Old, Uncollectable Loans Jeopardize Japan’s Financial System : Banking: Excesses of the ‘80s and real estate crash left a heavy burden. Capital for economic recovery may be lacking.

More than four years after the collapse of Japan’s bubble economy, bad loans still haunt the banking system here, and no end to the problem is in sight.

Despite government efforts to play down the banks’ inability to recoup funds lent out during the expansion years of the 1980s, many financial experts say the problems are so severe that banks won’t recover before 1999.

In a July report, Moody’s Japan warned, “It may take up to a decade for the Japanese banking system as a whole to work through its (loan) problems.”

No one suggests that Japan’s system, which includes the world’s largest individual banks, is in danger of collapsing. But experts say it is likely that some banks, including some of the biggest, will have to seek merger partners or otherwise be significantly transformed.

“Even in Japan there is not enough money to bail everybody out intact in their present form,” said Alicia Ogawa, a Salomon Bros. Asia vice president. “There’s going to have to be some kind of amputation. Some number of people are going to have to lose their jobs; somebody’s going to have to pay.”

A more immediate concern is that weak banks will put a damper on Japan’s nascent recovery from its most serious post-World War II recession.

Businesses are not yet seeking expansion funds, said Toyoo Gyoten, chairman of the Bank of Tokyo and a former vice finance minister. Increased demand for loans should be the next phase of recovery, experts say, but the fear is that banks won’t be able to come up with their share of the money, and the shortage of funds could choke off economic growth.

Banks “don’t have enough strength now” to support economic growth, added Tadao Yonei, general manager of Cooperative Credit Purchasing Co., or CCPC, which was set up by the banking industry to dispose of bad loans.

Worst of all, Ogawa said, the bad-loan problem is creating “uncertainty that is pervading all aspects of economic activity. . . . It’s coloring everybody’s decisions.”

Adding to the uncertainty are questions about just how badly damaged the banks are.

Only the top 21 banks, which account for 45% of outstanding loans, are required to disclose all of their bad debts. And such disclosures leave out a huge chunk of loans that, by American standards, would fall into that category.

“What would be a non-performing loan in America doesn’t become a non-performing loan in Japan,” said Takashi Hosomi, a former vice finance minister who now heads the NLI Research Institute.

For example, Mitsubishi Bank--the only Japanese bank listed on the New York Stock Exchange and thus required to meet Securities and Exchange Commission standards--reported to U.S. authorities that the portion of its bad loans not announced in Japan rose 36% last year.

Virtually nothing is reported about the 55% of loans made by the other 5,700 financial institutions in Japan.

“What about the credit unions, the credit cooperatives or the local banks? You find the most horrendous things there,” said Vittorio Volpi, managing director of the Swiss Bank Corp. Group, Japan.

Although seven of Japan’s eight housing loan companies are teetering on the brink of bankruptcy, their problem loans are not classified as bad debts.

The Asahi newspaper said the housing loan company debacle by itself is enough to “shake Japan’s financial system.”

The official figure for bad loans is $136 billion. Yet at least $450 billion in bad loans can be documented from information available from various sources. The higher number--more than three times the official report--includes loans that would be classified as non-performing by U.S. standards.

Hosomi said estimates of total bad debt run as high as $700 billion, considering the signs of distress in the large number of financial institutions for which no information on loans is available.

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Government officials are “deceiving” the people by downplaying the extent of the problem, he said.

“Japanese are happy if problems are cured while they remain unaware of them existing. Basically, Japanese like being deceived. Right now, the authorities are busy deceiving them,” Hosomi said.

“The Japanese government has been very creative in the past in sweeping these things under the rug,” said an American financial analyst who asked not to be named. “I don’t think there is any person, including any person at the Bank of Japan or at the Finance Ministry, who has any real grasp on a numerical estimate of this problem even within several trillions of yen.” (One trillion yen is about $10 billion.)

Added Salomon Bros.’ Ogawa: “The local press and, to a lesser extent, some of the regulators coming out and saying, ‘Everything is fine, the problem is ancient history,’ is irresponsible in the extreme. . . . Nobody, including the banks themselves, has any idea about the true health of the financial system or what cost may pertain to keeping it afloat.”

