J A P A N C R E D I T P E R S P E C T I V E S

Koyo OzekiAugust 2008

Responding to Financial Crises: Lessons to Learn from Japan’s Experience

The financial crisis sparked by the subprime loan problem has intensified to the point where U.S. and European governments have had to extend support to financial institutions, and we believe that governments will need to widen and deepen the scope of this support framework in the near future. Japan’s experience in dealing with bad loans and financial crises serves as an insightful lesson about public support. In this special edition of Japan Credit Perspectives, we reflect on Japan’s financial crisis in the 1990s and early 2000s, then compare it to the present situation in the U.S., and consider the implications for government action.

Part 1: A Brief History of Japan’s Financial Crisis

Summary: The Four Phases of Japan’s Financial Crunch

Japan’s financial crisis persisted for nearly 14 years, from the burst of the economic bubble in 1991 until around 2004, but throughout that timeline there were transitions in the state of the markets and the nature of the crisis. Broadly speaking, we can divide the progression into four phases (Chart 1).

■ Phase 1 (1991-94): The real estate bubble collapsed, triggering an economic shock. The government responded typically with economic stimulus packages, such as public works projects.

■ Phase 2 (1995-96): Signs of instability appeared in the financial system. Even as banks failed due to financial difficulties, the government failed to come up with a comprehensive policy package that would address financial system issues.

■ Phase 3 (1997-99): The bankruptcy of major banks triggered a financial emergency. Through establishment of new laws and budgetary measures, the government nationalized failed banks and injected taxpayer money into large financial institutions. Even so, it was unable to resolve the situation.

■ Phase 4 (2000-04): The system again reached a crisis point due to the massive volume of excess debt held by corporations. The Financial Revitalization Program (“Takenaka Plan”) promoted the disposal of non-performing loans, and the government supplied public funds to tottering Resona Bank. These measures finally helped bring the crisis to an end.

Four Phases of Financial Crisis and Share Prices

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Source: Bloomberg, PIMCOChart 1

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Early Background: Excess Liquidity, Massive Bank Lending, and the Property BubbleThe sharp appreciation of the yen and accompanying monetary easing following the Plaza Accord of 1985 gave rise to a tremendous amount of excess liquidity in Japan. As a result, a massive volume of funds poured into commercial real estate and the stock markets. Bank lending doubled between 1985 and the first half of the 1990s, most of which went into the real estate market. We estimate that direct and indirect investment (including loans to nonbanks) in commercial real estate accounted for around 40% of total lending; another 20% went into loans to individuals for the purchase of rental property, such as apartments; and 40% went into non-manufacturer loans, many of which were presumably used to acquire property (Chart 2). Bank lending also grew after the bubble burst in 1991, but we suspect this was largely to prop up corporate borrowers experiencing a slump in business.

Phase 1: Collapse of the Commercial Real Estate Bubble (1991-94)The collapse of the bubble economy in the early 1990s sent the value of land, which represented more than half the nation’s wealth, spiraling downward by nearly 500 trillion yen (US$4.5 trillion)1, and the total value of share prices plummeted by 300 trillion yen (US$2.7 trillion). That is, assets lost 800 trillion yen (US$7.3 trillion) in value, equivalent to almost 1.6 times the gross domestic product (GDP) of Japan (Chart 3).

Corporations held around 40% and individuals 60% of the nation’s land assets, so the sharp decline of land value had a significant impact on both corporate and household balance sheets. The bad debt problem, however, was concentrated primarily in commercial real estate due to the extremely speculative and broad acquisition of land for commercial building construction and golf course development. In the household sector, falling asset values had a large effect, but leverage had not expanded as much because a system for borrowing money using homes as collateral, such as home equity loans, wasn’t readily available. As such, there was only a modest volume of bad debt related to residential property loans (Chart 4). One factor that probably helped stem the default rate on home mortgages despite the sluggishness in the economy was the relative employment stability, thanks to the system of lifetime employment. Phase 2: Prolonged Land Price Decline Sparks Sharp Rise in Bad Debt (1995–96)

Land prices continued their dramatic plunge in the mid-1990s (Chart 5). By our estimates, Japanese banks had around 50 trillion yen (US$450 billion) in non-performing loans immediately after the burst of the bubble in 1993, which shot up to nearly 100 trillion yen (US$910 billion) by 1996, along with the loss rate (Chart 6). As a result, financial institutions

