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Shinsei's way

It was quite a moment for Masamoto Yashiro, the 71-year-old CEO of Shinsei Bank. On December 28, 2001, Shinsei became the first major Japanese bank to file for one of its own borrowers to get legal protection from creditors without that client's consent...

It was quite a moment for Masamoto Yashiro, the 71-year-old CEO of Shinsei Bank. On December 28, 2001, Shinsei became the first major Japanese bank to file for one of its own borrowers to get legal protection from creditors without that client's consent -- indeed, despite the client's vigorous opposition.

What Shinsei did was file an application for rehabilitation under the recently enacted Corporate Reconstruction Law on behalf of First Credit Corp., a mortgage loan specialist listed on Tokyo's over-the-counter stock market. It did so at a critical point in a loan rescheduling with a group of Japanese financial institutions. With a loan book estimated at ¥130 billion ($1.1 billion), Shinsei was the biggest of First Credit's 32 lenders.

First Credit challenged Yashiro's preemptive action but lost when the Tokyo District Court ruled in March that the company's shaky financial state meant it had little chance of rebuilding without the help of a court-appointed receiver. The court ruling was a triumph for Yashiro and the foreign-owned Shinsei, but it didn't make ordinary Japanese banks feel any more at ease with the feisty new arrival in their tradition-bound industry.

"The Shinsei move in December was a big shock," says a member of the planning staff at one of Tokyo's four newly created "megabanks," who insists on remaining anonymous. It's not unknown for banks in Japan to guide a corporate client to the bankruptcy courts by delaying acceptance of a loan renewal request, he says, "but to file directly for the equivalent of Chapter 11 in the U.S. without the client's consent is simply not acceptable in the Japanese system."

Shinsei had sound reasons for acting as it did. If the bank had not filed for creditor protection for First Credit, it could have been left without collateral on its loans to the company. But the planning manager at Shinsei's rival argues that driving companies into bankruptcy will damage the mutual trust between lenders and borrowers. "That trust," he concludes, "is essential when Japan stands on the brink of a deflationary spiral that could cause a wave of corporate failures and a huge rise in unemployment."

In fact, no one should have been surprised by the First Credit affair -- least of all the big Japanese banks that have been watching Shinsei's tactics with a mixture of alarm and admiration since a group of foreign institutional investors led by U.S.-based Ripplewood Holdings bought the former Long-Term Credit Bank of Japan from the government in March 2000.

During its 28 months in business, Shinsei has overturned nearly every convention in the Japanese banking world, including the time-honored practice of automatically rolling over loans to corporate borrowers, regardless of whether they can repay principal. Apart from simply getting tough with borrowers, Shinsei has tried to introduce what to Tokyo is a novel combination of investment and commercial banking, offering clients an array of sophisticated financial products as well as, or more often in place of, plain-vanilla corporate loans.

A year ago Shinsei began breaking away from its wholesale-oriented, debenture-based funding system by launching a retail banking operation, something the old LTCB never considered. And it has shocked its own technical staff by hiring an army of Indian consultants to help switch the bank's information technology system from mainframes to personal computers.

"The most remarkable thing about Shinsei isn't originality," says James Fiorillo, Tokyo-based bank analyst for ING Securities (Japan). "It's the way it has pushed through in two years reforms that other banks have been talking about for a decade."

Says Yashiro in fluent English, "Japanese banks have been pushed to the wall by unprofitable corporate lending and lack of diversification. They have no choice but change."

Changes as radical as Shinsei's, coming at what by Japanese standards has been the speed of light, caused ructions inside the bank as well as in the financial community at large. During the first year after Ripplewood took over, 300 former LTCB staff members left the bank voluntarily, and 70 others were invited to join what the bank calls "second career programs."

Those departures suggest the transition hasn't always run smoothly. Still, Yashiro is confident that the bank has emerged with a significantly strengthened corporate culture -- and a readiness for more drastic changes. The surviving LTCB men are not just the brightest of the bank's old staff, says the CEO, but they've got "hard backs" and have shown creativity in meeting the challenges Shinsei has thrown at them. Strange as it might seem, that's not the norm for the elite salarymen who staff Japan's deeply troubled banking industry.

