Morgan Stanley Dean Witter & Co. plans to make securitization of non-performing loans a cornerstone of its Japanese ABS business. The bank, which successfully closed the first issue backed by Japanese non-performing real estate loans (see page 12), sees a huge business opportunity in the backlog of bad loans sitting in Japanese banks.

"The potential in Japan is very, very large," said Douglas Kennedy, executive director of the securitized products group at Morgan Stanley in Tokyo. "The way we've explained it is that estimates of real estate non-performing loans in Japan are somewhere between $400 billion and $500 billion. We figure that if even one-tenth of that is eligible for securitization, we could do 250 deals exactly like the one we've just done, and that is a very attractive market for us."

Once it became clear that Morgan Stanley was working on an NPL securitization, Japanese originators began knocking on their door. "We're hoping to demonstrate to potential originators that securitization is a valid strategy for them, and we're quite confident that we'll be able to do more of these transactions," Kennedy added.

Though most of Asia is awash in bad loans following the 1997 financial crisis, Japan stands out because it has a big enough market and the legal framework to make securitization possible. "A prerequisite for securitizing non-performing loans is to have a large supply, and the legal and regulatory structure that allows you to securitize in an efficient manner. There are not a lot of other markets in the region that have both a large supply of assets and the regulatory framework to do this," Kennedy pointed out.

Finally, because of the pass-through nature of the cashflow on the securities, they are difficult to hedge into other currencies, and international investor appetite for some of the region's currencies remains limited, he said.

Morgan Stanley hopes to repeat in Japan the success of its non-performing asset-backed issues in Europe, where it arranged three securitizations backed by Italian assets over the last three years. That was one reason why it chose to name the issuer in the Japanese deal after the one in the Italian deals. "That way when someone says International Credit Recovery, people will know what asset class they're talking about."

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