Program on Alternative Investments The Program on Alternative Investments, under the aegis of the Center on Japanese Economy and Business and in cooperation with the student-run Business Association and Private Equity Club of Columbia Business School, hosted its sixth seminar on April 22, 2003. The event featured Mr. Hiroshi Nakamura, President and Managing Partner, Moore Strategic Value Partners Japan, and was moderated by Dr. Mark Mason, Director of the Program. Mr. Nakamura’s presentation focused on his experiences as a leader at one of the top distressed investment firms in Japan, as well as his perspectives on the historical development Hiroshi Nakamura of the distressed industry and market in Japan. Following are excerpts from Mr. Nakamura’s presentation together with selections from the subsequent question and answer period.

The Program on Alternative Investments analyzes several major alternative asset classes —including private equity, hedge funds, distressed investments, and commercial real estate —in Japan and elsewhere in East Asia. The Program meets its substantive goals through a combination of research projects and seminar presentations by leading practitioners in each of the alternative asset classes. Throughout the year, the Program also conducts cutting-edge research on these topics under the direction of Dr. Mason and with the assistance of highly qualified research assistants. For a schedule of upcoming seminar presentations, consult the Center’s web site at http://www.gsb.columbia.edu/japan. Dr. Mason can be contacted at [email protected].

Co-sponsors: HVB Group; Takata Corporation 2 Center on Japanese Economy and Business

Distressed Chart I Investments in Japan have been involved in the I Japanese distressed business since its inception in 1997. Over II the past six years, investment in the distressed business has been increasing. For example, in 2001- 2002, the total annual investment in distressed assets was approxi- mately $5-6 billion. In just the first quarter of 2003, $2.5 billion was invested into the distressed business field. We expect more distressed business opportunities over the next year or two. Over 1 the past 3 ⁄2 years, my company and 20 times larger than Taiwan have been more than $100 billion. has invested about $1.2 billion in ($62 billion). Many banks have written off cash and we have already collected The Japanese distressed market their bad debt, yet the Japanese 80 percent of our investments. has been fueled by continued distressed market continues to We now focus completely on high levels of insolvencies and increase (Chart II). For example, Japan, and we employ more than bankruptcies. Chart I shows the from 1992 to 2001, a total of $680 70 people in our Japanese opera- continuing high insolvencies in billion in bad debts had been tions. The distressed investment Japan. The bar graph indicates written off. It is a huge number. industry is a very quick turnover the amount of debt held by insol- Classified loan balances were business in Japan. vent companies. Between 1991 $350 billion in 2001 compared Today I will focus on the size, and 1996, insolvencies in Japan to $106 billion in 1992. Banks history and dynamics of the dis- were continuously more than continue to write off loans tressed investments market as well $50 billion. Since 1997, insolvencies semiannually, but classified loan as the Japanese government’s ini- tiatives to clean up the distressed Chart II business. According to an estimate by Ernst & Young, the size of the Japanese distressed market is $1.2 trillion. But according to the Financial Supervisory Agency (FSA), the size is only $400 billion. A third estimate by Goldman Sachs quotes the market at $1.8 trillion. Although the figures vary, the distressed market is probably 30 percent of Japan’s GDP, and there are major opportunities in the business. Compared with other Asian countries, Japan’s distressed debt market is 12 times larger than South Korea ($104 billion) Alternative Investments Report 3 balances continue to increase. The government is saying the distressed debt problem is over, but the statistical numbers indicate that the problem is still there. I view the development of the Japanese distressed market in three phases. The introductory phase began around 1997. At that time, I returned to Tokyo and started the distressed business at Merrill Lynch. In 1997-1998, there were very few investors from overseas who realized the great opportunities in Japan. Most banks were unfamiliar with dis- tressed or non-performing loan sales so they were reluctant to From left: Dr. Mark Mason, Mr. Hiroshi Nakamura, Professor Hugh Patrick sell. As the market evolved, the government decided to invest distressed assets to investors The RCC began to play a larger $77 billion in public money into and transactions became more role by buying distressed assets major Japanese banks. standardized. The Resolution more aggressively and became and Collection Corporation (RCC) involved in the corporate restruc- Between 1999-2001, the market (similar to the RTC in the U.S.) turing process for small and entered a more competitive phase. began to buy distressed assets mid-sized companies. From Foreign investors became much from sound banks, which was the beginning of May 2003, a more interested, and there was a shift from buying assets only new entity called the Industrial an increase in the number of from bankrupt banks. Revitalization Corporation (IRC), investors, sellers and brokers. sponsored by the government, Most major banks were selling From the beginning of 2002 to the present the distressed market will begin to play a major role in entered into what I call “the dis- restructuring large corporations. missal phase” (strong investors There are various participants enter the market and weak in the distressed investments investors are forced to retreat business, including the banking from the market). FSA Minister sector, the non-bank financing The Japanese Heizo Takenaka and the FSA sector, the corporate sector, and distressed market began to pressure the banks to insolvent companies. Increasingly clean up the NPL problem, and important investors or sellers in has been fueled the market has since become much this market are the government- by continued high more competitive because many sponsored IRC and the RCC who Japanese investors have entered buy assets, try to restructure the levels of insolvencies the market. It was apparent that corporate sector, and compete only seasoned investors could with the private sector. At the and bankruptcies. survive in the market. Expertise same time, the RCC has begun and experience were the differ- to sell its own assets in bulk, entiating factors weeding out the which they purchased from strong and weak market players. banks 2-3 years ago. The RCC Weak foreign investors withdrew. actually bought too many assets 4 Center on Japanese Economy and Business

