Once known as Tokyo Sowa Bank, TSB was a victim of the Japanese banking crisis of the 1990s. Crushed by its non-performing loan burden, and with no Japanese bank willing to mount a rescue, the bank was allowed to fail. Lone Star stepped in and snapped it up for $400 million in 2001. The US-based private equity fund then sold down 30% of its holding via an initial public offering on the Tokyo Stock Exchange in 2005. That IPO raised $860 million for the US investors, more than doubling their money, and valued the bank at $2.6 billion.
That valuation has not been sustained, although Lone Star will still make a handsome profit on its remaining shares. It will get 68% of the offer amount, which is the balance of its stake following the IPO, or $1.7 billion. Together with the original $860 million it received from the IPO, this will bring Lone Star's gross proceeds to a more-than-respectable $2.6 billion. (However, the US private equity firm will pay a 20% capital gains tax on its profits. The tax was introduced in 2005 and is called the "Shinsei Tax" as it was a direct result of Ripplewood paying no tax on the profits it made on its investment in Shinsei.)
This will not be the end of the trades in TSB, however. Advantage Partners has announced its intention of taking the bank private and will doubtless sell it at a higher multiple, either by IPO or to a strategic buyer, a few years down the line.
Stockmarket investors who bought the bankÆs shares in the IPO havenÆt done nearly as well. TSBÆs shares have underperformed the Nikkei 225 index by a substantial margin ever since its sale to the public. While the Nikkei hit a five-year peak of over 18,000 in June 2007, TSBÆs shares had slid to Ñ384,000 ($3,598) from its Ñ430,000 IPO price. The Ñ360,000 per share price which Advantage is offering is still at a substantial discount to that IPO price. The stock price was languishing at Ñ295,000 at Christmas 2007, but has risen to Ñ355,000 on news of the offer. The other foreign private equity invested banks are also trading at a substantial discount to their IPO prices.
ItÆs clear that successful private equity players are masters at buying cheap and selling dear. Fears relating to subprime losses have caused a sell-off in banks worldwide and disappointing earnings growth from their traditional business has further weakened the earnings growth of Japanese banks, as a recent Lehman Brothers report makes clear. That makes it a good time to buy under-valued assets like TSB.
Although starting from a very low base, the bank has considerably improved on what it once was. Nevertheless, the chances of sustained, rapid earnings growth for a small player in a crowded market look doubtful.
The bankÆs survival strategy has been to clean up its loan book, partly through securitisation, and to re-invent itself as a small-scale lender to families and companies. It provides more sophisticated products, such as reverse mortgages and deposit-linked mortgages. The former enables homeowners to extract value from their homes without selling it, and the latter gives depositors preferential interest rates on their deposits, up to a certain percentage of their outstanding mortgage. It also provides financial help through its "financial lounges" which are innovative for Japan, and help debtors consolidate their liabilities. For these and other convenient features, the bank can charge a premium.
TSBÆs figures are respectable, although some of the key ratios are edging downwards. Return on equity was 17.6% in the first half of 2006, but just 15.63% in the first half of 2007. Similarly, return on assets was 1.06% in the first half of 2006 and 0.99% for the same period in 2007.
The bank does have some subprime exposure, which it calculated at 0.39% of its risk-adjusted capital, or 3.7% of its risk capital, in its 2007 interim earnings announcement. The lender estimates it will make an operating profit of Ñ76 billion for 2007. The bankÆs strategy is to expand nation-wide. In fact, scale is considered crucial to successful retail banking, so this kind of growth will be important. It will also be difficult to attain, given the competition from the universal banks, the regional banks, the trust banks and the securities companies.
Together with other private equity investments in Shinsei Bank (former Long-term Credit Bank) and Aozora Bank (former Nippon Credit Bank), the picture of private equity activity in the banking sector in Japan is somewhat mixed. Banks like Aozora and Shinsei were certainly kept alive but the Japanese tax payer paid a steep price.
In practice, the private equity investors managed to negotiate to keep the healthy loans in return for buying the banks, or insisted the Japanese government inject billions of dollars to help provision against the bad loans. Shinsei-acquirer Ripplewood, for example, had a famous "put option" whereby it was allowed to sell the worst of the loans back to the Japanese government. Lone Star was "gifted" $7 billion from the government when it bought TSB to help with the non-performing loans. In the banks where the government acquired a stake through the injection of emergency funds, it shared in the upside. That was the case at Shinsei, but not at TSB.
Perhaps the strangest aspect of this business is why the Japanese banks are not interested in bidding for these undoubtedly more modern and nimble banks. Either the domestic banks still don't consider them good investment opportunities and feel the private equity-inspired banking model is not relevant to their own way of doing business, or they are too short of capital. Whatever it is, the answer would reveal much about the direction in which Japanese banks are going.
Merrill Lynch is advising Advantage Partners, while Credit Suisse is advising Lone Star.
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