Japan’s Banks Shaken by Fall in California Values

The buying binge by Japanese investors who gobbled up premier California commercial real estate in the 1980s is long over, but the problems resulting from those investments are only now causing severe indigestion.

The steep downturn in commercial real estate in California and elsewhere has badly shaken Japanese investment in offices, hotels and resorts. A new study, scheduled for release today by the well-known real estate consulting firm of Kenneth Leventhal & Co., is expected to show that Japanese purchases of U.S. properties plunged last year.

While most U.S. and other foreign lenders have already written off their troubled loans, only recently did the California arms of about two dozen Japanese banks start to act.

“Believe it or not, a lot of Japanese banks just didn’t take any action to resolve their problem loans,” said Yukuo Takenaka, who heads an investment banking and consulting firm in Los Angeles and Tokyo. “They hoped the situation would improve, but it hasn’t.”

Riding the real estate wave in the late 1980s, overseas branches of Japanese banks financed well-publicized acquisitions and construction projects. Though initially profitable, the projects started quietly bleeding red ink last year as property values eroded at alarming rates.

From office towers in downtown Los Angeles to the posh Hotel Bel-Air and up the coast to the Pebble Beach golf links, Japanese banks and their offices here have taken a beating.

As a group, their California offices lost $55 million in the first six months of 1992--their first red ink since they became a financing force here--and regulators say that losses are expected to go higher when new figures are released in the next few weeks.

They are facing increased pressure from federal regulators to own up to their deteriorating loans. Regulators are using a strict, year-old law to step up their audits of foreign banking operations here, and that has all foreign bankers concerned.

(Their troubles generally have not spread to the American subsidiaries of Japanese banks, such as Union Bank and Sanwa Bank of California, which cater to California consumers and small businesses.)

The topics of bad loans and stepped-up regulation are sensitive subjects. The few bank executives who would talk publicly would not discuss specific loans or their bank’s difficulties.

Any selloff of Japanese-financed projects is likely to worsen the already overbuilt commercial real estate market in Southern California--a market some experts already believe will remain depressed throughout the 1990s.

In addition, the problems at the California offices of these Japanese banks could not be happening at a worse time for the financial institutions themselves.

Japanese banks are beset by recessionary troubles at home, where the value of their real estate loans and stock holdings also has plummeted. The institutions have seen dramatic drops in their already thin levels of capital, their final cushion against losses.

Japan’s Ministry of Finance, long a banking ally and friendly regulator, is requiring more financial disclosure from its banks. At the end of March, for instance, Japanese banks must for the first time reveal publicly the amount of bad loans they hold.

Japan’s banks are poised to write off or sell $12 billion worth of devalued real estate loans, according to recent Japanese news reports. The development follows the ministry’s recent decision to allow banks to sell stocks so they could raise money to cover write-offs.

Many analysts believe, though, that the problems are so great that the Ministry of Finance will not allow the banks to make a full disclosure. Instead, they said, it will continue to support the traditional way the nation’s banks have handled bad loans--allow new loans to be made until the borrowers recover and pay off the loans.

That may not be so easy. Estimates of troubled loans at Japan’s banks range as high as $150 billion--nearly the amount spent in the last decade to clean up the U.S. savings and loan debacle.

“Nobody has any idea how big the problem really is, but it’s huge,” Takenaka said. “We’ll all know at the end of March.”

The Ministry of Finance tried to restrict real estate lending worldwide in 1990, but bankers had committed so much to new construction and purchases here that real estate loans continued to grow as a percentage of total loans even as the economies of both the United States and Japan fell apart.

In California, the Japanese banking offices held $60 billion in loans and other assets at the end of June--about 75% of all assets held by foreign banking operations here. A third of their loans were on office buildings and other commercial real estate--much of it now worth less than the mortgages on the properties.

The banks also have serious problems in New York, where they held $240 billion in loans and other assets at the end of June. A consortium of Japanese banks, for instance, lost $129 million--more than 50 cents on the dollar--on a Times Square skyscraper they sold last year.

The length and the severity of the recession in U.S. real estate has been a rude awakening and revealed sharp clashes in business cultures between the two countries.

