The Program on Alternative Investments, under the aegis of the Center on

Japanese Economy and Business and in cooperation with the student-run

Japan 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

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.

Program on Alternative Investments

The Program on Alternative Investments analyzes several major alternative asset classes —including privateequity, hedge funds, distressed investments, and commercial real estate —in Japan and elsewhere in EastAsia. 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 Programalso conducts cutting-edge research on these topics under the direction of Dr. Mason and with the assistanceof highly qualified research assistants. For a schedule of upcoming seminar presentations, consult the Center’sweb site at http://www.gsb.columbia.edu/japan. Dr. Mason can be contacted at mm412@columbia.edu.

Hiroshi Nakamura

Co-sponsors: HVB Group; Takata Corporation

Distressed Investments in Japan

I have been involved in theJapanese distressed business

since its inception in 1997. Overthe past six years, investment inthe distressed business has beenincreasing. For example, in 2001-2002, the total annual investmentin distressed assets was approxi-mately $5-6 billion. In just thefirst quarter of 2003, $2.5 billionwas invested into the distressedbusiness field. We expect moredistressed business opportunitiesover the next year or two. Overthe past 31⁄2 years, my companyhas invested about $1.2 billion incash and we have already collected80 percent of our investments.We now focus completely onJapan, and we employ more than70 people in our Japanese opera-tions. The distressed investmentindustry is a very quick turnoverbusiness in Japan.

Today I will focus on the size,history and dynamics of the dis-tressed investments market as wellas the Japanese government’s ini-tiatives to clean up the distressedbusiness. According to an estimateby Ernst & Young, the size of the Japanese distressed market is $1.2 trillion. But according tothe Financial Supervisory Agency(FSA), the size is only $400 billion.A third estimate by Goldman Sachsquotes the market at $1.8 trillion.Although the figures vary, thedistressed market is probably 30 percent of Japan’s GDP, andthere are major opportunities inthe business. Compared with otherAsian countries, Japan’s distresseddebt market is 12 times largerthan South Korea ($104 billion)

and 20 times larger than Taiwan($62 billion).

The Japanese distressed markethas been fueled by continuedhigh levels of insolvencies andbankruptcies. Chart I shows thecontinuing high insolvencies inJapan. The bar graph indicatesthe amount of debt held by insol-vent companies. Between 1991and 1996, insolvencies in Japanwere continuously more than $50 billion. Since 1997, insolvencies

have been more than $100 billion.

Many banks have written offtheir bad debt, yet the Japanesedistressed market continues toincrease (Chart II). For example,from 1992 to 2001, a total of $680billion in bad debts had beenwritten off. It is a huge number.Classified loan balances were$350 billion in 2001 compared to $106 billion in 1992. Bankscontinue to write off loans semiannually, but classified loan

2 Center on Japanese Economy and Business

Chart I

Chart II

II

balances continue to increase.The government is saying thedistressed debt problem is over,but the statistical numbers indicatethat the problem is still there.

I view the development of the Japanese distressed market in three phases. The introductoryphase began around 1997. At thattime, I returned to Tokyo andstarted the distressed business atMerrill Lynch. In 1997-1998, therewere very few investors fromoverseas who realized the greatopportunities in Japan. Mostbanks were unfamiliar with dis-tressed or non-performing loansales so they were reluctant tosell. As the market evolved, thegovernment decided to invest$77 billion in public money intomajor Japanese banks.

Between 1999-2001, the marketentered a more competitive phase.Foreign investors became muchmore interested, and there wasan increase in the number ofinvestors, sellers and brokers.Most major banks were selling

distressed assets to investors and transactions became morestandardized. The Resolution and Collection Corporation (RCC)(similar to the RTC in the U.S.)began to buy distressed assetsfrom sound banks, which was a shift from buying assets onlyfrom bankrupt banks.

From the beginning of 2002 tothe present the distressed marketentered into what I call “the dis-missal phase” (strong investorsenter the market and weakinvestors are forced to retreatfrom the market). FSA MinisterHeizo Takenaka and the FSAbegan to pressure the banks toclean up the NPL problem, andthe market has since become muchmore competitive because manyJapanese investors have enteredthe market. It was apparent thatonly seasoned investors couldsurvive in the market. Expertiseand experience were the differ-entiating factors weeding out thestrong and weak market players.Weak foreign investors withdrew.

