Yesterday, I posted an item on Naked Capitalism about the bankruptcy of Yamaichi Securities in 1996 as testament to lingering weakness in a country’s financial sector if sick financial institutions are not dealt with swiftly. In essence, the entire Japanese banking sector remained weak for years despite multiple cyclical upturns after the Bubble Economy burst.

So, let’s fast forward to 2003 and take a look at Sumitomo Mitsui, Japan’s third largest bank. This is a full 13 years after the bubble burst in December 1989.

The story is from the NY Times. I have bolded the important bits.

The Goldman, Sachs Group will set up an investment fund to buy as much as 1 trillion yen ($9.1 billion) in nonperforming loans from the Sumitomo Mitsui Banking Corporation, the latest effort by a foreign firm to help a Japanese bank strengthen its balance sheet.

Goldman Sachs, which has longstanding ties with the Sumitomo banking group, says it hopes to make a profit by rehabilitating the borrowers and repackaging the loans into potentially lucrative investments, like asset-backed securities. Goldman Sachs has been buying golf courses and other Japanese properties with steady cash flow and is considered one of the best foreign firms at reviving distressed assets.

Other foreign investment banks, most notably Merrill Lynch and Deutsche Bank, have bought troubled assets from Japanese banks. Some have also helped banks raise capital so they can more easily write off their sour loans. In January, Goldman Sachs agreed to buy 150.3 billion yen ($1.4 billion) of preferred shares from the Sumitomo Mitsui Financial Group.

Sumitomo Mitsui, like other large banking groups in Japan, is under pressure to meet the government’s stiffer requirements for financial health. Regulators want banks to more than halve their nonperforming loans as a percentage of their total lending to 4 percent by March 2005. Sumitomo Mitsui says it hopes to meet the goal early by selling many loans at once.

The Japan Endeavor Fund, as it is tentatively named, will be 58 percent owned by Goldman Sachs and will begin buying loans from Sumitomo Mitsui early next year. The Daiwa Securities SMBC Company and Sumitomo Mitsui will also invest in the fund. The venture will buy loans to medium-sized companies that have had trouble making interest payments and require ”special monitoring,” jargon for watching borrowers in danger of default.

At the same time, the Sumitomo Mitsui Financial Group will set up a separate venture that will send turnaround experts to the businesses that have had their loans sold to the investment fund. This is intended to strengthen potentially profitable businesses so that they can generate steady sales and repay their loans.

”We have always just sold our nonperforming loans,” said Yoshifumi Nishikawa, president of the Sumitomo Mitsui Financial Group. ‘‘By setting up this revitalization company, we will not only accelerate bad loan write-offs, but also increase our chances for turning a profit.”

The new venture, called the SMFG Corporate Recovery Servicer, may also dispel widespread fears among Japanese executives that a foreign buyer like Goldman Sachs will foreclose on delinquent borrowers.

Investors were encouraged by the establishment of the two companies, partly because Goldman Sachs — a healthy, outside investor — is shouldering some risk for disposing of the nonperforming loans. The Sumitomo Mitsui Financial Group’s shares rose as much as 4.4 percent on Tuesday.

Since Goldman’s investment fund will only start buying loans in early 2004, Sumitomo Mitsui’s balance sheet will probably not be affected much this fiscal year, which ends in March. Sumitomo Mitsui hopes to sell 1 trillion yen in loans within one year, Mr. Nishikawa said.

Sumitomo Mitsui expects to earn 150 billion yen ($1.4 billion) in fiscal 2003, a reversal of the bank’s 465 billion yen loss ($4.2 billion) last year.

As in other cases where bad loans are sold, the key to each company’s profitability is how the loans are valued. The buyer typically wants to pay less for riskier assets, while the seller wants to recoup as much as possible from the sale.

”The question is what’s the haircut,” said Hironari Nozaki, a banking analyst at HSBC Securities, referring to the discount the buyer receives. ”The sale is a big help to Sumitomo Mitsui because it saves time. But if the price is too favorable to Goldman Sachs, it could limit Sumitomo Mitsui’s net income.”

According to Mr. Nozaki’s estimates, selling 1 trillion yen in non-performing loans would reduce Sumitomo Mitsui’s bad loan ratio to 6.6 percent. Additional measures by Sumitomo Mitsui to write off loans could push that number closer to 4 percent, he said.

Goldman Sachs, meanwhile, must devise a strategy for profiting from the loans. Foreclosing on loans, especially to large companies, is difficult because of the bad publicity it generates and because of outside pressure from politicians, regulators and others. But loans can be packaged into bundles and resold as securities, or restructured individually to produce a higher return.

It may also take time to identify the loans with the best chance of turning a profit.

But a Goldman Sachs executive said the investment bank had been reviewing Sumitomo Mitsui’s loan portfolio for several months, , so it had begun identifying loans with potential.

”This is no walk in the park,” the executive said, ”but we’ve been doing our homework.”

Goldman to Buy $9.1 Billion in Sumitomo Loans – NY Times

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