Bank Lending Volume

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Source: Bank of Japan, PIMCO estimates (based on statistics from BoJ, MoF, CCPC, bank financial results and others)

Chart 2

85 87 89 91 93 95 97 99 01 03 05 07 Jun 08

Increase in bank loans

For Commercial Real Estate ¥110 trn (GDP Ratio 22%)

For Individuals ¥50 trn (GDP Ratio10%)

For Non-manufacturers ¥100 trn (GDP Ratio20%)260 trillion yen

(GDP Ratio 52%)

Estimated Use of New Bank Loans During Bubble Era (1986-93)

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Chart 3Source: Cabinet Office (Japan)

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found themselves in a rapidly deteriorating position, and a succession of bankruptcies among relatively large regional banks in 1995 signaled an impending crisis in the financial system.

Phase 3: Collapse of Major Banks (1997–99)Anxiety over the financial system intensified with the failure in November 1997 of Hokkaido Takushoku Bank, one of the nation’s leading banks, followed closely by the collapse of securities giant Yamaichi Securities. In the following year, Long-Term Credit Bank of Japan (LTCB) and Nippon Credit Bank (NCB) were nationalized when they too went under. All of the failed banks at this time had loan-to-deposit ratios of over 100% and a high dependence on the interbank market and bond issuance (long-term credit bank debentures) for financing. Funding problems in the short-term financial markets and bond markets caused them to fold.

With the failure of LTCB in October 1998, the government established a new framework to protect the banking system and in March 1999 injected 7.5 trillion yen (US$68 billion) in taxpayer money into the major banks. The situation improved temporarily from the first half of 1999 through the first half of 2000, thanks to the global stock market boom fueled by the IT bubble as well as the rapid pace of bank mergers and other financial industry reorganization.

The emergence of a so-called “Japan premium” in foreign interbank markets from 1997-99 meant higher fund procurement costs for Japanese banks in these markets (Chart 7). However, thanks to funding from domestic sources and a reduction in assets, there was no shortfall of liquidity or consequent market turmoil.

Chart 4

Home Mortgage Delinquency Rate and Unemployment

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Unemployment Rate (Seasonally Adjusted)Home Mortgage Delinquency Rate (12-month Moving Average)

Source: Ministry of Internal Affairs and Communications (Japan), Japan Housing Finance Agency, Bloomberg Note: Disclosure of home mortgage delinquency rate data started in 1996

92 94 96 98 00 02 04 06 08

Source: Japan Real Estate Institute

Chart 5

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Chart 6

Bad Debt and Loss Ratio (Estimate)

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Phase 4: Excessive Corporate Debt Spurs Renewed Crisis (2000–04)In the latter half of the 1980s, Japan’s corporate sector was aggressive in capital spending on plants and equipment. In particular, as noted earlier, non-manufacturers expanded their borrowings significantly during this time. When the bubble burst in 1990, the slump in profits caused their debt burden to swell, and worsening in leverage indicators persisted until the late 1990s (Chart 8).

When the IT bubble deflated in mid-2000 and share prices began to sink, corporate bankruptcies spread through several sectors. In addition to construction firms, real estate companies and other sectors directly affected by land investment, there was also a steep rise in failures of non-manufacturers carrying excess debt (Chart 9). On top of the sluggishness in earnings caused by the prolonged economic slump, the funding environment suffered badly from a severe credit crunch.

Resona Bank reached the brink of crisis in May 2003, spurring the government to supply 2 trillion yen (US$18 billion) in taxpayer money. In 2004-05, UFJ Bank faced a crisis due to massive losses and subsequently merged with Mitsubishi Tokyo Financial Group (MTFG). At that time, the banking crisis was not caused by funding difficulties; instead,

asset valuations by auditors and financial authorities found that banks had capital shortages or excess debt. Survival of such banks was possible only through the intervention (support) of the government or mergers with other banks. The bank regulators’ prudence policy evolved as they sought to assess bank balance sheets through a proper valuation of assets before funding difficulties could build to a point that threatened a bank’s viability.

Government support for Resona Bank, one of the sector’s major players, consisted of “soft” capital injections through the purchase of preferred shares, which protected ordinary shareholders. Combined with the ongoing improvement at the time in the macroeconomic environment, this had a dramatic positive impact on market sentiment. The creation of the Mitsubishi UFJ Financial Group (MUFG) in 2005 by the merger of MTFG and UFJ formed the nation’s largest banking group, and helped put a firm end to Japan’s financial crisis.