to work out by themselves in a need to have expertise in the States there are initial public timely manner, and now they are business. offerings (IPOs) and sales of selling assets every quarter. In There are new opportunities companies, which offer us clear two or three years, the RCC is for investors. One is hard real exit strategies. But in Japan, the mandated to clean up its balance estate and the other is corporate capital market is too small, imma- sheet. From the private sector’s restructuring (turnaround busi- ture and inflexible, so we can point of view, the RCC and IRC ness). In real estate, we see two neither expect an IPO in a timely will eventually become important opportunities. One is to buy manner nor sell a small cap stock clients. distressed real estate and real in the market when we wish to. Due to the weak economy and estate under management. In dis- Corporate restructuring is a rela- the enforcement of rigid banking tressed real estate it is relatively tively long-term investment. One inspections, NPLs are still increas- simple for us to buy low and sell positive item is the development ing, despite the massive write-offs. high. This takes up to two years. of debtor-in-possession (DIP) However, the characteristics of However, in real estate under man- financing. The Development Bank the NPLs have changed slightly. agement, we needed to build-up of Japan (DBJ) is aggressively They are not as profitable as our expertise, such as change providing DIP financing for these they used to be, but a sizable managers and property managers. entities. opportunity exists. The sellers Typically, these are three to five The RCC, IRC and the DBJ are are diversified compared to five year investments. Corporate leading the government’s initiative or six years ago. They are not restructuring has been favorably to clean up the balance sheet only banks. From the investor’s accepted as the “White Knight” problems. The RCC is an experi- point of view, in the field of in the market. Usually, we are enced and proven organization bankrupt and “de-facto” bank- considered as a vulture fund with 2,600 employees. It is fully rupt companies, the distressed and disliked by many Japanese. armed with a banking, trust and investment business is very com- The problem with this field is loan-servicing license. They are petitive. It is very difficult for the scarcity of experience and also expected to contribute to newcomers to enter this market talented turnaround managers. the restructuring of small and and expect a high return and We have not seen any proven or medium size corporations, and good opportunities. So, they clear exit strategies. In the United they are mandated to be an agency

Columbia MBA students and other members of the audience mingle with Mr. Nakamura during the post-seminar reception. Alternative Investments Report 5

