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Old Japanese Debt in New Packages


Even the most casual observer of Japan's financial markets knows this much: The banking system is riddled with nonperforming loans. And betting on Japanese stocks and real estate these days is close to masochistic.

Investor beware? Of course. But there is a way to invest in the Japan market, make a good return, and not worry about losing your shirt. Unfortunately, with some exceptions, it's not for the retail investor. Institutional investors, however, are warming up to such exotic fare as synthetic collateralized debt obligations and other instruments that fall into the category of "structured finance," also known as securitization. Interest in the field is booming, which could be the best news Ohtemachi, Tokyo's financial district, has had in years.

Securitization occurs when a bank, company, or government agency converts an asset--be it a loan, mortgage, or piece of real estate--into a tradable security it can sell to investors. The advantage to investors is that the paper is backed by a stream of income, which could be loan payments, credit-card payments, or rent receipts. The advantage for issuers is that they can raise cash from the securities, strengthen their balance sheet, and shift risk to investors.

Any quick way to raise money and deleverage is bound to arouse the enthusiasm of Japan's hard-pressed banks. That's why Japan is likely to do some $31 billion in securitization deals this year, a 75% increase from 2001. The emergence of a securitization market will "help banks use capital more efficiently and improve our capital bases," says Takayuki Yokota, investor relations chief at Mizuho Holdings Inc., the world's biggest bank by assets.

Most of the deals are in equipment leasing, credit-card debt, and auto loans. The banks are mostly selling corporate loans, while the Government Housing Loan Corp. is starting to sell more mortgage-backed securities of the kind Fannie Mae and Freddie Mac buy in the U.S. Companies are making sale-and-lease-back deals, in which they might, for instance, sell their headquarters, then lease it back from the buyer. The seller gets cash to use for other purposes; the buyer has a long-term lessee he can depend on.

Companies are also selling their office and other properties to real estate investment trusts, called J-REITs in Japan. Similar though not identical to REITs in the U.S., J-REITs are backed by properties that pay out rents and other income, less expenses, to investors in the form of dividends. So far, six J-REITs, which trade like stocks on the Tokyo Stock Exchange, have been set up by real estate giants such as Mitsui Fudosan Co. and Mitsubishi Estate Co. "They are the best-performing sector of the market, up about 12% this year," says Clem Salwin, executive director at UBS Warburg in Tokyo.

Japan's securitization market is still dwarfed by the $249 billion in deals done last year in the U.S. Tokyo is behind in the structured finance business in part because it didn't pass legislation governing such transactions until 1993. Indeed, the market for J-REITs is barely a year old. One hope among policymakers is that the new market will help wean Corporate Japan from its over-reliance on bank lending and help it develop deeper and more liquid financial markets.

Japan's monster "city" banks are eager to participate. Mizuho, which has outstanding loans of nearly $298 billion, last month sold off $11 billion of its corporate loan portfolio to international investors in the form of bonds. "It's the first really large deal attempted by a Japanese bank," notes Chinatsu Hani, vice-president for international structured credit research at Merrill Lynch Securities Japan. The paper Mizuho sold is investment-grade, but junkier debt may soon be available, too. Part of Prime Minister Junichiro Koizumi's bank reform plan is to force banks to package and sell risky loans at a small percentage of their book value. Assuming the Japanese economy recovers over the next three to five years, returns could be enormous.

Koizumi also has plans to create a more vibrant secondary market for Japan's $1.3 trillion in home mortgages. He wants to privatize the Government Housing Loan Corp., which now does direct home lending, and convert it to an agency like the U.S.'s Federal Home Loan Mortgage Corp., which buys home loans from banks and bundles them into tradable securities for investors.

There are still several regulatory and tax hassles that must be removed if securitization is to really take off. But Japan watchers are encouraged that the market is growing so rapidly even without reforms. Besieged Japanese finance officials, of course, would like nothing better than to bundle up their troubles and sell them to the highest bidder. By Brian Bremner in Tokyo


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