Japan's first non-performing loan-backed securitization is in the pipeline, and may be launched as soon as the end of November, according to sources in Tokyo.

The transaction aims to securitize a portfolio of non-performing loans backed by real estate purchased from banks by Morgan Stanley Real Estate Fund (MSREF), one of the most active buyers of distressed assets in Japan. It will likely be placed with a handful of investors in the domestic market, where pricing in recent months has been tight compared to the Euromarket.

The size and structure of the deal have not been finalized, as it may be tranched out into more junior pieces to fit investor demand. Moody's, Standard & Poor's and Fitch IBCA have all studied the transaction, but whether all three will rate it is undetermined.

Cashflow on the deal will likely come from a liquidity reserve initially, and then from the proceeds of the loans as they are sold off or restructured, said sources. "[MSREF] actually has several options: they can foreclose, work them out with the borrowers, or auction them off. It depends on their strategy," said an analyst in Tokyo.

Bankers have expressed keen interest in the deal, as it would be the first major securitization of non-performing loans not only in Japan but also one of the first in Asia, where non-performing loan securitization has been touted as one way for corporates to raise funds following the regional financial crisis. So far in Asia, only the Korea Asset Management Corp. has managed to securitize a portion of its non-performing loan portfolio, while Lehman Brothers securitized distressed assets bought from the Financial Restructuring Authority in Thailand.

Japanese financial institutions have been slow to come to grips with their non-performing loans, as most problem loans are collateralized by commercial property that has drastically fallen in value over the past decade. The forthcoming transaction from Morgan Stanley will be a test of investor appetite for similar transactions. "The ramifications of this deal for Japan are very important, since it will serve as a bellwether for future NPL-backed deals. But the salability of this is a big question mark; it will be very interesting to see how it sells," commented one source.

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