The RCC began to play a largerrole by buying distressed assetsmore aggressively and becameinvolved in the corporate restruc-turing process for small andmid-sized companies. From the beginning of May 2003, anew entity called the IndustrialRevitalization Corporation (IRC),sponsored by the government,will begin to play a major role inrestructuring large corporations.

There are various participantsin the distressed investmentsbusiness, including the bankingsector, the non-bank financingsector, the corporate sector, andinsolvent companies. Increasinglyimportant investors or sellers inthis market are the government-sponsored IRC and the RCC whobuy assets, try to restructure thecorporate sector, and competewith the private sector. At thesame time, the RCC has begun to sell its own assets in bulk,which they purchased frombanks 2-3 years ago. The RCCactually bought too many assets

Alternative Investments Report 3

The Japanese

distressed market

has been fueled

by continued high

levels of insolvencies

and bankruptcies.

From left: Dr. Mark Mason, Mr. Hiroshi Nakamura, Professor Hugh Patrick

to work out by themselves in atimely manner, and now they areselling assets every quarter. Intwo or three years, the RCC ismandated to clean up its balancesheet. From the private sector’spoint of view, the RCC and IRCwill eventually become importantclients.

Due to the weak economy andthe enforcement of rigid bankinginspections, NPLs are still increas-ing, despite the massive write-offs.However, the characteristics ofthe NPLs have changed slightly.They are not as profitable as they used to be, but a sizableopportunity exists. The sellersare diversified compared to fiveor six years ago. They are notonly banks. From the investor’spoint of view, in the field ofbankrupt and “de-facto” bank-rupt companies, the distressedinvestment business is very com-petitive. It is very difficult fornewcomers to enter this marketand expect a high return andgood opportunities. So, they

need to have expertise in thebusiness.

There are new opportunitiesfor investors. One is hard realestate and the other is corporaterestructuring (turnaround busi-ness). In real estate, we see twoopportunities. One is to buy distressed real estate and realestate under management. In dis-tressed real estate it is relativelysimple for us to buy low and sellhigh. This takes up to two years.However, in real estate under man-agement, we needed to build-upour expertise, such as changemanagers and property managers.Typically, these are three to fiveyear investments. Corporaterestructuring has been favorablyaccepted as the “White Knight”in the market. Usually, we areconsidered as a vulture fund and disliked by many Japanese.The problem with this field is the scarcity of experience andtalented turnaround managers.We have not seen any proven orclear exit strategies. In the United

States there are initial publicofferings (IPOs) and sales ofcompanies, which offer us clearexit strategies. But in Japan, thecapital market is too small, imma-ture and inflexible, so we canneither expect an IPO in a timelymanner nor sell a small cap stockin the market when we wish to.Corporate restructuring is a rela-tively long-term investment. Onepositive item is the developmentof debtor-in-possession (DIP)financing. The Development Bankof Japan (DBJ) is aggressivelyproviding DIP financing for theseentities.

The RCC, IRC and the DBJ areleading the government’s initiativeto clean up the balance sheetproblems. The RCC is an experi-enced and proven organizationwith 2,600 employees. It is fullyarmed with a banking, trust andloan-servicing license. They arealso expected to contribute tothe restructuring of small andmedium size corporations, andthey are mandated to be an agency

4 Center on Japanese Economy and Business

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

Alternative Investments Report 5

Taisei Corp. Construction MizuhoTobishima Corp. Construction Mizuho *Fujita Corp. (New) Construction Sumitomo Mitsui