Part 2: Evolution of Japanese Government Policy In concert with the financial crisis, there were many changes in government measures and the legal framework governing bank failures. There were three main developments.

Chart 8

Capex and Ratio of Net Interest-Bearing Debt to EBITDA

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6Total/Construction*ManufacturersWholesaleRetailTransport, TelecomServiceReal Estate Other

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Total Debts by Industry

Source: Teikoku Databank Ltd., PIMCO

(％)GDP Ratio

＊FY80–94 is total. FY95–05 is construction industry.80 82 84 86 88 90 92 94 96 98 00 02 04 06

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Bankruptcy Cleanup Through Enforced Cooperation, Mergers and Takeovers (through 1997)Prior to the temporary nationalization of LTCB and NCB in 1998, the authorities dealt with failed or tottering banks by orchestrating mergers or asset takeovers by other banks. Large banks had the financial leeway to rescue smaller financial institutions, and the authorities would lean on multiple banks to bear the losses in what was known as a “subscription list” policy, followed by mergers and asset transfers. However, as the health of the banking system as a whole worsened, this method reached its limit when Hokkaido Takushoku Bank and Yamaichi Securities failed in 1997. In addition, the Bank of Japan (BoJ) had greatly expanded the scope of its special loans, significantly raising its risks in the event of a bank failure. Thus, the use of liquidity support to deal with solvency issues was nearing its limits as well.

Nationalization of LTCB and NCB and Capital Injections into Large Banks (1998-99)Faced with this situation, the government passed the Emergency Measures Act for Financial Function Stabilization and injected 1.8 trillion yen (US$16 billion) into 21 large banks in March 1998. This was the first capital injection, but the sum was small and did little to boost market sentiment. Hurt further by the turmoil in global financial markets in the wake of the Russian financial crisis and Long-Term Capital Management’s failure in the summer of 1998, Japan again entered a financial crisis mode.

The severity of LTCB’s troubles deepened as its finances worsened and its share price fell, and the government was again forced to prepare a framework for a bank bailout. By October 1998, it passed necessary legislation such as the Financial Revitalization Law, the Financial Function Early Strengthening Law and a revised version of the Deposit Insurance Law, and offered 60 trillion yen

(US$545 billion) (equivalent to 12% of GDP) in budgetary measures. Once the laws were enacted, LTCB was immediately nationalized under the Financial Revitalization Law, and NCB followed in December. With the state takeover, the banks’ debt was fully guaranteed, but because audits had found the banks in a state of excess debt, the value of their shares fell to zero.

Along with enacting new laws, the government overhauled the financial regulatory system and transferred oversight responsibility of the nation’s banks from the Ministry of Finance (MoF) to the Financial Reconstruction Committee (now the FSA). The committee injected 7.5 trillion yen (US$68 billion) into 15 banks in March 1999 based on the Early Strengthening Law.

New Financial Framework and Public Money for Resona Bank (2000-04)Both the Financial Revitalization Law and Financial Function Early Strengthening Law were temporary measures, and there remained the need for a permanent framework for dealing with bankruptcies. In that regard, numerous legal measures were passed in 2000-01, including another revision of the Deposit Insurance Law. Based on past experience, the new framework incorporated faster and more diverse bankruptcy disposal methods and measures for responding to financial crises. It was the sum of all the lessons learned from the previous ten years. As part of this new framework, the Deposit Insurance Law (Article 102) introduced three models to address different levels of systemic risk: capital injections in extremely serious cases (Item 1), protection of all debt through special financial aid in the case of small bank failures (Item 2), and nationalization in serious cases (Item 3). A 15 trillion yen (US$136 billion) emergency fund was established as a permanent budgetary measure for use in enacting these items. In the second half of 2002, the government tightened its asset audits through the Financial Revitalization Program

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(also known as the Takenaka Plan after the then-financial services minister), and banks hastened the pace of their bad debt disposal. Emergency measures were carried out under the new framework: Resona Bank found itself with a capital shortage in 2003 as a result of the faster debt disposal, and the government provided public funds as prescribed in the new law’s Item 1. The government also nationalized Ashikaga Bank, one of the major regional banks, as per Item 3.

Part 3: Questions and Answers Regarding Government Response

Q: Why did it take so long to resolve the crisis?A: It took nearly 14 years from the burst of the Japanese bubble economy in 1991 until the financial crisis finally came to an end. There are several reasons for this unusually long timeframe.

