Japanese Financial System at Crossroad Toshiyuki Tsujioka Tsuyoshi Daito Robert Early

Who are they?

Agenda Overview of Japanese Financial System Japan Post – the Last Crusade The new wave (Shinsei Bank and Ripplewood)

Japan’s amazing economic success since WWII – Why? Per Capita GDP ‘000 USD Japan U.S.

What is Gosoh-Sendan ? 護送船団 Unique banking system in Japan Literally means “Convoy System” Essentially means “No Loser” in banking Government’s policy to maintain robust, regulated banking sector

How did Gosoh-Sendan work until ’80s? Government High Regulations Corporations Banks Private Deposits Loans Employment

Why was Gosoh-Sendan successful? Gosoh-Sendan System Rising asset price Risk- averse culture Long- term investment Today’s first take-way if the word Gosoh Sendan. The direct translation is convoy system. Meaning: convoy system = Most successful business model since WWII Government’s strategy to develop industries by robust finance support by banks No one should fail Corporations’ high dependence on bank loans (=indirect finance) Highly regulated system This is the key to understand Japan’s success after WW2 Japan’s GDP grew at 8-10% annually after WW2, second largest economy in the world Toyota, Sony – These companies huge capital expenditure and growth were supported by this convoy system High dependence on bank loans as a means of financing, capital markets did not develop until 80’s Interest rates (borrowing, lending, short-term, long-term), size and numbers of branches, extremely high entrance hurdle to business

What happened in ’90s? Gosoh-Sendan Globalization Burst of Bubble Vicious Cycle of Credit Crunch Asset prices fall Bad loans accumulate Banks become reluctant to lend

Reform after reform since late ’90s Change in regulatory body Capital injection by government Strict write-off policy Banks are forced to restructure Default & nationalization Mega mergers These are painful, but necessary steps!

An optimistic scenario is… Corporations Banks Private Deposits Loans Capital Markets Bonds Equity Equity Investment ETF 401K Hedge Funds Indirect Finance Direct Finance But…

Banks hold more than 50% of Financial institutions assets 22% $44 trillion Banks: 54% $26 trillion

Japanese households hold more than 50% of assets in cash/deposits. 13% $35 trillion Cash: 55% $13 trillion

Japan Post The biggest financial conglomerate in the world. Total assets: USD 3.8 trillion Huge market impact. Holds about ¼ of JGBs outstanding

Axis of Evil: Politicians, Government, and Japan Post need to sell JGBs Politicians: need votes

Key take aways The privatization of Japan Post is the last step to market efficiency. Regardless of the outcome, market participants must follow their moves. The opportunities are in specialized segments (hedge funds, private equity, etc.)

Ripplewood and Shinsei Bank A Major Force for Restructuring

Ripplewood and Shinsei Bank Bought Long Term Credit Bank from Japanese government and turned it into Shinsei Bank Total investment of $1.15B in 1999 IPO of 35% for $2.1B Shinsei is valued at over $6B BIG PROFITS

Timothy Collins of Ripplewood Philosophy degree from Depauw MBA from Yale 6 years of M&A at Lazard 5 years of fund management at Onex, Toronto Investment Company NO experience in Japan

Long Term Credit Bank Traditional lender to industry Real estate speculation hit hard times in 1989 when Bank of Japan raised interest rates Bad loans increased In October 1998, LTCB applied to become nationalized under new law Goldman Sachs chosen to organize bid

Ripplewood and Connections Had contacts in Clinton administration that knew of LTCB problems and bids Convinced Masamoto Yashiro, former chairman of Citigroup Japan, to join Joined with former Goldman Sachs executive, J. Christopher Flowers, banking deal specialist Advised by Paul Volcker, former head of Federal Reserve System

Sale of LTCB Ripplewood only serious bidder Even though impossible to assess bad loans, Japanese government offered the possibility to “return” some bad loans after sale Ripplewood raided more money than necessary including from Mellon Bank

Shinsei Bank Masamoto Yashiro became CEO Focus on entering retail bank market and deal with loans On June 28, 2000, returned loans and capital for Sogo, reputable retailer, forcing bankruptcy IPO in 2004 Current numbers Total revenue of ￥123.5billion Net income of ￥66.4billion

The Future: Japanese Activities Japanese private equity investment increasing Unison Capital Inc. Nippon Mirai Capital Co. Japanese banks back private equity groups Mizuho Capital Group Phoenix Capital Co.

Don’t be like this!!!

Back-ups

“Main Bank” System 6 mega banks 3 long-term banks 80 first-level local banks 100 second-level local banks Toshiba Mitsui Bank Mitsui Chem. Mitsui Insur. Mitsui Corp. Toyota Cross-Share Holding