Yet for all of Shinsei's dynamism, observers doubt that the bank will provide a template for change in the underfinanced and arthritically managed Japanese banking industry. To start with, the bank isn't large: Its assets of ¥8 trillion and its branch network of 24 outlets make it a minnow compared to the four Japanese megabanks, whose assets range from ¥80 trillion to ¥140 trillion. Moreover, Shinsei is actually getting smaller as its tough policy on loan rollovers forces corporate borrowers to switch to other banks. And despite its stringent lending standards, the bank's portfolio of nonperforming loans remains stubbornly high, a source of concern to the credit rating agencies and hardly a model for the industry.

"I'm not blaming Shinsei for this," says Koyo Ozeki, credit analyst for financial institutions at Merrill Lynch Japan, "but there's no doubt that for various reasons, including opposition by some politicians to foreign ownership of financial institutions, the bank is in a challenging situation."

Still, rival banks could learn from its example. Start with corporate governance: Shinsei broke new ground in 2000 by appointing a board consisting almost entirely of outside directors, in contrast to the usual management-dominated Japanese bank board, which may boast a single symbolic outsider.

Decentralization is another Shinsei obsession. Soon after Ripplewood took over, the bank scrapped a general planning unit that issued mandatory production norms to all other departments. Those departments, such as retail, institutional relations and risk control, now set their own targets and even hire their own staff. The bank no longer has a rotation system for staff, and it has abolished what remains the main power center in most Japanese banks -- a personnel department that is the sole arbiter of who works where and for how long.

Shinsei's determination to go its own way has earned mixed reviews. The bank was pounded in the press two years ago when it refused to join other lenders in bailing out leading department store Sogo Co., which quickly slid into bankruptcy. Yet the mass-circulation Yomiuri newspaper featured Shinsei in a November 2001 story on "how foreigners can reform Japanese industry." Its banking peers offer a similarly divided view. "Shinsei's attempt to nudge customers away from conventional bank borrowing to capital market finance doesn't make sense, because Japan's capital markets just aren't big enough," says a banker at one of the megainstitutions. Yet this same banker says Shinsei was absolutely right to abolish central planning.

SHINSEI BANK'S PAST HARDLY HINTED AT ITS revolutionary present. The bank's predecessor, LTCB, was founded in 1952. It raised money through debenture issues and used the proceeds for loans to so-called strategic borrowers vital to the Japanese economy. LTCB was nationalized in late 1998 after accumulating a massive portfolio of uncollectible loans to decidedly nonstrategic real estate developers, department stores and consumer loan companies. The government spent about ¥3.8 trillion of taxpayers' money on a partial cleanup of LTCB's books before offering it back to the private sector for a token price.

Because LTCB required an expensive recapitalization and the government didn't allow bidders a peek at its loan book, only two offers came in, one from a consortium of Japanese banks headed by Chuo Mitsui Trust and Banking Co. and the other from a heavyweight team of foreign institutional investors put together by Ripplewood founder and CEO Timothy Collins. Among the team's more prominent members: ABN Amro Bank, Deutsche Bank, GE Capital Commercial Finance, Mellon Financial Corp., Citigroup's Travelers Investment Group and UBS PaineWebber.

Minister for Financial Services Hakuo Yanagisawa was then chairman of the Financial Reconstruction Commission, a temporary body formed in 1998 to fend off a looming bank crisis and to handle sales like that of LTCB. He accepted Ripplewood's bid, because it offered better terms -- including a capital injection of ¥120 billion into LTCB after the bank's sale for a nominal ¥1 billion -- than Chuo Mitsui's.

Although he didn't say so publicly, Yanagisawa may also have wanted to prod other banks into action by creating something new -- a Japanese bank owned and run by foreigners. "The idea," says Tim Marrable, a bank analyst for Crédit Agricole Indosuez Securities in Tokyo, "seems to have been that only a bunch of empowered outsiders could break through Japan's banking traditions."

Shinsei CEO Yashiro isn't a foreigner. He's a Japanese citizen with a blue-ribbon background, including degrees from Japan's two most exclusive universities, those of Tokyo and Kyoto. But he's no ordinary Japanese business leader, either.

