose funds come from the nation's postal savings and national pension fund. This news goes directly against the "hard landing" retoric that the new FSA chief, Heizo Takenaka. Indeed, some see it as a retreat from the government's apparent commitment to take a stricter stance on dud borrowers. Moreover, the banks, who were supposed to be under pressure from the government to clean up their loan books, will be asked to fork over JPY25 billion~JPY13 billion, with the Development Bank providing JPY10 billion. The company had won a JPY520 billion debt waiver from its creditors just this last March. The new "Daiei Fund" will be managed by Shinjiro Takagi, who heads the government's advisory panel on debt-ridden companies. The state-run Development Bank, is also in talks with other companies to make investments in similar funds.


This clearly is a case of rooting for the losers,based on the same doubtful logic that protecting Japan's major banks and allowing current management to stay in place protects jobs and prevents a major financial crisis. Ostensibly (according to the twisted logic) letting Daiei go would cause a crisis in Japan's retail sector. But the Development Bank has also lent money to debt-ridden Kumagai Gumi. How does this logic, and the Bank's stated objective of making loans for "sustainable development"?


The storm clouds brewing after Mr. Takenaka's appointment as FSA minister and economics czar are already producing rain, in the form of backtracking from a hard line scenario. In the "giron" (debate) with opponents and potential supporters, Takenaka's vision for recovery is looking increasingly unattainable given the political realities. In the end, the Japanese government will do just enough to quell the immediate brushfires, and concentrate on quick-fix economic countermeasures. Even the ostensible tax cuts of JPY2.5 trillion are now looking iffy.

Unrealized Profits of the Major Life Insurers Shrink 90% in Six Months


The banks are not the only financial institutions hurting from the sell-off in equities. Of the major life insurers, only two have unrealized gains on their stock portfolios at current market levels, and Yasuda Life, Mitsui LIfe, Asahi Life as well as Sumitomo Life have unrealized losses ranging from JPY100 billion to JPY400 billion. From the beginning of this fiscal year (FY2002), Japanese insurance companies had planned to reduce their portfolio risk profile by reducing stock holdings, and each firm sold several hundred billions of yen of stock in the first half of the year. From July onward, however, falling stock prices meant that selling programs slowed dramatically. Heretofore, the life insurers had been using the proceeds of stock sales to produce operating profits to use as a source of dividend payments. If the current latent losses continue, they will be forced to draw down internal cash reserves to meet dividend payments.

Japanese Banks Lobby Heavily Against Takenaka Hard Landing Scenario


Meetings with the senior management of Japan's banks and Heizo Takenaka only steeled the banks' opposition to Takenaka's budding clean-up effort, and they are openly hostile to Takenaka. The last thing Takenaka needs at this point is to get bogged down in "giron" (debate) with those who oppose his hard landing stance. More talk will only delay the task force's recommendations. While achieving a consensus first has traditionally been how things got done in Japan, the fact is that there is no consensus among the banks, their supporters in the government and the reformists, and there never will be. This is because bank senior management and other heretofore protected constituencies are directly threatened by these reforms.


To make any progress Mr. Takenaka will need to build a coalition within the LDP and the MOF. But leaders of Japan's three largest banking federations told Takenaka's task force the same old story--that they had enough money to write off their non-performing loans and to protect against further losses. This however is based on their loose classification of bad credits. They thus oppose tightening the definitions of bad credits, as they know better than anyone else that that would lead to capital infusions and pressure on bank management to take responsibility.


Banks are Pushing for a Souped-Up RCC


The banks and their political backers in the government are pushing for a souped-up Resolution and Collection Corp. (RCC) role. The softer landing approach would preserve the banks' independence and allow them to avoid the issue of responsibility while getting the government to fork over more money–i.e., the ultimate moral hazard. This "moral hazard", and the traditional coddling of the banks by the MOF and the BOJ, are why the banking sector has been unable to produce internally or market-generated reforms. A third view different from the confrontation between the "hard landing" proponents led by Heizo Takenaka and the "soft landing" proponents in the banks and the LDP is the now-discredited view that more capital infusions for the banks will only encourage them to dally longer on NPLs. But this view seems to ignore the larger issues, such as the need for the banks to reduce their cross-holdings to a level below their core capital, and the fact that valuation losses on current stock holdings continue to erode the banks' capital in a negative Catch 22 spiral.