■ Hopes for a turnaround in property prices: From the collapse of the bubble economy until the mid-1990s, most people assumed that real estate prices would eventually turn upward again. Policy makers were also focused on encouraging an economic and market recovery through fiscal stimulus measures such as public works projects.

■ Existence of colossal latent stock profits: At the start of the 1990s, Japanese banks had stock portfolios with unrealized profits amounting to nearly twice their net worth. This acted as a buffer for loss write-offs, encouraging a complacent stance that they could hold out until the real estate market made its comeback. The plunge in the stock prices in 2000 severely eroded these latent profits, and appraisal losses began to have a negative impact on profits. Banks and financial authorities gradually came to recognize the risks regarding the shares in their portfolios, and proceeded to trim their holdings.

■ Massive scale of the problem: Japan’s cumulative bad debt totaled an estimated 25-30% of GDP, while the value actually written off by financial institutions amounted to nearly 100 trillion yen (US$910 billion) or 20% of GDP. The large banks alone accounted for 75 trillion yen (US$680 billion) of this total (Chart 10). This exceeds the combined value of their net worth of 20 trillion yen (US$180 billion) and 14 years worth of net operating profits at 50 trillion yen (US$450 billion). They realized profits from their share holdings to supplement the portion that could not be covered by net operating profits. Though this conclusion is made in hindsight, it is clear that banks simply did not have the financial strength to dispose of these vast losses in a short period, and they had no choice but to take their time to write off debt using their annual earnings and unrealized profits.

Q: Why did the capital injections in 1998-99 fail to solve the problem? A: At the time of the taxpayer money injections in 1998-99, authorities maintained the position that most of the major banks were fundamentally healthy, despite the fact that they were aware of the damage being done to bank capital by bad debt. At the same time, a credit crunch was becoming a serious issue

Chart 10

Source: Financial Services Agency (Japan), Japanese Bankers Association, PIMCO Japan

Earnings by Major Banks

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Bad Debt Disposal Costs (Total 74.5 trn yen)

Net Equity Profit and Loss of 3 Accounts (Total 14.8 trn yen) Net Operating Profits (Total 49.8 trn Yen)

Net profits (Total 16.8 trn yen)

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as the banks turned increasingly reluctant to lend, and authorities provided public funds to ease the credit situation. They set their policy goals with this in mind, such as requiring banks to boost their lending to small businesses. These cash injections might be characterized as preventive actions, but because the policy had multiple objectives, it did not act as a genuine incentive to comprehensive bad debt disposal.

Q: Is rapid disposal really the key to early resolution of problem? A: In responding to a crisis, authorities must 1) rapidly analyze the nature of the problem, 2) evaluate its scale, and 3) devise necessary measures. It is difficult to identify the precise causal relationship between financial system measures and a bottoming out in asset prices, but one lesson that can be learned from Japan’s financial crisis is that the delay in recognizing the problem during Phases 1 and 2 (1991-96) made the subsequent fallout even worse, and an underestimation of the situation’s severity and the authorities’ trial-and-error approach in Phase 3 (1997-99) caused the delay in settling the problem.

Q: How effective were the BoJ’s zero interest rate and quantitative easing policies? A: Phase 4 of the crisis (2000-04) was a problem of surplus debt at private corporations. Under the surface, however, corporate fundamentals were improving rapidly (Chart 11). The ratio of net debt to EBITDA (earnings before interest, taxes, depreciation and amortization) in the corporate sector as a whole took a swift turn for the better, improving from 5.3 times in 1999 to 3.0 times by 2005. Reduction of capital spending mainly made debt repayment possible (Chart 12).

During this period, interest payments also dropped considerably, bringing the ratio of interest payments to operating profits down from 42% to 15% (Chart 13). This is due to both a reduction in interest-bearing

debt and a decline in interest rates, but we estimate that the latter had around twice the impact. That is, monetary policy not only helped maintain liquidity in financial markets, but also played a large role in improving corporate balance sheets.

Chart 11

Corporate Leverage

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Interest Payments

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Part 4: Implications for the Subprime Loan Crisis

Differences between U.S. Subprime Crisis and Japan’s CrisisBoth the subprime loan turmoil in the U.S. and the financial crisis in Japan resulted from a bubble created by the presence of surplus liquidity. However, there are several differences.