Yashiro came to Shinsei after ten years at Citibank Japan, where as nonexecutive chairman he had been responsible for setting up what remains by far the most successful foreign retail banking franchise in Japan; indeed, Citi's range of foreign currency accounts, consumer loans and access to a worldwide network of ATMs put it far ahead of what most Japanese banks can offer. Before Citi Yashiro had worked for 30 years at Exxon Corp. (now ExxonMobil Corp.), where he served twice as president of Esso Sekiyu, Exxon's main Japanese subsidiary.

One of a handful of business leaders who appear equally at home in the Japanese and Anglo-Saxon business cultures, Yashiro, says Shinsei CFO David Fite, "has been a priceless and unique asset when it comes to guiding Shinsei's public image and winning acceptance from the Japanese business establishment." But even with a charismatic CEO, Shinsei has had some run-ins with both business leaders and politicians.

In June 2001 Yashiro was called before the Financial Affairs Committee of the upper house of Japan's Parliament to explain why Shinsei had -- allegedly -- pushed Sogo into bankruptcy by refusing to support the ¥200 billion loan rescheduling package put together by other banks.

It wasn't only politicians who were angry. Other Japanese banks were furious with Shinsei for, they asserted, triggering a clause in Ripplewood's purchase agreement with the government that allows it to return devalued loans inherited from LTCB. By refusing to participate in the rescue package, Shinsei, they alleged, made its existing Sogo loans nonperforming and therefore subject to a government buyback. But Yashiro had counterarguments ready. He was able to convince at least some members of the committee that the government would have been destroying its own handiwork if it had forced Shinsei to join the Sogo rescue.

Elaborating on this point in an interview with Institutional Investor, Yashiro asserts that if Shinsei had forgiven ¥98 billion of loans to Sogo, as requested by other banks, it would have triggered a compulsory downgrade in the credit quality of its own loan book, dictated by the terms of government guidelines. That, in turn, would have cost the bank ¥28 billion in increased provisions against its remaining Sogo loans, enough to wipe out Shinsei's profits in its first year as a privatized bank.

"Would the government really have wanted that to happen after spending ¥3.8 trillion worth of taxpayers' money to clean up LTCB?" asks Yashiro. The answer wasn't clear at the time of the parliamentary debate, but two months later another temporarily nationalized long-term credit bank -- Nippon Credit Bank, since renamed Aozora Bank -- was sold to a Japanese consortium. That deal included similar buyback terms. Presumably, the government would not have agreed to them a second time if it didn't think they were necessary.

In addition to his ability to fend off external pressures, Yashiro boasts an unmatched network of contacts dating from his days at Citibank. This has enabled him to fill a lot of top posts at the bank with friends and former colleagues. IT boss Dhananjaya Dvivedi, an Indian-educated engineer who at Shinsei has ruthlessly sliced his way through many of the problems that bedevil Japanese banks' IT departments, was head of IT at Citibank Japan in the early 1990s before moving on to similar jobs in New York and Singapore.

K. Sajeeve Thomas, the Indian-born head of Shinsei's one-year-old retail banking unit, was Yashiro's treasurer at Citibank Japan before moving to New York to head the risk management department at Citi's global corporate and investment banking division. Janak Raj, head of corporate risk-return assessment, spent 25 years at Citi before joining Shinsei.

"Janak and the others had all worked for me in Tokyo, and I kept in touch with them when they went on to other jobs," says Yashiro. "They came to Shinsei because they wanted to, not because they were head-hunted by Ripplewood."

Of course, the entire top management team isn't ex-Citi. CFO Fite came to Shinsei after a career that began in consulting (at the U.S.'s Bain & Co.) and included helping Australia's Westpac Banking Corp. to overcome a bad-loan crisis in 1999­2000. "I learned a lot at Westpac about how to get back to business as usual after a workout at a seriously troubled bank," says the 39-year-old.

Fite's experience has been invaluable because, even by non-Japanese standards, the bank is working on a very tight schedule. "There's an obvious reason for that," says the head of a financial consulting firm. As a private equity firm Ripplewood will need to cash out its investment in a relatively short time period, probably no more than another four to five years, says this executive. Yasuhisa Shiozaki, a former Bank of Japan staffer who now sits in Parliament for the ruling Liberal Democratic Party, says Yashiro's brief is "to prepare Shinsei for relisting [on the Tokyo Stock Exchange] as fast as possible."