Yasushi Mieno, Bank of Japan governor, has cited write-offs of $32.4 billion in fiscal 1993 and a slight decrease in the officially acknowledged bad-loan figure as favorable signs.

But, said Ogawa: “What the banks have essentially done is just push a couple of things around on the balance sheet, but it (the bad-loan problem) is still there. And, in fact, there is more of it than there was a year ago.”

Japan’s banking crisis stems from the collapse of real estate prices that followed an orgy of speculation in the late 1980s. Increased property values would improve the portfolio of banks, which are holding commercial real estate as collateral for most of their non-performing loans.

But real estate values are not rising; many analysts expect to see a further 20% to 30% decline. Worse yet, there are few buyers in a glutted market.

In addition, indications are mounting that measures being taken to cope with the problems aren’t working. A rescue merger plan for three banks in northeast Japan collapsed when one of the banks balked at assuming the debts of its would-be partners.

Despite new infusions of loans, Nippon Mortgage Co., a non-bank money lender, filed for bankruptcy, citing debts equivalent to $4.7 billion. It was Japan’s third-largest postwar insolvency.

Details are yet to be formulated for a government plan to save Nippon Trust Bank, one of the “Big 21” major banks. Already, two of the 21 have announced virtually unprecedented dividend cuts, actions viewed as pleas for government help.

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America’s banking problem of the early 1990s was solved by closing more than 2,000 banks and savings and loans, using $150 billion of taxpayers’ money for rescues and selling off real estate held as collateral via fire-sale auctions. Japan is taking none of these steps. Instead, the Finance Ministry has committed itself to preserving its post-World War II record of preventing bank failure.

“The Bank of Japan and the Finance Ministry are vigorously trying to strengthen the banks to the point at which they could withstand another 20% to 30% slash in the value of their (real estate) collateral,” Hosomi said. “But right now, another 20% to 30% cut would be risky.”

The CCPC--Japan’s equivalent of the U.S. Resolution Trust Corp.--has a program for absorbing bad real estate loans from banks. But the banks can recover, at most, only half the value of the loans.

According to the procedure, general manager Yonei explained, the CCPC borrows funds from the bank to buy--at 50% of value--property held by the bank as collateral. The loan is repaid only if the CCPC can sell the property. The bank also absorbs any additional loss if the sale price turns out to be less than the already halved value.

The CCPC deals enable banks to take tax credits on the 50% taken off the value of the real estate. They can also take all the bad loans off their balance sheets. But in effect, they wind up with new “bad loans,” albeit ones half as large as the old ones.

So far, the CCPC has disposed of a mere 6% of the property on its books, because “potential buyers expect the prices to fall still more,” Yonei said.

Some banks are selling off their holdings of other companies’ stocks to pay for direct write-offs of bad loans. Most, however, are buying back the stocks immediately, saddling themselves with more costly investments that yield minimum returns, said Shinano Morita, associate director of Standard & Poor’s Asia.

“Japanese stocks pay only 1% in returns, and you no longer can expect prices to rise to provide capital gains,” she said.

Japan’s Bad Debts

The extent of bad loans held by Japanese banks and other financial institutions may be larger by several hundreds of billions of dollars than official reports. According to available information, including official figures, about $450 billion in bad debt can be documented if certain loans of institutions not included in official reports are included and if bad debt is calculated by U.S. standards.

Official figures reported for 21 major banks: $136.0 billion

Restructured loans held by the 21 majors calculated as bad loans by U.S. standards: $140.0 billion

Unsold collateral property held by the CCPC*: $22.8 billion

Specialized housing loan firms’ bad debts: $139.7 billion

64 regional banks’ bad loans: $6.7 billion

65 second-tier regional banks’ bad loans: $5.1 billion

Total**: $450.3 billion

* Cooperative Credit Purchasing Corp., an agency set up to dispose of banks’ bad real estate loans.

** Excludes loans held by more than 5,000 banks not required to report bad debt.

Sources: Official reports, estimates by the Japan Center for International Finance, Cooperative Credit Purchashing Corp., Nikkei Financial Daily, Japan Regional Bank Assn., Assn. of Second-Tier Regional Banks