■ Complex structure of U.S. bubble: Whereas Japan’s bad debt problem stemmed from commercial real estate and excess corporate debt, the U.S. subprime problem involves a more complicated mixture of bubbles related to the housing market, financial institution business models and financial products for investors.

■ Speed of valuations: Japan’s bad debt was mostly bank lending, and valuations took some time as regulators conducted asset inspections. In contrast, the subprime loan problem involved securitized products, so market valuations were completed relatively quickly. The valuation of housing loans by commercial banks in the U.S. could take longer than securitized products, though, so we should keep a close eye on future developments.

■ Creditor nation vs. debtor nation: Japan is a creditor nation and does not rely on overseas financing, so its bad debt situation was an internal problem. The U.S. is a debtor nation, which complicates the matter. Also, U.S. housing loans and other securitized products are widely held by overseas investors, so the risk can easily spread to global markets. This will naturally impact how the government responds to the problem.

■ Scale of the problem: Japan’s bad debt problem on a cumulative basis amounted to a whopping 25-30% of the nation’s GDP (Chart 14), whereas the subprime problem is an estimated 5-10% of

U.S. GDP. The difference in scale will likely affect the cost and speed of resolving the situation.

Part 5: Summary

Framework Necessary for Cleanup of Individual Bank FailuresIt is important for a government’s financial crisis-response package to include a framework that will help avoid systemic risks arising from the bankruptcy of financial institutions that are crucial to overall stability. Japan finally introduced such a framework in 2001 after much trial and error, which helped bring the crisis to a close. We believe that the Federal Reserve opening its discount window to investment banks and facilitating the rescue of Bear Stearns in March 2008 were important steps in the right direction. However, lending by a central bank is essentially a liquidity policy. There are limits to the extent to which the central bank can accept bad debt risk in dealing with solvency problems at financial institutions. In the case of Bear Stearns, the Fed provided loans at official discount rates for ten years to the bad bank, which was established to take over Bear Stearns’ high-risk assets. If the loans go bad, however, it could compromise the credibility of

Bad Debt and Public Cleanup Costs

Chart 14

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Source: World Bank, OECD, PIMCO EstimatesBad Debt (GDP Ratio) Necessary Costs (GDP Ratio)

Scandinavian Bank Crisis (Mid-1990s)

Asian Financial Crisis (1997)

US S&L Crisis (Late1980s)

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the central bank and therefore the currency. Thus, a Bear Stearns-type rescue model should be seen only as a temporary measure until a solid framework for government support can be established. A financial institution rescue package using public funds will require the approval of Congress, and the appropriate legislation needs to be laid out quickly in order to better prepare for possible future developments. Japan’s financial crisis-response framework designed in 2001 could serve as a useful reference.

Preventive Capital Injections: Impact Questionable, but Methods May Be Useful as a ReferenceBecause bank rescues are a very delicate matter politically, it is not easy to move proactively to keep the situation from getting out of hand in the first place. In Japan’s case, capital injections in 1998-99 had no clear policy goal and thus no substantial result. However, major banks were able to repay the money in the subsequent economic upturn, and the nation earned a profit from the rebound in share prices, consequently reducing the fiscal burden. In going-concern bank support, indicating a clear exit strategy can help in winning taxpayers’ understanding. The Japanese examples may be helpful in this sense.

Framework Needed for Debtor Balance Sheet Adjustments Loss write-offs and capital restructuring at financial institutions are, in fact, balance sheet adjustments on the creditor side. It is important that their balance sheet adjustments also lead to adjustments on the debtor side in order to halt the decline in asset prices caused by a downturn in the overall economy. For example, the Brady Plan played an important role in resolving the Latin American debt crisis of the 1980s, and the Resolution Trust Corporation helped resolve the savings and loan crisis from the late 1980s and early 1990s. Likewise, Japan’s bad debt disposal process was helped considerably by various measures in the framework that addressed debtor

balance sheet corrections. Such measures included the passage of the Civil Rehabilitation Law in 2000, the reinforcement of the Resolution and Collection Corporation (RCC) in 2001, and the establishment of the Industrial Revitalization Corporation in 2003. A cleanup of the high volume of housing loan debt will require a different method than for corporate debt, and we will be closely watching the future course of debate and policy initiatives.