The presence of outsiders in nearly all the top jobs at Shinsei may speed the rebuilding, but the process won't be easy. Consider the case of Michiyuki Okano, a systems engineering consultant who was a 17-year veteran of Shinsei's IT department when Ripplewood took over. Okano says he lost 11 kilograms (about 24 pounds) during the first three months of Dvivedi's reign as the bank's new IT boss and slept only three or four hours a night for the first year.

"Dvivedi was telling us to change the entire system, but at first we just didn't understand what he was talking about," says Okano. "And when he started calling for specific functions like a central internal payments system instead of a branch-based system, we just didn't know how to do it."

Hidehiko Arakawa, general manager of operations and planning in the IT division and another LTCB veteran, adds that he and his colleagues were annoyed by Dvivedi's habit of communicating with the bank's IT staff through a team of 80 to 90 Indian software consultants from various systems vendors who were brought in to spearhead the changes. "When I raised this with him, he asked me to regard the Indians as messengers," says Arakawa. Dvivedi explained that he didn't have enough time to tell individual members of the old LTCB IT staff all the things he wanted done and how to do them.

Gradually, Arakawa and Okano began to get the hang of Dvivedi's ideas -- many of them more cost-effective than traditional solutions. "Jay's basic idea is that an IT system should be adjustable to whatever new business the bank wants to enter," says Okano, using Dvivedi's nickname at the bank. "It shouldn't be a fixed system designed years in advance to serve predetermined needs." That meant phasing out mainframes and replacing them with a networked system of personal computers. "The PCs function like a Lego set," explains Okano. "Each individual piece is small, but you can add or subtract to make the system do whatever the bank needs."

In contrast, executives at other Japanese banks typically submit requests to the IT division and wait months for an answer -- which is sometimes that a certain project is impossible.

After two stressful years Okano thinks the Dvivedi revolution is beginning to pay dividends. Shinsei has spent ¥6 billion on IT since Ripplewood took over, down from an annual IT budget of ¥10 billion under the old regime. But it's gotten a lot for its money: a management information system that can measure the profit or loss performance of any new product within six or seven days, compared with twice-yearly summaries before, and a unified payments system that replaced decentralized payments at the branch level.

THE IT REVOLUTION WASN'T JUST AN EXAMPLE of management convincing specialists to serve the entire bank's interests. Fite says the Lego-like approach has become the key to implementing almost all the other parts of the Yashiro business model. Having a flexible, quick-responding system has allowed the bank to design a process of measuring risk and return on corporate loans that has raised the net margin on them from 0.6 percent in Shinsei's first full business year to 1 percent in the six months ended September 2001.

The revamped technology has also enabled decentralized decision-making, allowing individual divisions such as retail or institutional relations to operate more freely. The bank doesn't devote a lot of resources to centralized planning. "We still have a seven-person strategic planning group, but its work also includes government relations, and its members actually spend most of their time on that," says Fite. In contrast, other banks, he says, set norms, which are passed on to business divisions for mandatory implementation. Managers can only assess their performance every six months when the mainframes churn out the bank's half-year business results.

Most critically, Shinsei's distributed IT system has enabled the bank to develop investment banking services that LTCB didn't have, including project finance, acquisition finance, asset-backed securitization and credit derivatives. A main pillar of the bank's strategy is to reduce dependence on earnings from loan spreads and increase fee income from services.

To push the strategy, in January Shinsei created a single institutional relations department that offers corporate clients a menu of financial services, ranging from corporate loans to sophisticated derivatives products. The institutional department works under senior managing director Hidebumi Mori, one of the few top management holdovers from LTCB. Mori's two chief lieutenants are ex­Lehman Brothers senior vice president Brian Prince and LTCB veteran Teruaki Yamamoto. "It's incorrect to say that Prince does investment banking and Yamamoto does loans," says Yashiro. "They both do both."

