The involvement of organized crime in Japanese real estate is a risk that investors should be aware of, said agencies rating the first securitization backed by distressed properties in Japan.

The presence of local criminal gangsters, or yakuza, in real estate deals is not new to foreign investors of Japanese distressed assets. The issue first gained attention last year, as foreign investors realized that some of the bad loans they were buying from Japanese financial institutions were collateralized by property linked to the yakuza. In the most serious incident, the Tokyo house of an executive of Cargill was burnt down, allegedly by the Yakuza. Cargill, a U.S. company, had been among the most active buyers of distressed real estate loans.

Most distressed asset sales in Japan are secretive, and investors don't publicly comment on the issue, but in the first public securitization backed by non-performing Japanese real estate, ratings agencies have little choice but to bring the risk to investors' attention.

"A feature of commercial real estate in Japan is the involvement of organized crime [which] can be present at the borrower, creditor, and/or tenant level," admitted Fitch IBCA in a recent report detailing its new criteria for rating distressed Japanese real estate deals. The presence of gangsters usually increases the time required to resolve the assets and reduces the resolution proceeds, since they may scare away potential investors, said the agency.

The 22.8 billion ($218 million) deal arranged by Morgan Stanley Dean Witter's Tokyo office is backed by 700 properties, of which 4% are linked to organized crime, said Fitch. Moody's Investors Service described 7% of the portfolio as "problem loans", since borrowers or tenants had ties to criminal organizations.Though organized crime is a concern in the transaction, the number of affected assets is relatively small compared to the entire pool, agreed analysts. The risk is also offset by a high level of diversification provided by the mixture of good and bad quality properties.

"The problems with organized crime existed long before Morgan Stanley purchased the assets. They took great pains to find out about the assets, but this is a calculated risk when you buy NPLs in Japan," said one analyst. Both Fitch and Moody's rated the top tranche triple-A.

Key to resolving distressed assets are the special servicers, in charge of working with delinquent borrowers, overseeing repossessions and selling off assets. In this case, such work will be done by Lombard Servicing, a unit wholly owned by a subsidiary of Morgan Stanley, whose past experience in resolving problem loans in other countries was a factor in obtaining the triple-A rating.

Its workout team has a number of ex-policemen on hand who are well equipped to deal with the yakuza. "They will do their best to realize within the legal framework the highest proceeds for investors. But a special servicer like Morgan Stanley has the connections and people who would be able to take out organized criminals by physical means, if necessary," said one analyst.

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