J@pan Inc Magazine Presents:
M O N E Y W A T C H
Weekly Financial Commentary from Tokyo
Issue No. 55
Tuesday, December 2, 2003
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++ Viewpoint: It Ain't over yet for Japan's Banks
The Bottom Line
o The Financial Services Agency (FSA) moved over the weekend to
shut down yet another bad bank, this time the largest regional
bank in Ibaraki Prefecture,the Ashikaga Bank. At first blanch,
this one will cost Japanese taxpayers about 1 trillion yen.
o Foreign investors need to read the fine print on the latest
bank bailout, which is different than the Resona case. There
are actually three Chapters under Article 102 of the Deposit
Insurance Law, the law being used to nationalize effectively
insolvent banks. Chapter 1 was the pattern used for Resona,
where the government effectively bailed out the bank, its
shareholders and its management. Chapter 2 and 3, however, are
not so investor- or management-friendly, and the government
apparently intends to use one of these for Ashikaga Bank.
o As we have pointed out before, both gold and equities have
entered a secular bull market, which means it is a matter of
time before these gains begin to be reflected in long bond
yields and inflationary expectations. While this process will
probably take longer in deflation-plagued Japan, the OECD is
also projecting some bang-up numbers for growth in world trade
over the next year.
o This is good news for Japan's long-depressed nonferrous metal
stocks and Japan's shipping companies. While both have had
massive rallies from severely over-sold levels in the past six
months, they will return again, ostensibly in early 2004.
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++ Viewpoint: It Ain't over yet for Japan's Banks
On Friday, the Nikkei Shinbun reported that the government was
considering a bailout of Ashikaga Bank, based in Ibaraki Prefecture.
The government and the bank said the report was just speculation.
Right. If the news was "just speculation," why did the government
convene a meeting of the Financial Emergency Council on Saturday?
Ashikaga Bank was informed of the results of the inspection
conducted by the FSA, at which time the FSA demanded that the bank
undergo a drastic liquidation of its bad loans, a move expected to
push Ashikaga into deficit and net negative equity for the interim
period ended this September.
Article 102 of the Deposit Insurance Corporation Law provides for
three basic methods of dealing with troubled banks. Chapter 1 of
Article 102 was used to bail out Resona and is for banks that have a
capital shortage but not negative net equity. Chapter 2 and Chapter 3
are for the treatment of banks with negative net equity and subject to
liquidation. If Ashikaga Bank is deemed to have negative net equity,
it is likely that Chapter 2 or 3 will apply, not Chapter 1.
What's the difference?
Chapter 2 and 3 basically deal with the bank as a failed financial
institution, not a going concern. Under Chapter 2, an administrator
would be appointed to facilitate the transfer of the failed bank's
deposits and good debts to a receiving institution. Under Chapter 3,
all of the outstanding shares of the bank would be purchased by the
government, and it would become a "special risk managed" bank, i.e.,
temporarily nationalized and then, ostensibly, liquidated. The bad
credits would be sold to the Resolution and Collection Corp. (RCC).
Moreover, while the depositors would be protected, Ashikaga Financial
Group's shareholders would not. In addition, the public funds that are
used to protect depositors will not be recovered.
Ashikaga accounts for some 40 percent of all deposits and loans in
Ibaraki Prefecture. The Ashikaga financial group includes leasing as
well as credit card companies. It has 2,900 regular employees, total
reported assets of 5.2 trillion yen, deposits of 4.9 trillion yen and
is ranked number 10 among Japan's regional banks. In other words, it's
not a small bank, nor is its influence in the prefecture negligible.
It therefore never ceases to amaze Money Watch that it takes so long
for government regulators and, indeed, the troubled bank itself to
apparently realize it is effectively bankrupt. At least that is what
they would like the public to believe. In reality, the FSA, while to
its credit now consistently pursuing the cleanup of the nation's
banks, is in many respects "in cahoots" with the banks. That is, the
FSA basically knows where the skeletons are hidden. It is therefore
mainly a question of timing and prioritizing as to when they decide to
lower the boom on a bank that they have known is in deep trouble for
The deferred tax assets (DTAs) being used to shore up Tier 1 capital
are smoke and mirrors, and based on rosy five-year projections. Money
Watch believes there is still a lot of hot air in these DTAs, even
after the major banking groups scrambled to procure capital so that
they could write down their assumptions in their reported DTAs.
Which Chapter of Article 102 regulators choose in future bank cleanups
will make a huge difference to investors. This "risk premium" needs to
be incorporated into the stock prices of not only regional banks, but
also Japan's core banks as well.
While the Ashikaga Financial Group news was breaking, the FSA was
putting the final touches on a proposal to allow more proactive
capital infusions into troubled banks before their regulatory
capital dips below the required 8 percent for internationally active
banks and 4 percent for domestic banks. The proposal now must be
deliberated on by the ruling party and then included in the
fiscal 2004 budget proposal. The related legal amendments would then
be ostensibly passed at the next regular session of the Diet,
meaning that the new framework would not be in place before next
spring at the earliest. The new framework would remove the need
for the government to convene the Financial Emergency Council and
to officially declare a "crisis" before the government could act.
The bottom line is that while the FSA continues to work to improve the
stability of Japan's troubled banking system, investors will need to
remain aware that there is still a noticeable degree of risk in
Japan's banks, particularly if there is a renewed sell-off in stock
In Money Watch No. 49 ("Gold vs. Equities; Which is the Real Bull
Market?") we highlighted the technical breakout that the CRB was
showing from a long-term downtrend and suggested that the gold and
metals markets would continue to outperform the heretofore "hot"
Japanese equities market. Moreover, we noted that Japan's oil/coal,
nonferrous metals and commodity-pricing-dependent sectors tended to
outperform the Topix when the CRB index was in a secular bull market.
In addition, the most recent OECD economic projections from November
20 call for recovery in the OECD economies and for a rapid recovery in
world trade (from 4.0-percent growth in 2003 to an annualized 9.1
percent by the third quarter of 2004). This is very good news for the
secular bull market developing in the CRB index and the industrial
metals markets. The rally thus far seen in gold is a leading indicator
of this secular bull market.
From the bottom-up perspective, this means that we should continue to
see better performance from the basic materials sectors in Japan,
particularly those more closely linked to global basic materials
markets. Another sector that would benefit from more active world
trade is the shipping sector. Japan's shippers were among those
sectors reporting better earnings surprises at the September interim
results because they have worked to get labor costs down by hiring
foreign workers and because shipping fares have seen a noticeable rise
over the past year. Like the metals stocks, the shippers have had a
good rally. The stock prices of Mitsui OSK and Kawasaki Kisen have
more than doubled since the end of 2002.
Following the initial run-up, these stocks have recently been
consolidating and probably could continue to do so for the time being.
But Money Watch suspects the rally in these stocks is more than a
six-month wonder, given the global secular turnaround in the CRB
and industrial metals. This means that they will be back at some
point (probably in early 2004) for a second and third upleg.
-- Darrel Whitten
Money Watch 49
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THE ABW MARKET LETTER
"What You Should Read After Irrational Exuberance"
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