Yet for all the change orchestrated by Yashiro, results are still uncertain. It's not that the bank isn't profitable. Unlike the big four (Mitsubishi Tokyo Financial Group, Mizuho Holdings, Sumitomo Mitsui Banking Corp. and UFJ Holdings), which all reported net losses after massive bad-loan write-offs in the year ended in March, Shinsei posted a comfortable net profit of ¥61 billion on sales of ¥235 billion. But skeptics say the bank may be too far ahead of the game -- or too small compared with competitors -- to make its innovative policies stick. Shinsei's share of the Japanese corporate loan market is a minuscule 0.4 percent. Making customers pay higher rates may simply drive them elsewhere for services.

"I was impressed by Shinsei to begin with, but now I wonder whether their profit performance is really sustainable," says Merrill's Ozeki.

Although Shinsei spokesmen tout the bank's success in increasing income from fees and commissions and reducing reliance on corporate loan spreads, Ozeki notes that a significant part of the bank's noninterest income seems to come from loan trading. Noninterest income accounted for 34.2 percent of Shinsei's earnings in the year ended in March, but fees and commissions contributed only 4.8 percent. "Other business income," which the bank does not specify further in its accounts, amounted to 15.1 percent of earnings.

The corporate planner at the rival bank who disagreed with Shinsei's pushing mortgage lender First Credit into court-protected bankruptcy has other misgivings. He suggests that it may take longer than expected for Shinsei to persuade corporate clients to switch from "boring old" loans to various forms of direct financing because of the chronic underdevelopment of Japan's capital markets. He points out that the ¥50 trillion that Japanese corporations have raised through direct financing is a mere tenth of the ¥500 trillion they borrow from banks.

Shinsei's Prince says criticisms based on the size of the corporate bond market are incorrect. Shinsei doesn't underwrite bonds; it's offering a wider and more sophisticated range of financial services. Even so, Prince and co-head of institutional banking Yamamoto admit that they're in the early stages of making their diversified sales strategy work.

"You could divide corporate customers into three types," says Prince: "companies that are changing the way they handle corporate finance by moving from bank borrowing to direct financing, companies that want to change but can't because of internal bureaucracy and those that are happy the way they are." In its first two years, says Prince, Shinsei has mainly served the first type of customer. Shinsei is just beginning to attack category No. 2, which includes other banks' clients.

Converting a big chunk of these customers to other financing options will take time, but Shinsei does have advantages over its main rivals in this area, big international investment banks. "Most foreigners deal with the very top layer of Japanese business," says senior managing director Mori. "We're lucky that we inherited a customer base of about 4,000 corporates from LTCB. Shinsei also has close relations with regional banks and other local financial entities that buy its debentures."

Shinsei's retail banking service, the other important leg of the bank's diversification strategy, is equally hard to evaluate, partly because it's only one year old. "When we took over the old LTCB, we found we had 500,000 retail customers [debenture holders], but we didn't treat them like customers," says CFO Fite. "They came back every four years to cash in or renew their investments, and that was that."

Shinsei's retail bank, launched on June 5, 2001, aims to double this client base to 1 million, but numbers aren't the point. The bank wants to build deposits, rather than debentures, into its main source of funding by offering a select clientele a range and quality of service it can't get from mainstream "city" banks. It's doing all this with just 24 branches, not the 200-plus boasted by megabank rivals. The small network was all the former LTCB needed for its long-term lending business.

Shinsei's lures to retail investors include tie-ins with other financial institutions, giving customers access to 660,000 ATM machines around the world; a free ATM service that operates 24 hours a day, 365 days a year (in Japan most banks charge for withdrawals after 6:00 p.m.); and a remake of its branches into financial centers that offer much more than just conventional cash-handling services.

Among the bank's most attractive products are a five-year deposit carrying a fixed 1 percent interest rate -- nothing remarkable by U.S. or European standards but a treasure trove for Japanese consumers who are used to one-year yen deposits paying 0.03 percent. It also offers a "power smart" housing loan, which allows the user to make payments ahead of schedule, thereby cutting future interest payments; holders can withdraw surplus funds to meet payments like tax bills or school fees.