Koyo Ozeki Executive Vice President

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1985 3/29 Japan’s Ministry of Finance (MoF) eases regulations for banking and securities industries

9/22 Plaza Accord

1986 1/30 Bank of Japan (BoJ) lowers Official Discount Rate (ODR) from 5.0% to 4.5% (five consecutive cuts to 2.5% by Feb. 23, 1987)

1987 10/19 Black Monday (Dow Jones Industrial Average plummets)

1989 5/30 BoJ raises ODR from 2.5% to 3.25% (four consecutive hikes to 6% by Aug. 30, 1990)

10/27 Financial institutions asked to refrain from real estate lending linked to speculative trading

2/19 Nikkei Stock Average hits record high of 38,915.87

1990 4/1 MoF introduces volume restrictions on real estate lending

1991 7/1 BoJ lowers ODR from 6.0% to 5.5% (Monetary easing stance maintained until lifting of the zero interest rate policy in 2006)

1992 1/4 MoF ends volume restrictions on real estate lending

1993 1/27 Establishment of Cooperative Credit Purchasing Company

1994 2/8 Government launches ¥15.25 trillion economic package

2/8 MoF announces administrative guidance for banks regarding bad loans

6/22 Dollar falls below 100 yen in New York

10/17 Liberalization of liquid savings

1995 8/30 Failure of Hyogo Bank and Kizu Credit Cooperative

11/2 Daiwa Bank forced to shut down U.S. operations due to losses from N.Y. branch scandal

12/25 Jusen (housing loan company) Resolution Package includes ¥685 billion in public fund injections

1996 4/1 Establishment of Bank of Tokyo-Mitsubishi

6/18 Establishment of Jusen Resolution Law and four related financial laws

9/17 MoF presents banks with draft plan for private cooperative fund to resolve jusen problem

11/11 “Japanese Big Bang” reform announced with 2001 target

11/21 Hanwa Bank becomes first bank to receive a business-suspension order from the government in the post-war era

1997 11/3 Sanyo Securities applies for court protection

11/17 Hokkaido Takushoku Bank gives up attempt at self-rehabilitation

11/24 Yamaichi Securities ceases operation

1998 2/16 Establishment of Deposit Insurance Law and Financial Function Stabilization Law

3/31 Injection of ¥1.8 trillion in public funds into 21 large banks

10/21 Eight laws passed for Financial Function Revitalization Law and Resolution and Collection Corporation (both enacted Oct. 23)

10/16 Establishment of Financial Function Early Strengthening Law (enacted Oct. 23)

10/23 Collapse of Long-Term Credit Bank of Japan; first temporary nationalization under Financial Revitalization Law

12/13 Nippon Credit Bank shuts down and is temporarily nationalized

12/15 Establishment of Financial Reconstruction Commission

1999 2/12 BoJ adopts zero interest rate policy

3/31 Financial Reconstruction Commission provides ¥7.5 trillion in public money to 15 large banks

4/1 Establishment of Resolution and Collection Corporation (RCC)

4/11 Failure of Kokumin Bank

5/14 Kofuku Bank ordered to adopt prompt corrective measures

Appendix

Year M/D Events

11

1999 6/12 Failure of Tokyo Sowa Bank

8/6 Failure of Namihaya Bank

8/20 Fuji Bank, Dai-Ichi Kangyo Bank, and IBJ announce merger plan

10/1 Failure of Niigata Chuo Bank

10/14 Sumitomo Bank and Sakura Bank announce merger

12/14 Establishment of Civil Rehabilitation Law (enacted April 1, 2000)

12/29 Government agrees to delay lifting of “Payoff” (termination of blanket deposit protection) by one year to April 2002

2000 9/28 Startup of Mizuho Holdings (merged entity of Fuji Bank, Dai-ichi Kangyo Bank, and Industrial Bank of Japan)

10/9 Chiyoda Life applies for bankruptcy protection under Special Rehabilitation Law

2001 3/19 BoJ adopts quantitative monetary easing policy

4/1 Establishment of Sumitomo Mitsui Banking Corporation

4/1 Establishment of Mitsubishi Tokyo Financial Group

4/1 Establishment of UFJ Holdings

9/11 Terrorist attacks in U.S.

