Here, Credit Suisse's H. Andrew Brownfield III, head of investment banking for Japan, gives his views on the TSB transaction and other issues facing players in the Japanese market at the moment.
What are some themes that have come out of the sale of TSB to Advantage Partners in February this year?
AB: Staple financing will be popular, since the number of financiers has decreased in the wake of the credit crunch in the US. (Staple financing is the practice of advising the selling company while also providing some or all the financing for the buyer). For the selling company, staple financing provides a backstop, making a sale more likely. For TSB, we were hired by Lone Star, which owns part of TSB. We found some potential buyers and ran an auction until there were five companies left in the last round. The winning bidder was Advantage Partners.
Who was involved in the bidding process?
AB: We had a great spread. We had two private equity firms, a Japanese bank, an international bank, and a Japanese financial institution.
Are you surprised one of the megabanks didnÆt snap up TSB?
AB: I think the Japanese banks have looked at what foreign investors have done, and they have copied them. ThereÆs no need to buy such banks. Japanese banks have learned not to charge fees for bank transfers, make their branches more comfortable, and cut down on waiting time. So the megabanks donÆt need to buy. The regional banks might be interested, but many of these currently donÆt have the financial wherewithal. ThatÆs where third party capital comes in. Foreign sponsors can facilitate the process.
There has been some discontent in Japan about the number of private equity to private equity deals. What's your view on the role of financial sponsors?
AB: The Japanese market is ripe for banking consolidation. There are many regional banks here. I think that an outsider, like a private equity firm, can sometimes carry through consolidation more easily than a local bank, which is tied down by long-standing relationships. These outsiders can start building up regional banks, and then national banks. I worked covering small banks in the US and I saw this process first hand, starting in 1984. Bank of America went through 107 mergers to become what it is today for example. My belief is that there will be a wave like this in Japan, and that foreign financial sponsors will take advantage of that. In addition, Japanese bank stocks are trading at very low valuations, despite not being directly exposed to the problems faced by other banks, making them attractive targets.
Do you think Japanese banks are currently more focused outside Japan?
AB: Yes. In other markets, M&A synergies are made by combining people and branches. That is more difficult here. Japan is probably overbanked, with the demographics showing a shrinking population. Although household wealth is very high and there are plenty of opportunities in private banking, retail capacity is probably excessive. So for the megabanks, it makes sense to look abroad and to establish a global brand. Japanese banks have not bought much abroad, but they are now in a better position relative to Western banks to buy abroad.
One private equity player said he was interested at the leverage you managed to achieve, given the bank is already leveraged via its deposits.
AB: The equity portion was in the low 40% area. The debt was quite reasonable, as it had to be, given that TSB is a regulated entity and needs to maintain strong capital standards.
TSB certainly looked like a buying opportunity. ItÆs trading at below its 2005 IPO price, even though since then it has grown considerably. Although I would note its return on equity (ROE) and return on assets (ROA) have slipped in recent months.
AB: Yes, the bank has done well. It has avoided credit problems and it has new products and customers. But the overall market has declined. ROE and ROA have slipped partly due to the runoff on the bad loans which existed when the bank was bought. These are being amortised away.
Do you believe Advantage can really turn the bank around, or are they just swooping in because the share price is below fair value? Will they be able to spearhead consolidation?
AB: Japan is a tantalising market. There are so many great opportunities. I can vouch for that after being here for seven years. But getting deals done take longer than you think it possibly could. There are definitely fewer closed transactions than I would have predicted a few years ago.
What do you think the plan is? A quick IPO?
AB: I would imagine an IPO in five yearsÆ time, but there will be pursuit of regional consolidation first.
Is this kind of deal going to be your mainstay this year?
AB: Yes, itÆs the perfect deal for CS Japan. It calls on our international expertise and experience û we can link in people from our offices in New York and London, and we can get access to lots of foreign buyers. We are strong in FIG (financial institutions group), and we are good at financing and finding investors. In fact, we focus on finding third party investors. Ultimately, we are looking to distribute rather than use our own balance sheet.
Do you think sentiment in Japan is supportive of deals like TSB
AB: I have to say that the Financial Services AgencyÆs approval of this deal was like a bright light within Asia. It was a great step. We had a transparent and open auction.
What do you think of Japanese financial sponsors?