Thomas, the former treasurer of Citibank's Japanese operations who joined Shinsei to head up retailing, says the division began to "achieve traction" last December after a start handicapped by Japan's worst recession in a decade and the U.S.'s September 11 tragedy. Thomas expects Shinsei to earn a fully loaded profit from retailing by fiscal 2004 (ending in March 2005).

He's well aware, though, that almost every major bank in Japan is competing for the ¥1,300 trillion of assets held by private individuals. Competition will only stiffen next April when the government scraps an unlimited guarantee on current cash balances in banks and substitutes a payoff system guaranteeing deposits only up to ¥10 million. "When the talk turns to payoff, there are various points we can make," says Thomas. "One is that we have a 17 percent capital ratio, far higher than the average for Japanese banks." Another is that Shinsei earned a net profit in 2001, unlike almost all its big competitors.

One thing Shinsei can't say to customers is that its nonperforming-loan ratio is low. Quite the contrary. At the end of March, just under 20 percent of total loans were held by borrowers classified as "special watch," "potentially bankrupt" or "bankrupt," the three categories that are classed as nonperforming in the Japanese system. That compares with a 9 to 10 percent NPL ratio at most major banks.

Shinsei staff are quick to explain the reason for this discrepancy: About ¥2.5 trillion of the ¥7.5 trillion of loans the government selected as appropriate for LTCB to hold when it transferred the bank to Ripplewood were actually dubious or worse. Yashiro says Shinsei downgraded 55 percent of the bank's borrowers and 28 percent of the loans' total value from "normal" to "need caution" status during his first year on the job.

As a result, it might seem surprising that Yashiro remains confident that Shinsei can reduce its NPL ratio to about 5 percent by the time the government's agreement to take back bad loans expires. To get the rate down that low, the bank will have to make active use of this lifeline.

The all-important clause will expire at the end of February 2003, three years after ownership of the bank was transferred to the Ripplewood consortium. According to the Deposit Insurance Corp. (the entity that absorbs the loans), the government has taken back ¥710 billion of loans from Shinsei. (Amounts provisioned by Ripplewood against nonperforming loans are not included in the transfer.)

Also potentially bothersome is the bank's big outstanding loan to the troubled Daiei supermarket group. (Shinsei won't reveal the amount, but Daiei says it owes Shinsei about ¥100 billion on a consolidated basis.) Daiei was rescued in January when its four main banks agreed to a loan package that included ¥520 billion of financial relief in the form of debt-equity conversions and loan forgiveness. But it's far from certain that Daiei's long-term survival has been guaranteed by the rescue package.

"If Daiei hangs on until March next year but then collapses, Shinsei will be stuffed," says an analyst at a leading foreign credit rating agency. The Daiei issue is one reason why the agencies rate Shinsei's bonds at triple-B-minus, one notch lower than their ratings for the four Japanese megabanks.

On the plus side, there are good reasons to believe that Shinsei will survive the loan crunch and reach something like Yashiro's 5 percent target by March 2003. The LDP's Shiozaki says the Financial Services Agency, which ultimately decides on loan issues, "has to cooperate" because the government can't afford to fail in the first major attempt at nationalizing and refloating a troubled private bank. Success in his view means more than ensuring Shinsei's mere survival. It includes creating a situation where the bank can relist successfully on the Tokyo Stock Exchange.

Yashiro can count on other support, not least the fact that he has the unstinted backing of Shinsei's shareholders. That's quite unlike the salaryman presidents of most big Japanese banks, who are beholden to management rather than investors.

Yashiro can force change and scrap outdated systems because, unlike most Japanese bank presidents, he wasn't around when the systems were created. That makes him arguably the most powerful head of a bank in Japan, save some regional bank CEOs who run what are practically family fiefdoms.

Impressive as Yashiro's performance at Shinsei has been, his leadership style and Shinsei's business model may not be copied soon by other Japanese banks. The rate of change at Shinsei has simply been too rapid to be reproduced across the board in an economy that's teetering on the edge of a deflationary spiral. For Shinsei to become a model rather than a maverick, two things will be needed. "First," says a Tokyo-based credit rating analyst, "Japan's economy will have to come back from the brink, so banks can behave with a bit more self-interest. Second, Shinsei itself will have to stay on course for a successful IPO sometime in the next 12 to 18 months." Neither is impossible.

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