9/12 Nikkei average falls below 10,000 for the first time in 17 years

9/14 Large retailer Mycal Corp. applies for bankruptcy protection under Civil Rehabilitation Law

9/18 BoJ lowers ODR to 0.1%

11/7 Revised Financial Revitalization Law allows RCC to buy debt at market price (enacted Jan. 11, 2002)

11/12 Financial Services Agency begins on-site special inspections of major banks

11/21 Establishment of Banks’ Shareholdings Purchase Corp. and other acts limiting bank share holdings (enacted Jan. 4, 2002)

11/22 Taisei Fire and Marine files for insolvency under Special Rehabilitation Law

2002 2/15 Banks’ Shareholdings Purchase Corp. starts operation

3/1 Asahi Bank merges with Daiwa Bank (Resona Bank)

4/1 Implementation of lifting of Payoff only for fixed-term deposits

4/12 FSA announces additional loss writeoffs of ¥1.9 trillion after major bank special inspections

9/18 BoJ announces purchase scheme for bank shareholdings

10/7 Government postpones full Payoff two years to April 2005; allows permanent protection of settlement accounts

11/29 FSA Minister Heizo Takenaka announces Financial Revitalization Program and its schedule (“Takenaka Plan”)

12/11 Establishment of Financial Reorganization Promotion Law to support regional bank mergers (enacted Jan. 1, 2003)

12/11 Establishment of Revised Deposit Insurance Law including 2-year Payoff delay (enacted April 1, 2003)

12/12 Revision of laws limiting bank shareholdings in order to expand Banks’ Shareholdings Purchase Corp. (enacted Jan. 31, 2003)

2003 1/24 First negative interest rates in unsecured overnight call transactions

3/25 BoJ raises bank shareholding purchase ceiling from ¥2 trillion to ¥3 trillion

3/31 Announcement of ¥6 billion public fund injection into Kanto Tsukuba Bank, first under Merger Acceleration Law

Appendix

Year M/D Events

PIMCO Japan Ltd

Toranomon Towers Office 18F

4-1-28, Toranomon, Minato-ku

Tokyo, Japan 105-0001

813-5777-8150

Financial Instruments Business Registration Number: Director of Kanto Local Finance Bureau (Financial Instruments Firm) No.382 Member of Japan Securities Investment Advisers Association and Investment Trusts Association

Investment management products and services offered by PIMCO Japan Ltd are offered only to persons within its respective jurisdiction, and are not available to persons where provision of such products or services is unauthorized.

Past performance is not a guarantee or a reliable indicator of future results. This article contains the current opinions of the author but not necessarily those of the PIMCO Group and does not represent a recommendation of any particular security strategy, or investment product. The author’s opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. This article is distributed for educational purposes and should not be considered as investment advice or an offer of any security for sale.

Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, and inflation risk. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.

The value of assets under management will be affected by, and fluctuate based upon, movements in prices of securities in the portfolio, financial market conditions, interest rates, and credit risk arising from changes in the financial condition of issuers of securities in the portfolio, among others. Where investments are made in foreign currency denominated assets, the value of the assets will also be affected by movements in foreign exchange rates. All profits and losses resulting from investments are for the account of the investor. Thus, there is no guarantee that the principal amount of the investment will be preserved, or that a certain return will be realized; rather, the investment could suffer a loss. The fee charged for our activities related to the financial instruments business will vary depending on the investment trust acquired or the investment advisory agreement entered into, and thus these materials do not set forth specific fee amounts or their calculation methodologies.

No part of this publication may be reproduced in any form, or referred to in any other publication, without express written permission. ©2008, PIMCO

1 Approximate exchange rates as of August 2008: 1 U.S. dollar = 110 Japanese yen, 1 British pound = 200 yen, 1 euro = 160 yen.

PER038-080808

Appendix

2003 5/8 Startup of Industrial Revitalization Corporation

5/30 Resona Holdings applies for ¥1.96 trillion in public funds based on Deposit Insurance Law, Article 102

11/29 Nationalization of Ashikaga Bank after ¥1 trillion injection of public funds

2004 6/18 Establishment of Financial Functions Strengthening Law

2005 2/18 Official announcement of merger between Mitsubishi Tokyo Financial Group and UFJ

10/1 Startup of Mitsubishi UFJ Financial Group

2006 3/9 BoJ ends quantitative monetary easing policy

7/14 BoJ ends zero interest rate policy, lifting unsecured overnight call rate to 0.25% and ODR to 0.4%

12/20 Revision in Moneylending Business Law

2007 2/21 BoJ hikes rates, lifting unsecured overnight call rate to 0.5% and ODR to 0.75%

Year M/D Events