BOUNCING BACK
Amid the gloom of Japan's banking sector, a quartet of banks are thriving under foreign ownership.
By Ian Rowley

At the very least, Masaru Irie must have gained a lot of confidence as he watched the share price of Shinsei Bank rocket 57 percent on the day of its initial public offering on February 19. For three years, Irie has been one of only four CFOs in Japan whose task it is to help revive once-bankrupt Japanese banks that had been sold to foreign private equity firms. The IPO of Shinsei, the reincarnation of Long-Term Credit Bank (LTCB) that failed with a bang in 1998, was a clear indication that there is life after bankruptcy - if the restructuring is done right.

That's just what Irie is trying to achieve. As CFO of Tokyo Star Bank, formed after Texas-based Lone Star Group acquired Tokyo Sowa Bank in 2001, Irie is working closely with his American bosses to transform a small-time bank that had previously put profitability only as a secondary goal. "Our job is to transform a second-tier regional bank into a world-class bank," he says. "Almost everything has had to change." Looking at the bank's profits, they seem to be getting it right. With the success of Shinsei's IPO, the spotlight may now turn to banks like Tokyo Star.

In fact, Shinsei's IPO draws attention to the one consistent piece of good news in Japan's banking sector. Despite the recent profitability of Japan's four megabanks - Sumitomo Mitsui, IBJ, Mizuho, and Tokyo Mitsubishi - Japanese banks continue to swim against a tide of bad debt - 14.4 trillion yen (US$135.5 billion) by some estimates. While financial sector reform is still too slow and the government still too willing to prop up insolvent banks, the institutions that have fallen into the hands of foreign private funds are thriving on their own. .

New Life

In 1998, only nationalization saved LTCB from collapse. Since US-based investment firm Ripplewood Holdings bought the bank for 121 billion yen later that year, Shinsei has returned to profitability (34 billion yen in the 6 months to September); achieved a capital adequacy ratio of 20.6 percent (more than twice the global sector minimum of 8 percent); and shed 90 percent of its bad loans.

Its 231 billion yen listing is the largest IPO in Japan in almost four years - and that's just for a third of the bank. The deal marks a remarkable change of fortunes at Shinsei, which translates to "new life". "[Giving] credit where credit is due, Ripplewood was prepared to take a risk with Shinsei, and it looks like it's paying off handsomely," says Jason Rogers, analyst at Barclays Capital in Tokyo.

No less remarkable is that this feat isn't unique. All of the four insolvent banks sold to private equity investors between 2000 and 2001 - Shinsei, Tokyo Star, Aozora Bank and Kansai Sawayaka Bank (KSB) - are no longer basket cases. They now list among the most profitable in Japan.

Back in 2000, their prospects for revival were grim. While they shared a common problem - a mountain of bad debt - they started on different footings. LTCB (now Shinsei) and Nippon Credit Bank (now Aozora after being purchased by Cerberus Capital) were mid-sized, long-term credit banks with national reach. Tokyo Sowa (now Tokyo Star) and Kofuku (now KSB, after the purchase by WL Ross, owned by US private investor Wilbur Ross) were regional lenders hardly known outside their respective areas.

This difference remains to this day. "Each bank operates in different markets with its own niche," says Winston Tsui, former CFO of KSB, which was sold to WL Ross for 24 billion yen in late 2000. "Just because each of the banks are owned by American private equity firms doesn't mean there's one model." The banks also differ in size. By October 2003, Shinsei's assets stood at 6.5 trillion yen; Aozora's 5.4 trillion yen. By contrast, KSB's assets stood at 817 billion yen; Tokyo Star's at 1.1 trillion yen. (In comparison to Japan's megabanks, all four are practically dwarves.

Sumitomo Mitsui, for instance, has assets of over 100 trillion yen.) Tsui cites the importance of scale in analyzing the four banks' resurrection. "KSB's size and structure were key factors in its fast turnaround. At the end of the day, KSB is a relatively simple bank," he says, adding that the larger the bank, the more complex it is to undertake reform. "All that complexity can create surprises, but as a regional bank focusing on small- and medium-sized borrowers, things are much more stable."

Rise and Shine

Some industry watchers say the purchase agreements of the private equity funds with the Japanese government - rather than their scale or historical business focuses - explain the rapid recovery (see box, "Buyers' Advantage,"). That may be true. Still, they concede that the banks deserve praise for the speed with which they've turned around the failed banks.

Irie says changing the prevailing attitudes in and outside Tokyo Star was a big challenge for Lone Star. First, it had to overcome deep-rooted views of how banks should be run. "Traditionally, banks in Japan are viewed as organizations that exist to do prescribed functions only. If they made a profit, fine, but that was never the most important thing," he says. To this end, the bank had to shake up a workforce that had all but institutionalized the concept of standing still. "After over two years of making no new business or [not] even thinking of making money, we had to change the whole atmosphere at the bank," he says.

