A crucial part of the deal is that GE will share the repayment of some of the excess interest charged to customers, as ordered in recent legislation by the government. UBS advised GE on the deal, while Shinsei operated on its own.
For a mid-sized bank like Shinsei, the transaction (the fifth largest financial M&A deal globally this year) represents a sizeable financial risk. The price of the consumer finance unit, which has lost almost $3 billion over the past two years, represents almost 10 times Shinsei BankÆs fiscal 2008 net income of Ñ53 billion, and over twice its sales of Ñ200 billion. ItÆs not yet clear how the deal will be financed, probably from cash at hand followed by a major capital raising by the bank. Shinsei only recently injected almost half a billion dollars into its in-house ailing consumer finance unit Aplus, and increased its stake in another consumer finance unit Shinki. Strangely, Shinsei cancelled a heavily marketed covered bond issue in July, the first of what was to be a series.
According to an email from Shinsei spokesman Donald Macintyre, the acquisition is premised on Shinsei extracting a higher return on assets than GE was able to do. ôGiven the increasingly tough situation in the consumer finance market, particularly vis-a-vis funding, you have to be a bank-sponsored lender to be successful. We are, GE isn't,ö he points out.
Standard and PoorÆs Kyota Narimatsu told FinanceAsia that because Shinsei is taking deposits it ôcan issue debt and allocate cash to the consumer finance unitö.
It is possible that ultimately the separate consumer finance companies will be merged under the main bankÆs consumer and retail arms, though Macintyre didnÆt confirm this. Indeed, last month Shinsei restructured from a "three-pillar" model to a "two-pillar" model, by folding its consumer and retail businesses into the same group.
The acquisition of the GE unit looks contrarian, as itÆs occurring as regulatory changes capping interest rates and loan size are pushing other foreign operators, such as Citibank, out of the consumer finance market. A law passed in 2006 is to bring down interest rates to 20% by 2010 and loans may not exceed one-third of a borrowerÆs annual income. Consumer finance companies have also been told to repay billions of dollars in interest charges which have been retrospectively deemed illegal.
The legislation comes as the government is tilting in favour of the borrowers rather than the lenders. In Britain, a similar shift has occurred, with high-street banks being ordered to hand back excessive overdraft fees û from which they were making up to $5 billion per year. A particularly vulnerable group in Japan are the multi-borrowers, who do with finance companies what people do with credit cards in the West. Indeed, the consumer finance companies are an uncomfortable reminder of the declining wealth of some Japanese citizens (a recent OECD report wrote that Japan's GDP wealth per capita has tumbled from being in the top five in the world in the 1990s to 16th currently), and of the shocking absence of social security provisions.
ItÆs worth recalling that consumer finance in Japan, as represented in its most profitable form, is not consumer finance as it is known in other developed banking markets. Top consumer finance companies such as Aiful, Takefuji, Acom and Promise focus not on home mortgages, car financing and credit cards but mainly on short-term loans to people who urgently need cash. Consumer finance is thus a rather euphemistic term in Japan. In fact, some observers see parallels with the US subprime market, where financial institutions lent money to poor people to buy houses. These loans were very expensive and very profitable for the lender.
Indeed, lending money to poor people is one of the most lucrative forms of credit opportunities there is. The profile of a borrower using the service in Japan is somebody vulnerable, quite young or quite old, and hard up, possibly unemployed, who urgently needs some money. The average size of a loan from the consumer finance companies is Ñ500,000 ($4,800), according to Fitch Ratings in Japan, and usually with no effective maturity (the loans can be rolled over pretty much forever). But until the rates were first lowered by legislation in 1984, lenders could charge an annual interest rate of more than 100%. Often, the borrowers would be caught in a trap where all their earnings would go on servicing the interest of the loan, and further loans would be needed for daily necessities.
These operations were all the more profitable after the government introduced monetary easing measures in the wake of the bubble collapse of 1990. So the consumer finance companies could borrow at less than 5% and lend at 25%-30%, resulting in huge margins. Finance companies proliferated, running into the tens of thousands. Return-on-assets were rich, around 5% for Acom in March 2005, compared to 0.5% for the mega banks. Return-on-equity was also high, in the 30% range for the top finance companies.
Clearly, such operations do well when the economic cycle goes bad. In that sense, they are the opposite of consumer finance units like GE, which lends money for solvent people to buy mainstream consumer goods. And it would seem that ShinseiÆs plan is to abandon the old model and make consumer finance in Japan genuinely similar to consumer finance in other markets.
Japanese banks tend to be conservative. It was because they were focussed on corporate banking and tended to have inflexible lending standards for consumers that the consumer finance companies sprung up in the first place. (Banks do not provide overdrafts, for example.) An individual can go to one of the unmanned finance company booths, make an application by showing a social security certificate and driving license and get a loan all within one hour, without putting up collateral. That is a fast and smooth service by Japanese standards. And one which would clearly benefit many ordinary consumers who are reluctant to spend the time and energy going through conventional channels. Finance companies have specialised in this sector and use their own credit databanks û from which the mainstream banks are jealously excluded.
So the Shinsei plan makes a lot of sense: to make consumer finance mainstream. That plays to certain strengths Shinsei already has. It runs one of the most user-friendly ATM and internet networks around, for example. The new consumer finance model will not be as profitable as the old model, but it would efficiently incorporate mortgages, car financing, credit cards and personal loans to a consumer who has not had that service before.
Other Japanese banks are following suit, with Sumitomo Mitsui looking to put its consumer finance operations on the same platform as Promise, in which it has a 20% stake. Mitsubishi UFJ is seeking to do the same with Acom, in which it has a 13% stake. The paradox, however, is that Shinsei is moving into mainstream consumer finance at a time in the economic cycle when it has become less attractive, and when the Japanese banks are finally turning their full attention to the sector, making it more competitive.
At the same time, any reversal to the old style of consumer finance has been made impossible by government regulations. There does not seem to be any easy way to reconcile those two facts. But whatÆs for sure is that it would be of great benefit to mainstream retail customers in Japan if Shinsei does make a success of its bold buy. What happens to the poor and desperate is another question.