Japanese bankers put immense trust and faith in borrowers--especially long-term customers--to repay loans regardless of how long it takes, said banking lawyers and consultants.

While American bankers are quick to foreclose on properties when loans go bad, Japanese bankers are more apt to restructure loans or continue to make new loans to pay off the old ones.

In addition, American bankers usually have only the real estate available as collateral to cover bad loans, while in Japan, bankers usually require personal guarantees and other assurances as collateral.

Those added guarantees give lenders an edge and make borrowers more aware of the need to repay loans, said Toyohiko Yamashita, general manager of Dai-Ichi Kangyo Bank Ltd. in Los Angeles.

“Bankruptcy is very popular in the U.S., but it is a shame in Japan,” Yamashita said. “In Japan, we try to work out a problem loan and try to get a recovery. If the company is important to the public, we try to help out the company.”

Regulators in Japan encourage such help, though bankruptcies there are increasing. Banks can’t even foreclose on properties without approval from the Ministry of Finance and tax authorities.

“The ministry is concerned that one bank’s action not trigger other banks to act,” said Brian Kelley, vice president in the Los Angeles office of Long-Term Credit Bank of Japan Ltd.

Japanese regulators, for instance, do not want to create a situation in which banks are competing with each other to sell properties taken in by foreclosures, he said.

The opposite has been true here. The depressed commercial real estate market has been worsened partly by regulators requiring banks to sell bad assets quickly even as the Resolution Trust Corp. was dumping real estate from failed savings and loans on the market at severely reduced prices.

The Ministry of Finance is now encouraging banks to write off bad loans and sell them, but Japan’s taxing authority, which relies heavily on taxes from banks, is blocking the way. Bank losses would lower the revenue for the nation’s treasury, said Jack Rodman, a partner with Kenneth Leventhal.

Japanese bankers also are a bit befuddled by the adversary relationship that banks here have with federal examiners, according to banking consultant Karen Shaw, president of the Institute for Strategy Development in Washington.

“The Japanese have a tradition of high cooperation with their regulators,” she said. “They simply don’t understand what our regulators want of them.”

Unlike state or nationally chartered banks, including their own subsidiary banks like Sumitomo Bank and the Bank of California, the overseas offices of foreign banks have been largely ignored by U.S. regulators and lightly examined by state regulators.

The banks are not required to hold any capital in their U.S. offices, and their rules for maintaining reserves against possible loan losses are much less strict than U.S. rules.

The exception has been in California, where state and federal regulators have been examining foreign banking offices for a decade. That scrutiny now is getting tougher and, under a federal law that took effect last year, U.S. regulators are beginning to audit the overseas branches more closely.

“Our concern here is that we have sufficient good assets to satisfy any claims by third parties,” said David L. Scott, deputy superintendent of the California Department of State Banking.

Japanese bankers apparently are trying to ride out the California recession and ward off regulators without foreclosing on too many properties, even though a glutted market for office space has left buildings only partially occupied.

The 777 South Figueroa high-rise, for instance, is nearly two years old and was less than half filled at the end of 1992. More renters have been added since, which will help eventually to repay the $235-million loan provided by the Mitsubishi Bank Ltd. and Citicorp Real Estate.

At the Hotel Bel-Air, the Long-Term Credit Bank of Japan extended a 1989 loan for the owner, the Sazale Group in Tokyo. The Bel-Air, though, is at least generating enough cash to make reduced payments. “The Japanese bankers have shown remarkable patience in dealing with these loans,” said Eric Prevette, an executive in Sazale’s U.S. operation.

At Pebble Beach, developer Minoru Isutani paid $850 million to acquire the resort near Monterey in 1990. He sold it last year for $500 million, resulting in losses at the Mitsubishi Trust & Banking Corp. Ltd, which provided him with a $584-million loan, and the Sumitomo Bank Ltd., which held a second mortgage.

Most Japanese banks are trying to revise loans by lowering interest rates, resulting in lower monthly or quarterly payments, say their lawyers and consultants.

Though Japanese bankers are making fewer real estate loans, borrowers are still knocking on their doors.

In Santa Ana, two Japanese companies are getting ready to break ground on a $500-million hotel-office-residential complex, which would include Orange County’s tallest office tower--32 stories.