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This paper has benefited from extensive discussions with the Tokyo offices of Lone Star, Cerberus, Goldman Sachs, Morgan Stanley, Price Waterhouse Coopers, AT Kearney, Nippon Mirai, Moore Capital, Gitlin & Co., Nomura Research Institute, Lehman Brothers, and Deutsche Securities. The authors also met the relevant Japanese official sector regulators and officials at a few Japanese banks. We also thank Mr. Toni Gravelle and Mr. Lars Pedersen for their useful suggestions. Any errors or omissions remain our own.
Viable firms are operationally profitable but after interest and debt charges are loss making.
Forbearance typically refers to cases where banks continue to lend when ex-ante there is little prospect of repayment.
DTAs measure have been a useful rule-of thumb to proxy the extent of distressed loans as seen in the case of Resona and Ashikaga.
The NPLs existing at the that point needed to be disposed of off the banks’ book within two years.
Although the Ministry of Land and Transportation publishes official land prices they do not reflect real market prices partly because they are used for levying land taxes. A leading investment bank took several years to educate real estate appraisers and developed a nationwide database for real estate price information.
Market sources indicate that the foreign firms that have recently left the Japan distressed-debt market, or are in the process of doing so, include ING Barings, Bank of America, Moore Capital, and others.
Nonmain banks usually take the same collateral in subordinated ranks. If there is surplus after the first ranked collateral holder has satisfied his claim, the second ranked collateral holder recovers from the residual, and so on.
A series of regulations restricted the use of lands. For example, even in central Tokyo, small farm land was not allowed to convert to residential use. Forthcoming deregulation was expected to change that and (hence) further boost the value of land.
Data from Teikoku Date Bank indicates a similar trend for listed companies. These developments forced all major banks but Mitsubishi-Tokyo to become undercapitalized and led to an injection of public capital in March 1999.
Similarly when Yaohan went under judicial bankruptcy, the retail investors received about 30 cents on the dollar while the institutional investors received only 3 cents on the dollar.
Banks usually required owners of distressed corporates to make personal pledges and thus foreclosed their properties in the event of default.
Instead of writing off loans as credit loss, a bank that rolls over an impaired loan, loses the opportunity cost of lending the amount elsewhere, presumably to a more credit worthy corporate.
Short-term horizons (for a year or two) are largely a function of the bank’s ‘annual loss budgets’. In any case, market participants are unanimous that there is no long term vision for fundamental restructuring.
For example, Sumitomo, Tokyo Mitsubishi, and Mizuho Banks.
See Singh (2003), “Returns from Distressed Debt”, IMF Working Paper, 03/161
A Bank of Japan study (2004) indicates that corporates rated BB and below, on average, use 70 percent of their annual cash flow to repay debt. Doubtful borrowers would likely have higher ratios.
Given that the land price, a proxy for the liquidation value, has already gone down to 20 percent of the peak value and that it has recently picked up in the central Tokyo, the liquidation value appears to have stabilized sufficient to be used as a strike price.
Note that we excluded equity from the present value because (i) in some cases of debt-equity swap new money was involved (e.g., Hasekou and Kenwood) and (ii) the value of equity swapped from the loan appears to represent only a few percent of the initial book value in most cases.
The latest S&P and Moody’s data indicate that cumulative average 5-year default rates for corporates rated between B and C range from 30 to 60 percent. R&I, a Japanese rating agency, also reports that the accumulated 5-year default rate for Japanese corporates rated B and lower is on average 20 percent (R&I, News Release, 2003).
To elaborate, the debtor originally pays banks 2 cents on every $1 loan. After corporate restructuring, the new investor must pay banks (who have not sold their loans) 2 cents on every $1 loan. The distressed debt investor targets a return of 5.8 cents on every $1 loan that the investor has bought at 85 cents. Thus, in the example above, the average return on every $1 dollar must be (2 + 5.8)/2 =3.9, which is 95% larger than the original 2 cents i.e., (3.9 - 2)/2 = 0.95.
Typical routes to gaining equity exposure includes perpetual subordinated debt, preferred stock, or common stock.
In this connection, it may be prudent to discourage the practice of requiring owners of small and medium sized companies to provide personal assets as collateral. In fact, the Civil Code is now under review to limit this practice.
Officially, loans classified as doubtful, near- bankrupt, de facto bankrupt and legally bankrupt are labeled as NPLs. As defined earlier, in this paper, SPLs are loans classified as ‘doubtful’ and some that are classified as ‘near bankrupt’— i.e., borrowers that still have viable business.