As the three lead bankers for Starwood Hotels & Resorts Worldwide Inc. worked in January to line up multiple banks and $5.6 billion cash for Starwood’s $14.6 billion acquisition of ITT Corp., they felt a chilly wind from across the Pacific. Although Bankers Trust, Chase Manhattan, and Lehman Bros. were still able to complete the deal, the final 46-bank syndicate lost seven Japanese institutions. They included Fuji, Sanwa, Sakura, Dai-Ichi Kangyo, and Tokai– all among the top 10 Japanese banks in America.
Dealmakers certainly had anticipated some drop- off in participation because of Japan’s banking crisis. Still, “I don’t think they expected the Japanese to pull back so sharply,” says Jonathan D. Eilian, senior managing director of Greenwich, Connecticut- based Starwood Capital Group, which led the acquisition and financing of the ITT purchase. Indeed, overall Japanese funding dropped from about 40 percent to about 10 percent when the deal was completed.
“This was one of the reasons why we absolutely refused to increase the cash component of our offer for ITT,” Eilian says, describing the bank market as not “deep enough to finance a highly leveraged bid.” In the end, only two Japanese banks, in addition to the three largest ones in the United States, participated in the syndicate.
Titan Corp., a $330 million San Diegobased provider of information services to the military, felt similar cold gusts recently when it went to the capital markets to increase its line of credit from $35 million to $80 million. Titan CFO Eric DeMarco says that the company was turned down by “every Japane-se bank that in previous years would have pounded the doors to lead or be part of the syndicate.” To make matters worse, the lead bank in the original deal, Sumitomo of California, dropped out of the new credit. (Bank of Nova Scotia was eventually chosen.)
At first, Japanese banks expressed interest in participating, DeMarco recounts, but “once it went over to Japan for the ultimate blessing, word came back: ‘No, not at this time.’” And they explained that “it’s not you–it’s us.”
While for now it’s still more of a distraction than a disaster, American companies that have relationships with Japanese bankers are finding they must make do with less financing from Japan–or work harder to keep funding levels where they once were. The U.S. branches of Japan’s major banks, big loan-syndication players here until recently, increasingly have backed away from American business, especially lines of credit to investment-grade borrowers, term loans, and leasing, among other services.
Among the top 10 Japanese commercial lenders, total assets in the United States have shrunk 13 percent in the past two years, to $249.3 billion, with only Industrial Bank of Japan and Dai-Ichi Kangyo registering increases. At Long Term Credit Bank of Japan, U.S. assets have plunged by 25 percent and 35 percent, respectively, in the past two years.
For many blue-chip U.S. companies, this has meant a search for alternative funding sources, often at higher prices and with stricter terms.
Bigger Than The S&L Debacle
It wasn’t that long ago, of course, that Japanese banks thrived in the States. At their strongest, in 1992, the banks accounted for 18 percent of U.S. commercial loans. But today, Japanese participation is down to 14 percent and falling fast, according to research done for the Federal Reserve Bank of Boston by Joe Peek, an economics professor at Boston College, and Eric Rosengren, a Fed economist.
Many experts attribute the decline to the ability of Japanese banks to own equity securities under that country’s laws, and to the years of profligate lending during Japan’s “bubble economy.” Banks in Japan get a boost to their capital levels when the Nikkei is strong, but must cut back on loans to stay in line with international capital requirements when the Nikkei heads south.
“Once the Nikkei collapsed, the banks’ capital went through the floor,” says Rama Seth, an economist at the New York Federal Reserve and author of a recent work on the effect of the Nikkei on Japanese lending in the United States. “Their U.S. presence was growing very rapidly before that, and you definitely saw a drop-off after the crash.”
Because of the loose lending patterns of Japanese banks, the souring of that nation’s economy has left them facing a crisis much worse than the downturn in the real-estate market that U.S. banks confronted in the early 1990s. As the Japanese write off bad loans, they gradually eroded the banks’ equity cushions, leading to yet more cutbacks in assets to meet capital requirements. (The estimated $600 billion total cost of the Japanese crisis so far exceeds even the roughly $480 billion price tag put on the savings-and-loan bailout of the 1980s.)