There are already signs of slippage in the "hard landing" scenario. To be well-executed, the Koizumi Administration would need to include a proposed law enabling the use of public money before the banking system is in a "crisis" mode. However, the government apparently will not include in its anti-deflation package due out soon such a proposed law. In addition, Takenaka has reportedly agreed with LDP leaders to expand the role of the RCC, and to expand the functions of the Development Bank of Japan to assist small firms. The Development Bank of Japan's funding sources are the Welfare Pension Fund and postal savings. Moreover, there are indications that the government will also continue to support debt-ridden Daiei, despite Mr. Takenaka's comments to the press that no company or bank should be considered "too big to fail". In the end, the political wrangling between the hard landing, soft landing and other landing proponents will most likely produce a watered down version of countermeasures that are most likely to disappoint the market after a dramatic build-up in expectatons/fears about a tougher banking sector clean-up.


Easing the Pain of a Banking Sector NPL Cleanup


Japanese companies listed on the Tokyo Stock Exchange hold some JPY216 trillion in interest-bearing debts, an amount equal to 85% of market capitalization and growing as market capitalization continues to shrink. In FY2001, the industries where debt exceeds 10 years of annual cash flows are textiles, nonferrous metals, steel, oil/coal, real estate (where the ratio is 24 years) and retail/construction (where the ratios are 18 years). If there is a hard landing in the banking sector, many companies in these sectors will experience a substantial credit crunch. Thus the government's plan to set up a financial safety net anchored by the Development Bank of Japan stems from the growing fear that an accelerated cleanup of nonperforming loans could choke off credit even to ailing companies with solid prospects of recovery. This time around, it is deemed absolutely necessary for main banks to weed out the firms crippled by excessive debt loads. At the same time, the government is considering the establishment of an emergency loan and investment facility that will allow the government-affiliated Development Bank of Japan to provide funds under certain conditions to large companies that are pursuing restructuring measures such as cutting excessive debt. The government will also introduce a risk insurance system that will allow private-sector banks to transfer a portion of the risk of loan losses to the Development Bank of Japan, shoring up their capital ratios without reducing their actual lending. Companies receiving funds will be required to produce clear-cut plans to lower debt to 10 times or less the level of annual cash flow after restructuring. Loans from the Development Bank of Japan will not be allowed to exceed 50% of total borrowing, with the remainder coming from private-sector banks. Moreover, if the Development Bank of Japan makes a direct loan to a company, the loan will have to be repaid within three years. In addition to the lending and investment program, the government will also set up a risk insurance program that will allow banks to transfer a portion of their lending risk to the Development Bank of Japan in return for premium payments. The Development Bank of Japan will underwrite only the portion of lending with relatively low credit risk, but the program will allow banks to effectively reduce their risk assets without actually cutting back on lending.

Small Business Operators Failing to Pay National Pension Dues


The shortfall of unpaid national pension dues in FY2000 reached approximately JPY1.7 trillion, or 2X the level prevalent in 1990. Small business owners, squeezed by a weak economy and structural changes, are finding it difficult to keep up the payments for the national pension. Small business owners who are participants in the national pension scheme have two years to make the payments before they are considered in default and dropped from the program. At this point, the losses are realized by the national pension fund. The rising number of drop-outs from the national pension system also has a negative effect on the finances of the welfare pension system for salaried workers, and on the public employees' pension system. In FY2000, the average monthly contribution charged to pension fund subscribers was JPY12,700, excluding the government subsidized portion.


As Japan's pension fund system is reaching the maturity stage where the burden of pension benefit payouts begins to exceed the fund inflows from new participants, the growing gap between required returns and declining actual returns is a double punch for the nation's pension funds. Using current trends to project the future financial status of these pension funds, salaried workers will be facing either increases in the amount they bear for these pension fund benefits, or they will have to accept lower pension benefits. This was the whole reason for the general movement to a defined contribution (a Japanese version of the 401K) as opposed to a defined benefit program. The introduction of the 401K-type of defined contribuition plans however is currently being slowly introduced, and currently being run in tandem with the old defined benefits system.

Japan's Major Banks Need JPY9.7 Trillion in Additional Capital


That's Goldman Sach's estimate, but it is pretty close with the Bank of Japan's internal, non-pulic assessment. Should the government purchase more bank stock as a way of bolstering capital bases, as they did in the previous purchase of bank preference shares, the government's holding ratio would rise to 45%, which would mean an effective nationalization of major banks.


The Bank of Japan's internal estimate of the capital needed by major banks if they were to realistically reclassify their loan book and make the appropriate loan-loss reserves is also about JPY10 trillion, so Goldman's number does not appear to be too wide of the mark. Keep in mind the government in their financial system stability safety net had earmarked JPY15 trillion for "crisis countermeasures", but this would require PM Koizumi to declare such a crisis before the money could be used. In addition, this JPY15 trillion is not actually funded, but merely earmarked. Consequently, a full-scale bank recapitalization would also require the government to come up with JPY10 trillion-plus from somewhere, ostensibly from issuing bonds. The question is whether the JPY2 trillion in stock purchases the BOJ plans to implement would be included in the total amount of bank capital infusions.

