NEW YORK - Despite the deep recession that Japan continues to endure, securitization has bloomed and may just be the answer to many of the country's existing problems, said speakers at last week's conference, Finding value: The risks and opportunities in Japan's emerging securitization market, hosted by the Japan Society.

With about 100 attendees, the conference provided a variety of panelists ranging from rating agency analysts to theoretical analysts of credit enhancements to market participants working on deals. "I thought there was a broad spectrum of opinions and I think people were pretty honest," said Frank Cavallo, managing director of global securitization at Citibank and a panelist at the conference. "Japan has changed a lot, securitization has grown percentage-wise very much in the last few years but is still very small compared to the U.S."

And, while market participants have repeatedly addressed the issue of non-performing loans, keynote speaker Wilbur Ross, chairman and CEO of WL Ross & Co., spoke about the true state of the Japanese banks. His presentation clearly outlined the ongoing quandary of NPLs and provided a series of solutions. And, in part, the recent negative rating actions imposed upon Japan's sovereign rating by Moody's Investors Service, Fitch Ratings and Standard & Poor's are a result of the government's delay in providing some type of structural reform.

The downgrades also came as a result of the country's debt now reaching nearly 140% of the gross domestic product. According to Hidetaka Tanaka, deputy managing director and head of the structured finance rating department at Rating and Investment Information, Inc. (R&I), the company has not taken any rating action on Japan's sovereign because, "We believe Japan can accept an additional tax burden and can finance the fiscal deficit so we are confident about the Japanese market."

Non-performing loans

Similar to the non-performing loan problems that the United States went through, Japan experienced a "bubble" from 1985 to 1989, in which real estate stocks reached astronomical levels. "It would make the Internet bubble prices of Internet stocks small by comparison," said Cavallo. As the stock market continued to rise, Japanese banks continued to make loans and eventually, the market crashed and the value of the loans that the banking system had in place soured.

According to Ross, however, the existing problem is not the result of the bubble bursting in the early 1990s. By 1997, the loan problem had become a crisis, wiping out a significant portion of the banking system's capital and the Japanese government was forced to inject equity into all of the major banks.

At the same time, the recession in Japan was accelerating and newer loans not related to the bubble also began to go bad and that is what speakers at the conference said is continuing to be the problem today. "Because of the recession, loans are going bad faster than the banks are writing off old ones," Cavallo said. "They're not catching up; things are just getting worse. The bulk of the problem goes back to lending against real estate values, which have collapsed."

Furthermore, Cavallo said that the Japanese banks have not changed their ways, in terms of lending and in terms of placing credit properly. "Whether a company is double-A or double-B, they would probably lend at the same rate," Cavallo noted.

Panelists at the conference also discussed the existing problem with organized crime in Japan. "Japan is the safest country in the world," Cavallo said. "You could walk down the street with thousands of [dollars] hanging out of your pocket and no one is going to bother you, but the organized crime has [grown] within the area of real estate."

According to market participants, buildings that have been taken over by organized crime secure a high percentage of the NPLs and foreclosing on those buildings can be quite dangerous. However, according to Masako Osako, senior director and head of Fitch's structured finance group in Tokyo, these buildings that have been taken over by organized crime only account for 4% or 5 % of the total NPLs. "It may not be as big of an issue as the media makes it out to be," Osako said.

Securitization as a solution

Ross suggested that Japanese banks and the economy itself are in need of a weaker yen in order to jump-start the economy. "Asset value deflation directly hurts banks' collateral value and simultaneously makes business wary of capital expenditures and of inventory and discourages consumers from buying goods," Ross said. "Arresting deflation would make business and consumers more willing to acquire assets, and therefore would have longer-term secondary effect well beyond the direct stimulation from increased exports."

Ross also noted that another solution to the problem would be to create a policy that makes tax credits transferable so banks could sell them at a slight discount to tax- paying entities. Additionally, he said the country should maintain its schedule to reduce all deposit issuance to 10 million (U.S.$77,971.00) for April 1, 2003, but to assure that municipal and provincial deposits are not withdrawn by extending their insurance coverage for a year. Finally, Ross also said banks need to improve their operations more rapidly.

However, perhaps the most significant aspect of the NPL problem is that the true value of the NPLs are unknown. While the Japanese government estimates that the value of the loans are about $35 billion, the rating agencies say those numbers are likely to be over $200 billion.

Some market participants at the conference agreed that securitization could be the answer to the problem since it would create a liquid market. "If there's no real market for buying and selling these loans, you really can't value them," Cavallo said. "So securitization creates a liquid market; you can put a value on those assets and then if banks can sell them they can use the proceeds to reinvest in their business."

The Japanese market has already seen a few NPL deals (see ASR 02/11/02), although sources noted that they have been relatively small.

And, while some agreed that securitization would be helpful, one panelist noted, "Securitization is an answer for bad debt, but I'm cautious about securitization as the end-all answer. They will need other huge equity infusions."

Panelists also noted that investor appetite for Japanese deals both domestically and internationally already exists.

Japan's securitization


Last year, Japan issued about 3 trillion ($22.5 billion) and is expected to increase issuance by 25% to 50% this year (see ASR 03/04/02).

According to Cavallo, general consumer assets in Japan, including auto loans, equipment leases, residential mortgages and corporate trade receivables, are extremely high quality.

Japan currently holds the third largest securitization market in the world. The U.S., obviously the largest market, is followed by Europe, with a significantly smaller amount of volume. However, many market players at last week's conference predict a booming securitization market in Japan going forward.

Growth in the market will not only include NPL deals, but the high quality general consumer assets as well. "Japan is smaller than Europe, but Europe is smaller than the U.S.; but ironically, I think Japan has the potential to be larger than Europe. They have the potential to be the second largest market," Cavallo said.

Moving into the second slot will not happen overnight, however. "It will take some time to change, to expand for a lot of reasons, primarily more systematic issues of how the government operates," Cavallo said. He also noted that excluding Japan, potential growth in the securitization arena in Asia is very limited because the markets are too small.

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