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 MizuhoSXL Corp. Construction Mizuho *Misawa Homes, Co. Construction UFJKobe Kiito Co. Textiles & Apparel SMBCKanebo Ltd. Chemical SMBC *Tesac Corp. Metal Products SMBCDaio Paper Corp. Pulp & Paper AozoraShowa Denko KK Chemical MizuhoUbe Industries Chemical UFJTsumura & Co. Pharmaceuticals BOTM *Japan Energy Corp. Oil & Coal Products SeisakuTaiheiyo Cement Glass & Ceramics MizuhoNKK Corp. Steel Products MizuhoSumitomo Metal Ind. Steel Products SMBCKobe Steel Steel Products MizuhoGodo Steel Steel Products Mizuho *Mitsubishi Materials Nonferrous Metals BOTMSankyo Aluminum Metal Products Sumitomo Trust *Sumitomo Heave Ind. Machinery SMBCChiyoda Corporation Construction BOTM *Clarion Co. Ltd. Electrical Machinery Daiwa *Mitsui Engineer and Shipping Transport Equipment SMBCHitachi Zosen Corporation Machinery UFJMinolta Co. Ltd. Precision Instruments SMBCSega Corporation Other Products SMBCKanematsu Corporation Wholesale BOTM *Nissho Iwai Corporation Wholesale UFJ *Mitsukoshi Ltd. Retail SMBCTokyu Department Store Retail Chuo MitsuiMatsuzakaya Co. Retail UFJOMC Card, Inc. Miscellaneous Finance UFJ *Daiei, Inc. Retail UFJ *Seiyu Retail MizuhoNippon Shinpan Miscellaneous Finance UFJ *Orient Corporation Miscellaneous Finance Mizuho *Tokyo Tatemono Real Estate MizuhoTokyu Land Corporation Real Estate BOTM *Sumitomo Realty & Developer Real Estate SMBCTowa Real Estate Real Estate UFJ *Daikyo Incorporated Real Estate UFJ *Taiheiyo Kaiun, Co. Marine Transport BOTMKansai Kisen Marine Transport SMBC

List as 30Company Name Industry Main Bank Companies

Chart III

6 Center on Japanese Economy and Business

for the resale of NPLs and hardassets to the private sector.

The IRC is a product of acompromise between the LiberalDemocratic Party and its cabinetand between the Ministry ofEconomy, Trade and Industryand the Ministry of Finance. TheIRC has no proven track record(unlike the RCC), and we do notknow its capability. The IRC ismandated to contribute to therestructuring of large corporationswith a very limited time horizonto work-out.

The DBJ was given a mandateto budget 200 billion yen for theCorporate Rehabilitation Fund.The DBJ has since invested inNippon Mirai Capital, PhoenixCapital, AC Capital, BNP ParibasJapan, MKS Partners, and theCarlyle Group.

Chart III is a list of 51 companieswhich many people believe rep-resent candidates for the IRC orRCC. Out of these 51 companies,Mitsui-Sumitomo Bank represents16 companies, Mizuho Bank rep-resents 14 companies, and UnitedFinancial of Japan (UFJ) repre-sents 10 companies. These threebanking institutions represent 80 percent of the 51 companies.This presents the banks with adifficult situation because nowthey must use the RCC or IRC towork out these large entities. Thisis a heavy burden for these banks.Most of the companies are listedon the Tokyo Stock Exchange.

There are two points I wouldlike to conclude with. First, theJapanese distressed market is huge,and it was initially triggered bythe collapse of the bubble econ-omy and further driven by Japan’s

continued poor economic per-formance. Japan needs time toclean up this situation becausedistressed assets represent 30percent of Japan’s GDP. Second,from the investor’s point of view,real estate and corporate restruc-turing offer good opportunitiesover the next two years.

Question and Answer

Q: Do you have a strategy to mit-igate deflationary pressure?

Nakamura: When we startedthis business three years ago I didnot expect the Nikkei to go downmore than 50 percent. At thattime, the Nikkei was 20,000 yen,now its approximately 7,700 yen.We are suffering from decliningreal estate values for the last 21⁄2years. Avoiding these pressures is very important to us in termsof exit strategies. Our averageinvestment life is only 17 months.When we underwrite the assets, weapply a 24 or 36-month workout.In reality, we achieved a 17-18-month workout. That has helped

us to achieve a good IRR. If wehold our investments for three orfour years, we may not achieve avery high return under a poormacro economy.

