Tokyo, Jan. 19 (Bloomberg) -- Japan, reeling from a depressed stockmarket and moribund economy, doesn't need any more bad news. It's going to get some from a familiar source, analysts and investors say:the construction industry, where bankruptcies rose 20 percent last year tothe second-highest number on record. This year may be even tougher, as a slew of bank mergers and newaccounting rules may pressure lenders to pull the plug on morecontractors. A slowdown in public works spending is likely to speed theday of reckoning. The crunch won't occur without controversy, as construction firms accountfor 10 percent of Japan's nonfarm jobs and have been coddled bypoliticians and lenders. Still, ``the industry has long been ready for ashakeout,'' said Nobuaki Kurisu, a fund manager with Sumisei GlobalInvestment Management Co. Some names on the endangered list: Arai-Gumi Ltd., Fujita Corp.,Nakano Corp., and Ichiken Corp. All four have interest- coverage ratiosaround one, meaning their annual interest payments are about equal totheir operating profit, according to Nomura Research Institute. Japan's economic slump helped push an estimated 6,000 constructionfirms, many of them small regional operators, into bankruptcy last year,according to Teikoku DataBank, a financial information service. That wasthe most since 1984 and about 30 percent of all firms going belly up inwhat was a record year for Japanese bankruptcies.
Bad Loans
Contractors are in trouble largely because of debt accumulated in the1980s to buy land, golf courses and other investments and a subsequentplunge in real estate prices in the early 1990s. These losses will come to light in the fiscal year starting in April, as thenew rules require companies to account for real estate up for sale atcurrent market value, rather than previous purchase price. The failures are digging a hole for Japan's lenders. After real estate, loansto construction companies are the biggest source of bad debt for banks,according to HSBC Holding Plc. About 1.4 trillion yen ($11.8 billion) worth of debt, or roughly 11 percent ofthe 16 biggest Japanese banks' bad loans, is owed by constructioncompanies. The industry accounts for about 5 percent of total banklending, HSBC said.
Off the Hook
Japanese banks have been letting some contractors off the hook out ofconcern that more failures in the industry could batter the broadereconomy. Last year, banks waived 615.6 billion yen owed by four publicly tradedcontractors. That includes 430 billion yen in debt forgiven for KumagaiGumi Co. in December, Japan's biggest-ever debt waiver. ``Japanese banks tend to consider the political issues surroundingcompanies,'' said Brian Waterhouse, an HSBC analyst. ``They are likelyto be considering the effect that the company's bankruptcy would have onthe employees and the local society.'' The country's biggest banks also have traditionally supported businessborrowers through the so-called ``main-bank'' system, in which one bankprovides most of a company's financing as well as management advice. Kumagai Gumi With Japan's biggest banks merging, such traditional ties may loosen.The drive for greater profits that is fueling the mergers also will causebanks to be more aggressive in dumping poor credit risks like ailingconstruction companies, analysts say. Kumagai Gumi is an important test case for proponents of bailouts. Thecompany, which built the Bank of China building in Hong Kong and otherAsian landmarks, has lost money for seven years. The debt waived by itsbanks in December accounted for 38 percent of its total loans of 1.12trillion yen. ``With 600 billion yen (in debt) still left, the company has not returned to acompletely healthy state,'' said Daisuke Fukushima, a Nomura ResearchInstitute analyst. ``The 600 billion yen accounts for 40 years of theircurrent operating profit.'' Cutting Costs Kumagai Gumi expects to improve earnings and reduce debt under a 12-year restructuring plan announced last September, said companyspokesman Tomoyuki Shibayama. Even with the number of its projectsdecreasing, he said, the company's turnaround plan is ``realistic.'' Kumagai Gumi's stock -- which traded as high as 2,050 yen in 1989 --closed Thursday at 35 yen. Other construction stocks that trade for lessthan 50 yen include Fujita, Hazama Corp., Tobishima Corp., and AokiCorp. Fujita, which won a debt waiver of 120 billion yen in 1999, is confident itcan survive, said company spokesman Nobuyuki Ushirogouchi. YoshinoriMimura, a spokesman for Ichiken, said his company can repay its debtand is trimming costs through job cuts. Nakano said in a written statement that it has been successful in cuttingcosts and debt since 1997, though it acknowledged it is being squeezedby competitive contract bidding.
`Very Tough'
Arai-Gumi, considered by Nomura Research Institute as one of the firmsleast able to repay its debt, isn't as confident. In August, the residentialbuilding contractor unveiled a six-year plan to cut 10 percent of its parentworkforce in two years and slash parent debt by 30 billion yen in sixyears. ``Honestly speaking, things are very tough for us,'' said Masafumi Murase,an Arai-Gumi spokesman. ``Our restructuring plan is not going forward asplanned, and it seems unlikely that we will meet our goals.'' He declinedto give new projections. Even those contractors that get debt waivers may not survive. For one thing, the industry is shrinking: Its revenue slumped 13 percent inthe past five years to 70 trillion yen, according to Japan's ConstructionMinistry. ``Banks forgave by halves, hoping that the economy would pick up by thetime the companies ran out of money,'' said Daisuke Fukushima, aNomura Research Institute analyst.
Government Tightens Belt
That hasn't happened, he said, and some contractors, even after waivers,remain saddled with so much debt ``they can't possibly revitalize.'' To make matters worse, the government is tightening its purse strings. Itplans no increase in public works spending in the new fiscal year fromthis year's 9.4 trillion yen. It also is cutting provisional funding for extrapublic works to 300 billion yen from 500 billion yen in the past two fiscalyears. Hazama and Fujita derive about 39 percent and 30 percent of their sales,respectively, from government orders. Officials also are threatening to crack down on spending seen aswasteful. In November, the ruling Liberal Democratic Party said it wouldcancel 210 stalled public works projects amid criticism that taxpayers'money was being wasted on unneeded dams, rural roads and landreclamation. While healthier construction companies may consolidate to strengthentheir survival chances, there's little incentive for stronger construction firmsto pick up weaker ones, analysts say. That's because the weaker firms have few assets a buyer would want,said Till Vestring, a vice president with consulting firm Bain & Co. inTokyo. ``It's going to be a political game about how many get closed down andhow many get saved,'' Vestring said.