Chart III

List as 30 Company Name Industry Main Bank Companies

Taisei Corp. Construction Mizuho Tobishima Corp. Construction Mizuho * Fujita Corp. (New) Construction Sumitomo Banking Corporation (SMBC) * AC Real Estate Construction SMBC * Haseko Corp. Construction Mizuho * Mitsui Construct Construction SMBC * Sumitomo Construct Construction SMBC * Hazama Corp. Construction Mizuho * Tokyu Construction Construction Bank of Tokyo-Mitsubishi (BOTM) * Kumagai Gumi, Co. Construction SMBC * Nisseki House Ind. Construction Mizuho SXL Corp. Construction Mizuho * Misawa Homes, Co. Construction UFJ Kobe Kiito Co. Textiles & Apparel SMBC Kanebo Ltd. Chemical SMBC * Tesac Corp. Metal Products SMBC Daio Paper Corp. Pulp & Paper Aozora KK Chemical Mizuho Chemical UFJ Tsumura & Co. Pharmaceuticals BOTM * Japan Energy Corp. Oil & Coal Products Seisaku Glass & Ceramics Mizuho NKK Corp. Steel Products Mizuho Sumitomo Metal Ind. Steel Products SMBC Steel Products Mizuho Godo Steel Steel Products Mizuho * Nonferrous Metals BOTM Sankyo Aluminum Metal Products Sumitomo Trust * Sumitomo Heave Ind. Machinery SMBC Construction BOTM * Clarion Co. Ltd. Electrical Machinery Daiwa * Mitsui Engineer and Shipping Transport Equipment SMBC Zosen Corporation Machinery UFJ Minolta Co. Ltd. Precision Instruments SMBC Sega Corporation Other Products SMBC Kanematsu Corporation Wholesale BOTM * Nissho Iwai Corporation Wholesale UFJ * Mitsukoshi Ltd. Retail SMBC Tokyu Department Store Retail Chuo Mitsui Matsuzakaya Co. Retail UFJ OMC Card, Inc. Miscellaneous Finance UFJ * Daiei, Inc. Retail UFJ * Seiyu Retail Mizuho Nippon Shinpan Miscellaneous Finance UFJ * Orient Corporation Miscellaneous Finance Mizuho * Real Estate Mizuho Tokyu Land Corporation Real Estate BOTM * Sumitomo Realty & Developer Real Estate SMBC Towa Real Estate Real Estate UFJ * Daikyo Incorporated Real Estate UFJ * Taiheiyo Kaiun, Co. Marine Transport BOTM Kansai Kisen Marine Transport SMBC 6 Center on Japanese Economy and Business