AB: Japanese players have some advantages in terms of their human network, while foreign players have global knowhow. ThatÆs the tension and the competition which arises when both groups are competing for assets.
Mizuho bought a stake in Merrill. Do you think that is an effective strategy?
AB: IÆm curious. I think the best ever foreign investment by a Japanese bank was when Sumitomo bought a 20% stake in Goldman Sachs many years ago. It makes sense to buy a slug of a leading franchise, rather than trying to run foreign operations yourself. I would not be surprised if a Japanese bank bought into a private equity player, actually. There are loads of synergies. If you are Carlyle, how do you survive? You need financing and you need deals. A tie-up with a bank can give you both. The bank should probably not take such a big stake that other private equity players would feel they are losing out on financing. But if it took a small stake, say 10%, then it would still be in a position to provide financing to independent private equity players. Of course, I havenÆt thought it through in detail, but I believe itÆs a tantalising prospect. Remember that historically, Japanese banks have lost money when investing abroad.
So you would be against the Japanese banks buying another commercial/retail bank?
AB: The buyers need an acquisition that will bring growth. They need to create genuine operational leverage. Buying another bank like themselves would just provide more scale.
Do you think the number of leveraged finance deals will accelerate?
AB: If you look at the curve and extrapolate, sure! We did the first classic leverage finance buyout in Japan in 2001, with the usual bridge loan, take out financing and so on. Since then, the numbers have jumped every year û but from a low base.
What do you reckon differentiates Credit Suisse from other banks?
AB: The banks are all different. We are good in leverage finance, high grade debt and securitisation. ThatÆs our product strength and that helps our relationships with the financial sponsors. We donÆt focus on principal financing, so we are more likely to provide the financing to financial sponsors than other investment banks with a principal financing focus. However, we are putting a new emphasis on our equity underwriting capability. We have grown the research and the sales-force considerably. We want that to be on a par with the rest of the bank.
Have you ever seen sentiment this bad in Japan?
AB: Yes, in 2002-2003, it was awful. During that time, Japan was reduced from a triple-A credit rating to a single-A rating. Global banking sentiment was terrible, and then there was the war in Iraq. This is the second worse IÆve seen it.
Will things recover?
AB: Yes, of course, itÆs a cyclical business. ThereÆs always been an upturn. Leverage finance didnÆt really exist before 2001, but itÆs grown every year since.
How about the equity markets?
AB: I think Japan is more of a fixed income market. I come from a debt background. Equity has more growth in Hong Kong, for example. But Japan has a huge fixed income market, the banks are enormous and itÆs the biggest government bond market in the world. And with interest rates this low, companies are borrowing rather than selling equity.
How do you predict the total fee pool in 2008?
AB: The 2006 fee pool was sharply down on the 2005 fee pool, $2 billion versus $3.5 billion. 2007 was bit worse than 2006. I donÆt think this year will go much below last yearÆs figure.
What are you doing to compensate?
AB: We believe our leverage finance activities will partly fill the gap left by a decline in other activities. We are also targeting growing companies. Historically, there have not been many products between Libor plus 50 senior debt and equity in Japan û not much mezzanine financing. We are trying to produce that kind of product and supply growing companies. We just launched a bond for retailer Don Quixote, for example. In the US, it would be called high-yield issues û for growing, smaller players.
By the sparse number of IPOs, there donÆt seem to be many growing companies in Japan.
AB: Maybe so, but those that do exist are more solidly underpinned. In any case, leverage finance is our global specialty and we want to put it to work here. We need a differentiated strategy. ItÆs not good being the eighth guy pitching a client for an IPO. Pre-IPO or mezzanine financing helps us differentiate ourselves, and we work to add to the intellectual weight of the debate. In the relationship versus the idea debate, we come down on the side of the idea. We do have relationships in Japan, but not as deep as the Japanese companies. But clients like what we are offering and thatÆs enabled us to grow every year.
How do you get those ideas?
AB: We are very data driven. I will look for a data run of companies with certain cash flow or balance sheet characteristics, then weÆll sit around and brainstorm. Six or eight of us will throw out ideas, check data and research who might be receptive to what we come up with. WeÆll also visit companies we donÆt have a relationship with and show them some of our ideas. Overall, it's an approach that is working.