By Alexander Ross

Commentary Mar. 01, 2009 - 05:15AM JST ( 3 )

The news last week that SFCG Co, a Tokyo-based moneylender, in and of itself going bust is a big deal. With liabilities of over 300 billion yen, one yet again gets a feeling of endless replay with Japan and failing financial institutions.

For those who don’t know the history of SFCG, originally known as Shokoh Fund, the company started as a lender to small and medium-sized businesses, managed to survive during the credit drought years of the 1990s and found a bigger role for itself as lender to property developers in recent times.

Since the collapse of the incipient property bubble in central Tokyo from 2004 onwards, SFCG plainly overextended itself and found that its new clientele really had very little expertise in property development at all. So go the greedy, some might say.

However, we should be aware that there are several other big lenders on the ropes, some of whose bankruptcies would have severe ripple-off effects in this already damaged economy. 

It has long been rumored that Orix, the mightiest non-bank lender, is next in line for the ignominious fate of bankruptcy. Treading in waters where no other bank has the skill to follow, Orix has long been the lender of choice to the pachinko and love hotel industry. As is well known, many of these establishments are owned by descendants of North Korean origin. Despite being officially denied, industry players have noticed a virtual economic squeezing of the remaining Korean owners. So when bank loans fall due, banks have been demanding full repayment or sale, and the only financier to even half be interested in stepping up to the plate has unsurprisingly been Orix. 

With a stock price that has been battered down from the lofty highs of almost 40,000 yen back in 2006, Orix stock trades at a lowly price of 1,890 yen, for a trailing dividend of a whopping 11.95%. That high yield isn’t on the agenda going forward, but the company guidance remains positive, even eking out a profit in its forecast to the end of March this year. 

Now compare this company, run by a group of survivors whose continued existence has challenged the powers that be, to another one, Shinsei Bank, that could be characterized as a bunch of Wall Street con men with a sanitized balance sheet—compliments of the Japanese government, whose only real added value in banking seems to have been how to invest this cash pile in 2nd grade mortgages from the U.S. and copycat investments with their part owner fund in even worse run German real estate banks.

Orix, of course, gets fingered in the vernacular press again. Last week, Orix appeared on a list of companies where CDS prices indicate the chances of bankruptcy are close to 20%. This list of 23 companies, comprising mainly construction, real estate, consumer finance and trading companies, supposedly represents companies now on death watch.

While this CDS pricing indication may be a valid indicator of mathematical probability of a company’s demise, knowing the structure of markets, I suspect the CDS prices indicate nothing more than the desperation of the unfortunate institutions who are suffering the ruinous effects of these illiquid OTC contracts, otherwise aptly known as weapons of mass financial destruction, to get out of their exposure before their own end of March book closings.

Either way, with no further insight into the company’s financials than stock market analysts, the fact that CDS can exist in volumes way out of proportion to a company’s true debt levels and were invented to allow investors to gamble on corporate longevity when stocks play the same role means that CDS represent the tail that wags the dog. I would prefer to watch stock prices for hints of impending doom as insiders are more likely to be selling stock if a company’s fortunes really are bad.

The stock market tells a different tale. Orix has healthy volume and has not fallen to the corporate graveyard of stocks priced less than 100 yen. The same cannot be said of Shinsei, which even now languishes at 90 yen with rumors of mass layoffs and desperate last ditch cost cutting being implemented to avoid a second time around nationalization.

Is Orix really going bust like the unfortunate SFCG?

The writer is an independent investor in Tokyo.