“The way we saw it was that the capital base of the Japanese banks was shrinking both from declines in the value of their equity portfolios and the write-downs of loans,” says Starwood’s Eilian. “And because their equity base was shrinking, they were forced to shrink their loan portfolios. For this reason, I don’t think they would have changed their investment decision [in the ITT acquisition] even if the pricing were more attractive. Their cutbacks were driven less by price sensitivity and more by capacity sensitivity.”
The cutbacks in lending volume, and the profits that go along with those loans, have Japanese banks moving their assets into highly leveraged transactions with better margins.
“There is no rationale for them to do these investment-grade deals,” says Meredith Coffey, an analyst with New Yorkbased consulting firm Loan Pricing Corp. “A funded A-minus acquisition deal that is priced at LIBOR plus 22 basis points may well be below the Japanese cost of funding, so there is no spread income for them to make.” And, of course, “they have their attention on other issues.” The 18 to 20 percent market share the Japanese had in the investment-grade lending market over the past four years fell to below 10 percent in this year’s first quarter, she points out.
Japanese banks must now pay more for their funds than like-sized U.S. and European institutions, Coffey notes. Because Japanese banks have comparatively low deposit levels in the United States, they are forced to tap into public markets to raise dollars. But the deteriorating financial condition of the banks means they must pay higher rates to risk-wary lenders.
To Kazuteru Tanaka, former head of Bank of TokyoMitsubishi’s New York office and now economic adviser to the president of the parent bank in Tokyo, “the existence of the Japanese premium itself is one of the biggest motivations for most Japanese bankers to retreat from the loan business in overseas markets.” He suggests that the weaker institutions in Japan “need to consider cutting all their foreign assets as soon as possible” if they want to make money. “It is very difficult for them to keep funding their assets themselves.”
The First Black Cloud
“We used to commit $200 million to companies like IBM with a commitment fee of only six basis points, but there is no way you can make money doing that now,” says a vice president at another major Japanese bank, who requests anonymity. “We were hoping that, by building a relationship here in the U.S., we could get additional business with a higher return in three to five years. But that did not happen for most of our accounts. We understand that if we pull back, there is no relationship.” But “the pricing is not there,” the bank executive says, “and we know that we cannot get any additional business.”
Having enjoyed declining interest rates for much of the past decade, some U.S. finance executives see the Japanese pullback as the first black cloud to appear in quite a while. Coffey says some companies “are afraid that if they open up the bank list, the Japanese banks will probably leave.”
While companies like Starwood and Titan have been disappointed by some of the Japanese banks, others report that little has changed in recent years. Earlier this year, as CBS Inc. refinanced its revolving credit facility as part of its strategy to refocus on core media businesses, it faced the possibility of losing some of its Japanese banks from their existing syndicate. “We were a little concerned about them [leaving],” says CBS’s chief financial officer, Fredric Reynolds, “but they were all there and very supportive in the end. I think it could be somewhat attributable to the sector, since it is relatively easy to lend to the media industry. It is not capital-intensive and it is a high-cash-flow and high-margin business.”
Next Stop: Investment Banking
American companies with operations in Japan may also be getting special treatment from Japanese lenders. “We have very good relationships with some U.S. blue-chip companies that do business in Japan, even if in the U.S. we have small margins on the transactions,” notes the deputy general manager of another Japanese bank’s U.S. branch, who doesn’t want to be named. “We want to maintain relationships with such companies. But if the company has an office in Tokyo and we do not do business with them there, and if in the U.S. there is no profit in the relationship, then we will make the decision to pull out of the relationship.”
The future is hardly clear for Japan’s U.S. banks and their customers, given the roiling capital markets and the ongoing Asian crisis. Some companies remain concerned that the bank crisis could dissolve into total collapse.
On an individual-project level, though, the banks seem good about not committing to U.S. clients if they see a real possibility that they won’t be able to fund credit lines, experts say. And for now, at least, the Japanese seem to have no intention of launching a full-scale pullback from the U.S. market, even if investment-grade lending continues to decline.
Bank of TokyoMitsubishi’s Kazuteru Tanaka suggests that the trend to higher-margin business will continue. The next step, he suggests: more Japanese emphasis on investment banking, with its higher margins.