Q: How do Japanese tend to feelabout Western managers, likeCarlos Ghosn, and is there con-cern among Japanese about theradical surgery Western managerswant to impose, or do they seethem as saviors?

Nakamura: When Mr. Ghosnjoined Nissan Motors many peoplewere worried. But after two tothree years, he has become oneof the most respected managersin Japan. I think the Japanesepeople in the past have beenvery cautious about foreign man-agers, but now they have changedtheir mindset, due in part to Mr. Ghosn’s success.

Q: Why is distressed investing in Japan so heavily controlled bynon-Japanese investors?

Nakamura: Other than Orix, we do not see many competitivedomestic investors in Japan. Ithink the distressed business is aunique asset type, even overseas.In the U.S. the distressed playersare vulture funds, and financialinstitutions like Morgan Stanleyand Goldman Sachs. Retail banks,like Citibank and Chase, are notactive in the distressed market. InJapan it is the same. The bankingcommunity is not active in thismarket because of their relation-ships with their retail clients andcorporations. Only funds or biginstitutional investment bankshave opportunities in this market.

Q: The IRC has been greetedwith much cynicism. Of your list

The Japanese

distressed market

is huge, and it was

initially triggered

by the collapse of

the bubble economy

and further driven

by Japan’s continued

poor economic

performance.

of 51 companies, there seems tobe, coincidentally, a very niceproportion of clients among thethree major banking groups. Is itpossible that the IRC can do harmin the short run if they are inter-fering with the smooth functioningof this market?

Nakamura: The function of theIRC is to buy distressed assetsfrom smaller to medium sizedbanks. The main banks keeptheir debt and all the debt ownedby the other banks will be pur-chased by the IRC. The IRC is nota sponsor, but looks for sponsor-ship. They are an advising andcoordinating entity in the market.If economics works, the IRC doesnot take much risk because theIRC purchases debt from banksafter the IRC structured the exit. I think the main purpose of theIRC is to justify the transactionsto the public tax payer.

Q: Do you think the IRC will beable to convince the banks towork with them?

Nakamura: It is hard to say yesor no. The main banks are hesi-tant to work with the IRC becausethey have to take care of a majorburden for these corporations inthe restructuring process. Theywould rather deal with the pri-vate sector. In the last quarter,we were approached by severalmajor banks to work with themon a private basis in corporaterestructuring.

Q: Have you had to adjust yourreturn expectations?

Nakamura: As I mentioned, weinvested $1.2 billion over the last31⁄2 years. We have already col-lected 80 percent of this. There

is no magic, and we work veryhard to collect money. We col-lected approximately 70 percentof the money through so-called“discount payoffs”. We sit downwith the borrowers and ask themto pay back some of the money.Sometimes we ask them to sellsome of their collateral or realestate assets on a voluntary basis.If it is not successful then we doa foreclosure on the properties.In most cases (70-80 percent)things work out.

Q: When you construct a portfolio,is there a difference in the strategywhether you are dealing with alarger company as compared withmiddle-sized or smaller companies?

Nakamura: We do not have anyportfolio strategies for large com-panies because our fund size is$600 million. I believe diversifi-cation is very important in thisbusiness. At the peak we boughtmore than 3,000 loans. The largestinvestment portfolio I have isonly 3.4 percent of the total size.

Statistically, 70 percent of ourportfolio meets our expectations;20 percent of our assets per-formed much better then ourunderwriting and 10 percent ofour assets are under performing.Diversification, as I have said, is important and that is why wedo not want to deal with largecorporations.

Alternative Investments Report 7

Question and answer session

EDITOR

Joshua SafierAssociate DirectorCenter on Japanese Economy and Business

ASSOCIATE EDITOR

Dr. Yoko MochizukiProgram OfficerCenter on Japanese Economy and Business

PHOTOGRAPHY

Joe Pineiro

DESIGN/PRODUCTION

Melanie Conty

CENTER ON JAPANESE ECONOMY AND BUSINESS

Columbia Business School321 Uris HallMail Code 59983022 BroadwayNew York, NY 10027Phone: (212) 854-3976Fax: (212) 678-6958Email: cjeb@columbia.eduhttp://www.gsb.columbia.edu/japan