Since Lone Star's takeover in 2001, Irie and CEO Todd Budge quickly implemented a new strategy. While they stuck to the bank's historical strength of providing services for retail and small- and medium-sized companies, they overhauled Tokyo Star from top to bottom. For a start, they made it clear that the old system, such as lending at sub-market rates, couldn't continue. The key to success, Irie says, was to offer better services in its place.

Its branches, for instance, are now among the most welcoming and spacious in Japan, with 80 percent of space given to dealing with customers. This is unusual in a country where most retail banks resemble post offices with only a few staff serving customers while the majority perform back-office duties. The change is hardly cosmetic. The extra space provides a venue for selling a wider range of banking and money management products on top of the usual deposit-taking and lending.

A similar upheaval occurred behind the scenes. Irie overhauled the bank's credit scoring systems and introduced Western-style corporate governance. This helped Tokyo Star expand its business the right way. With a more disciplined lending policy, it can now provide medium-sized companies with financial products historically reserved for large corporations. For instance, Irie says the bank is now considering securitization and debt-for-equity swaps for such companies in need of fresh capital. "These are the sort of things that second-tier regional banks couldn't - or wouldn't - do in the past," he says.

Irie adds that the uncertainty in the banking sector in the last few years may have played a role in Tokyo Star's resurrection. The wave of megamergers left a lot of good people frustrated, and who have become willing to try new things under foreign employers. He should know; Irie ended a 27-year career with Sumitomo midway through its merger with Sakura Bank to become Tokyo Star's first CFO. "I had stability there, but when I looked around, I saw little room for growth. It made sense for someone like me to join this organization," he adds.

"The new owners were very careful when putting together the management team," agrees KSB's ex-CFO Tsui, pointing out that he, a Chinese national, was one of only two board members at KSB who weren't Japanese. The other, a Korean-American, is a fluent Japanese speaker. "WL Ross wanted people to see that we were a reputable management team which had the knowledge and experience to run a Japanese bank. The only difference was that we had foreign owners." Against that background, he says it was easier for him and his colleagues to implement reform.

The same is true of other banks. Shinsei's CFO John Mack is American, but president Masamoto Yashiro is Japanese. Tokyo Star CEO Budge has spent much of his career in Japan, and CFO Irie is Japanese. Aozora's American chairman Ed Harshfield hired Japanese CEO Hirokazu Mizukami. "All the owners know that they are introducing various new ways of doing things, but they are very careful to be seen as guests," Tsui says"

The Long Haul

The four banks' early successes have generated praise - but also skepticism. Analysts say it will be several years before they can turn short-term gains into longer-term profitability.

An urgent concern, says Japan Credit Rating Agency director Takefumi Emori, is how they will cope as the advantages built into their original purchase agreements expire. He notes, for example, that if Tokyo Star is to stay profitable, it needs to succeed in new business lines as its stock of deeply discounted non-performing loans (which it could turn around and sell or collect at higher values) gradually erodes.

"They need to build a solid customer base which will be a source of future profits," Emori says.

Another concern is where the larger banks Aozora and Shinsei are positioning themselves. On one hand, they no longer have the scale to take on Japan's megabanks as lenders. Mutsuo Suzuki, analyst at Moody's Investors Service in Tokyo, says Shinsei and Aozora are now far smaller than when their predecessors were nationalized in 1998, and as such "are no longer recognized as lead banks" by large Japanese corporations.

And expanding into new business areas isn't without risks. Ahead of Shinsei's IPO, for instance, analysts questioned its reliance on loan trading and investment banking services like securitization (which accounted for 42 percent of its half-year profits) at a time when it had applied for a commercial banking license, and signaled plans to grow its retail business. "People are asking what sort of bank it wants to be," says Barclays Capital's Rogers.

Meanwhile, their strength in tapping mid-tier firms is increasingly under threat as the megabanks spread their wings. Sumitomo Mitsui, for example, now offers new services such as securitization, M&A advisory, and investor relations support to medium-sized firms.

Still, analysts - not to mention the foreign-owned banks themselves - are upbeat. For one, their owners remain committed for the long haul. WL Ross hung on to 20 percent when it sold KSB, while Ripplewood plans to keep its remaining stake in Shinsei. Cerberus snapped up Softbank's stake in Aozora just one month before its repurchase agreement with the government expired - suggesting it was confident in its future growth.

Signs are also emerging that Japan is growing comfortable with foreign ownership. In the days following the collapse of regional Ashikaga Bank last November, Japanese commentators suggested that foreign investors could head the queue when Ashikaga is sold. Already, WL Ross and Lone Star Group are tipped to be interested, although Irie dismisses this.

Former KSB CFO Tsui perhaps best captures the mood of the banks enjoying a renaissance under foreign ownership. Having left KSB, he has joined a new company offering assistance to private equity investors in Japan. He says his experiences at KSB were wholly positive. "The beauty of this experience was that from beginning to end, it was logical - from the buyout through to the sale," he says, noting that the creation and sale of KSB made a good return for the investor while creating a stable regional bank in under three years. "Everybody should be happy," he says. Perhaps there is some good news in Japan's banking sector after all."