As investors ponder the long-term effects of the financial sector bailouts, it is worthwhile to look at the experience of Japan, which travelled a similar road in the 1990s. The collapse of the property bubble precipitated that crisis, but despite massive government help, recovery was stymied when recession added a wide variety of corporate loans to the long list of non-performing assets. This led to the so-called “lost decade” inhabited by zombie banks that escaped bankruptcy but were so weighted down by past mistakes that they could make little forward progress.
Some argue today that the US and European governments should take a more aggressive approach with large, troubled banks. Instead of just propping them up, they ought to nationalize, cleanse them of bad loans and weak management, then return them to the private sector with a clean slate, ready to fulfill their role in supporting a growing economy.
It’s interesting to see how one Japanese experiment with this more radical approach has turned out. One of the walking dead of that era was the Long-Term Credit Bank of Japan. It was finally put out of its misery and nationalized in 1998. Two years later, it was sold to a group of foreign investors, led by US billionaire J. Christopher Flowers. What made the bank particularly attractive was a pledge by the government of Japan to guarantee any assets that turned out to be worth less than 80 percent of book value.
The revamped bank was dubbed Shinsei, which means “rebirth” in Japanese. Management scrubbed the balance sheet of poor-quality loans and passed on 4.5 trillion yen in losses to the government. With that accomplished, the bank was ready for prime time and an IPO was launched in February 2004. The new shares were priced at 525 yen and were so popular that the issue was oversubscribed more than 20 times over. With that degree of enthusiasm, it was no surprise that the stock opened at 872 yen on the first day of trading.
So, was this really a phoenix rising from the ashes, or merely old wine in a new bottle? In a January 2007 CNN interview, Shinsei chairman Masamoto Yashiro was lauded: “He is to banking in Japan what Richard Branson was to the airline industry in Britain. An agent of change in a highly conservative industry.”
Mr. Masamoto, a former Exxon and Citibank executive, defined Shinsei’s key strategy as putting the customer first, not just in words, but with deeds. He also championed competition, profitability and performance, and proudly asserted, “I don’t follow the Japanese way of doing things.”
This rather immodest attitude did not square with the bank’s weak performance. In June 2007, Japanese regulators ordered Shinsei to submit a business improvement plan. But the situation was about to get much worse. With their wealth of experience with busted bubbles, the major Japanese banks largely avoided assets backed by sub-prime mortgages in the US and Europe. Not so for Shinsei, which suffered heavily in the aftermath of the Lehman debacle and racked up a loss of 143 billion yen for fiscal 2008.
Sufficiently chastened, Shinsei submitted a “newly revised Revitalization Plan” to regulators last month. Management has promised a back-to-basics strategy focusing on lending to corporate and individual customers in Japan, rather than proprietary investments abroad. Yup, that sounds basic all right, and just what a bank ought to be doing.
This week, Shinsei had some good news to report for a change, with second-quarter profit coming in at 11 billion yen. The Tier 1 capital ratio improved a little, but is still an anaemic 7 percent. That metric should be on firmer ground once a planned merger with Cerberus Capital–controlled Aozora Bank is completed. Shares moved up by 3.5 percent to 119 yen, still a pale shadow of its IPO price five years ago. The stock trades on the pink sheets with the symbol SKLKF.
If a financial institution gets the opportunity for a do-over and a fresh, clean start, it’s obviously a huge advantage. Unfortunately it’s also no guarantee of success. More important is a revised attitude, a willingness to forgo shortcuts and the “easy” profits of exotic investments and instead carefully build the business by understanding customers and the collateral they use to secure loans. That path will not only allow banks to eventually pay back public funds, but will help them avoid falling into deep holes in the first place.