for the resale of NPLs and hard us to achieve a good IRR. If we assets to the private sector. The Japanese hold our investments for three or The IRC is a product of a four years, we may not achieve a compromise between the Liberal distressed market very high return under a poor macro economy. Democratic Party and its cabinet is huge, and it was and between the Ministry of Q: How do Japanese tend to feel Economy, Trade and Industry initially triggered about Western managers, like and the Ministry of Finance. The by the collapse of Carlos Ghosn, and is there con- IRC has no proven track record cern among Japanese about the (unlike the RCC), and we do not the bubble economy radical surgery Western managers know its capability. The IRC is and further driven want to impose, or do they see mandated to contribute to the them as saviors? restructuring of large corporations by Japan’s continued Nakamura: with a very limited time horizon When Mr. Ghosn to work-out. poor economic joined Motors many people were worried. But after two to The DBJ was given a mandate performance. three years, he has become one to budget 200 billion yen for the of the most respected managers Corporate Rehabilitation Fund. in Japan. I think the Japanese The DBJ has since invested in continued poor economic per- people in the past have been Nippon Mirai Capital, Phoenix formance. Japan needs time to very cautious about foreign man- Capital, AC Capital, BNP Paribas clean up this situation because agers, but now they have changed Japan, MKS Partners, and the distressed assets represent 30 their mindset, due in part to Carlyle Group. percent of Japan’s GDP. Second, Mr. Ghosn’s success. Chart III is a list of 51 companies from the investor’s point of view, which many people believe rep- real estate and corporate restruc- Q: Why is distressed investing resent candidates for the IRC or turing offer good opportunities in Japan so heavily controlled by RCC. Out of these 51 companies, over the next two years. non-Japanese investors? Mitsui-Sumitomo Bank represents Nakamura: Other than Orix, 16 companies, Mizuho Bank rep- Question and Answer we do not see many competitive resents 14 companies, and United Q: Do you have a strategy to mit- domestic investors in Japan. I Financial of Japan (UFJ) repre- igate deflationary pressure? think the distressed business is a sents 10 companies. These three unique asset type, even overseas. Nakamura: When we started banking institutions represent In the U.S. the distressed players this business three years ago I did 80 percent of the 51 companies. are vulture funds, and financial not expect the Nikkei to go down This presents the banks with a institutions like Morgan Stanley more than 50 percent. At that difficult situation because now and Goldman Sachs. Retail banks, time, the Nikkei was 20,000 yen, they must use the RCC or IRC to like Citibank and Chase, are not now its approximately 7,700 yen. work out these large entities. This active in the distressed market. In We are suffering from declining is a heavy burden for these banks. 1 Japan it is the same. The banking real estate values for the last 2 ⁄2 Most of the companies are listed community is not active in this years. Avoiding these pressures on the Tokyo Stock Exchange. market because of their relation- is very important to us in terms There are two points I would ships with their retail clients and of exit strategies. Our average like to conclude with. First, the corporations. Only funds or big investment life is only 17 months. Japanese distressed market is huge, institutional investment banks When we underwrite the assets, we and it was initially triggered by have opportunities in this market. apply a 24 or 36-month workout. the collapse of the bubble econ- In reality, we achieved a 17-18- Q: The IRC has been greeted omy and further driven by Japan’s month workout. That has helped with much cynicism. Of your list Alternative Investments Report 7 of 51 companies, there seems to is no magic, and we work very Statistically, 70 percent of our be, coincidentally, a very nice hard to collect money. We col- portfolio meets our expectations; proportion of clients among the lected approximately 70 percent 20 percent of our assets per- three major banking groups. Is it of the money through so-called formed much better then our possible that the IRC can do harm “discount payoffs”. We sit down underwriting and 10 percent of in the short run if they are inter- with the borrowers and ask them our assets are under performing. fering with the smooth functioning to pay back some of the money. Diversification, as I have said, of this market? Sometimes we ask them to sell is important and that is why we Nakamura: The function of the some of their collateral or real do not want to deal with large IRC is to buy distressed assets estate assets on a voluntary basis. corporations. from smaller to medium sized If it is not successful then we do banks. The main banks keep a foreclosure on the properties. their debt and all the debt owned In most cases (70-80 percent) by the other banks will be pur- things work out. chased by the IRC. The IRC is not Q: When you construct a portfolio, a sponsor, but looks for sponsor- is there a difference in the strategy ship. They are an advising and whether you are dealing with a coordinating entity in the market. larger company as compared with If economics works, the IRC does middle-sized or smaller companies? not take much risk because the Nakamura: We do not have any IRC purchases debt from banks portfolio strategies for large com- after the IRC structured the exit. panies because our fund size is I think the main purpose of the $600 million. I believe diversifi- IRC is to justify the transactions cation is very important in this to the public tax payer. business. At the peak we bought Q: Do you think the IRC will be more than 3,000 loans. The largest able to convince the banks to investment portfolio I have is work with them? only 3.4 percent of the total size. Nakamura: It is hard to say yes or no. The main banks are hesi- tant to work with the IRC because they have to take care of a major burden for these corporations in the restructuring process. They would rather deal with the pri- vate sector. In the last quarter, we were approached by several major banks to work with them on a private basis in corporate restructuring. Q: Have you had to adjust your return expectations? Nakamura: As I mentioned, we invested $1.2 billion over the last 1 3 ⁄2 years. We have already col- lected 80 percent of this. There Question and answer session EDITOR Joshua Safier Associate Director Center on Japanese Economy and Business

ASSOCIATE EDITOR Dr. Yoko Mochizuki Program Officer Center on Japanese Economy and Business

PHOTOGRAPHY Joe Pineiro

DESIGN/PRODUCTION Melanie Conty

CENTER ON JAPANESE ECONOMY AND BUSINESS Columbia Business School 321 Uris Hall Mail Code 5998 3022 Broadway New York, NY 10027 Phone: (212) 854-3976 Fax: (212) 678-6958 Email: [email protected] http://www.gsb.columbia.edu/japan