Efforts to Increase Liquidity in the Property Markets


The Japanese government is currently considering reducing taxes due at the time of new property purchases, including acquisition taxes and registration taxes. Both registration and acquisition taxes are calculated from the fixed asset tax assessments, and produce annual tax revenues for the government of some JPY600 billion. While corporate tax reductions were also being considered for the new fiscal year as a means of stimulating Japan's moribund economy, it doesn't look like there is enough political support. Consquently, it is unlikely that corporate tax cuts are coming anytime soon.

Japanese Companies Move to Reduce Director Terms


More and more Japanese companies are moving to reduce the terms of their board members. According to the Commercial Law Journal (Shoji Homu), there have been 143 companies who have already introduced director terms to one year from a previous two years. With yearly as opposed to bi-yearly performance reviews, these Japanese companies aim to improve the operating efficiency of their boards. The current Commercial Code limits board director terms to two years, but 2,047 listed companies surveyed some 132 have already gained shareholder approval to reduce this to one year, and this follows 16 companies in 2000 and 68 companies in 2001. Shortened director terms are being accompanied by a general movement to reduce the total amount of board directors.

Impairment Accounting Finally on the Agenda


Considered the final--and one of the more thorny--steps in bringing Japanese accounting standards in line with international accounting standards, a scedule for the introduction of impairment accounting was finally introduced this August. Based on standards established by the Financial Services Administration and the Impairment Corporate Accounting Deliberative Committee, the Impairment Accounting Specialist Committee under the ageis of Corporate Accounting Standards Board will begin working on policies to flesh out the new standards. After an introductory period of two years, impairment accounting will become mandatory from March 2006. Whether the standards will actually function as intended will depend on the implementation policies. Under the new standards, factories which experience a sharp drop-off in operating ratios, or store outlets that are in deficit will ostensibly have to record impairment losses. The current focus of debate is how asset groups will be considered, i.e., if one store outlet is considered a group, accounting for the impairment losses of one store would be required. In the case of JR East, there is a sharp contrast between the profitable metropolitan railway lines and their deficit railway lines in the prefectures. If the lines are considered seperately, the losses on the prefectural lines would be subject to impairment accounting, but if the entire railway network is considered as one, they would not. Thus if the asset group unit is too small, there would be much more impairment accounting losses, while if the asset groupings are too large, there would hardly be any. Moreover, if left to the discretion of each company, the objectiveness of the new accounting rules would be compromised. In addition, a major precondition for the introduction of impairment accounting, i.e., objective assessment of asset values, also presents difficulties. Under impairment accounting, asset values are determined by the future cash flows obtainable, but the estimate can be greatly influenced by management projections. In other words, will accountants be able to determine the feasibility of mangement cash flow projections?


The accounting standards committee has one year to figure all of this out, as they need to have a specific application framework in place by the end of March 2004 for those companies adopting early introduction of impairment accounting standards. The Committee is expected to announce the results of the debate on these issues by next February, and to have their final proposals ready by the fall of next year. Whether the new accounting standards actually result in increased balance sheet visibility will depend on the effectiveness of the Council.

Heizo Takenaka's on the Case, But...


Heizo Takenaka's career has taken a big uptick, from University professor to head of Japan's Economic and Finance portfolio under the Koizumi Administration. His appointment by PM Koizumi to run the Financial Services Agency was a surprise move that gained the support from the US, the OECD and most foreign observers. The OECD on Monday acknowledged the need for the Japanese government to inject public funds into banks as they dispose of their bad loans. They urged the BOJ to raise money supply by increasing the scope and value of assets it buys. They also recommended that Japan trim budget deficits, create a broader based tax system with lower rates, and promote competition by giving the Fair Trade Commission more power.


However, Mr. Takenaka's appointment has the senior managers of Japan's banks in near panic because of his "hard landing" philosophies, and he has alienated old-guard LDP, his new subordinates at the FSA, and people at the MOF, with comments to the press before there was any significant internal coordination, and the absense of internal debate "giron" with his subordinates. In Japanese politics, there is always a call for "giron" (debate). In fact, Japan has been debating about the bad debt problem and a stagnating economy for the past ten years. Everyone that has gotten involved in serious debates with the various entrenched interests that would be hurt by reforms has gotten bogged down in filibuster. Mr. Takenaka's problem is that no one among conservative domestic investors (heretofore closely aligned with the old-guard LDP) believes he can actually pull it off, and in some cases they actually want him to fail. In other words, Mr. Takenaka had a credibility gap from the onset, that, combined with entrenched resistance in the BOJ, MOF and the FSA, will make it hard to achieve any forward progress--certainly not within the time-frame that the markets expect.