Concerns about the debt collection methods of certain Japanese small business finance firms the so-called shoko lenders have led investors to nervously scan their holdings to see if they hold asset-backed paper issued by such companies, said sources in Tokyo.

The concern has arisen after an employee of one such lender was arrested for allegedly telling a cash-strapped loan guarantor to sell one of his kidneys, an eyeball and part of his liver to pay off a debt.

The arrested employee worked at Nichiei, the biggest shoko lender, whose main business is providing unsecured, high-interest loans to small and mid-sized businesses. Though often vilified as loan sharks, such companies have flourished in recent years as domestic banks have tightened credit and left small businesses no other funding options. In recent months, shoko lenders and consumer finance firms in general have been coming under fire from Japan's financial regulator for their excessive lending and unethical collection practices.

According to reports in the Japanese and Western press, other shoko lenders not including Nichiei have forced borrowers or guarantors into prostitution and encouraged debtors to commit suicide so that the debt collectors can take advantage of life insurance included in loan agreements. Kenji Utsunomiya, a bankruptcy lawyer in Tokyo, said that this is a factor in the 30% surge in the Japanese suicide rate.

Many shoko lenders have issued securitizations over the past year, though most deals have either been privately placed or gone into conduits. Consumer finance companies which provide high-interest, unsecured loans to consumers and have a slightly better reputation than shoko lenders have also been among the more prolific ABS issuers this year. But the stigma attached to certain originators has led some asset-backed investors to carefully distance themselves from those issues.

"Often, transactions backed by unsecured consumer loans provide a good spread because of the reputation risk, since some companies have very tough collection methods," commented Kazuo Wakayama, manager of investment planning at Sumitomo Marine & Fire Insurance in Tokyo. "Because there is so much social criticism, a lot of investors don't want to touch these issues. We keep a list of good' and bad' companies, and their business practices," he added.

Similarly, "we don't approve of consumer loan deals [because of] lenders' high interest rates and unscrupulous business practices," noted Manabu Yukitomo, deputy manager of the investment and structured finance group at Tokio Marine and Fire Insurance in Tokyo.

Still, investor aversion hasn't stopped ABS bankers from going after such deals. Interestingly, most structured deals for shoko and other less-than-reputable moneylenders have been arranged by non-Japanese firms. For example, both Nichiei and Shohkoh Fund, the second largest shoko lender, have completed conduit deals since last year, both of which were arranged by western banks. That may be because western firms are eager for more business in the Tokyo market and less concerned about reputation risk than domestic firms, said one banker at a Japanese firm.

As if to underscore his point, one ABS banker at a western firm said that the consumer finance industry was getting a bad rap. "Obviously the publicity isn't great, but most firms have cleaned up their act compared to 10 years ago," he said. "At least, this will make bankers do a lot more due diligence before they take a deal to the market."

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