make desirable loan targets for ORIX Bank
ORIX Bank Corporation has always been an innovator. In the late 1990s, ORIX Bank pursued a unique business approach, breaking free from the limitations of conventional banking models. It became the first bank in Japan to offer time deposits to customers via mailed application forms, and shortly thereafter, online.
Because it was not weighed down by the costs of operating branches or a network of ATMs, it could offer higher interest rates on deposits, leading it to attract JPY100 billion from individual depositors within a year and 10 months - unprecedented given the conservative nature of both Japan’s banking industry and its people.
Now, as it turns 30 this year, ORIX Bank is rolling out another innovative business model that promises to diversify its loan portfolio, attract a new set of customers and raise returns. “We call it merchant banking,” says Jun Yamagishi, Corporate Senior Vice President in charge of this strategy at the bank, “but you can think of it as an asset-light model that is a mix of investment banking, project finance and trust banking.”
in charge of merchant banking strategy at ORIX Bank Corporation
A little history
To understand the reasons for this change of direction requires some background. Over the past 20 years, ORIX Bank has turned the savings of its more than 300,000 customers - who deposit around JPY7 million on average - into real estate investment loans. These have primarily been used to buy one-bedroom and studio apartments in big urban centers such as Tokyo, Osaka, Nagoya and Fukuoka, where demand has boomed as single-person households have multiplied.
Using the large store of property knowledge built up across the wider ORIX Group, the bank can analyze Japan’s national real estate market down to individual buildings and rent levels and this has kept credit losses low.
Add in ORIX Bank’s tight cost base and its return on assets (ROA) of 0.7% compares very favorably with that of Japan’s megabanks which run 0.3% on average.
However, ORIX Bank’s returns are lower than those of many other group businesses, with ORIX Group as a whole producing an ROA of 1.96%, a figure that Group CEO Makoto Inoue ultimately wants to raise to 3%. To do its part, ORIX Bank is targeting an improvement in its asset return to 1% by fiscal 2026 - and it intends to achieve this by focusing on merchant banking.
The merchant banking model
This is how the strategy works in detail, according to Mr. Yamagishi. A new project finance department works to identify promising initiatives in two new areas - renewable energy, such as solar farms and biomass facilities; and logistics, including warehouses and distribution centers.
After conducting extensive due diligence, the bank will offer sizeable support: one recent logistics facility received JPY9 billion in financing, while a package of three warehouses in the Kansai region and Shizuoka prefecture got a JPY19 billion loan.
But these loans do not stay on the bank’s balance sheet for long. Using its accreditation as a trust bank, ORIX Bank securitizes 80% to 90% of them in the form of trust certificates. The buyers are life insurers and regional banks that are asset hungry in general (having more deposits than lending opportunities) and have a particular appetite for green and sustainable projects.
In terms of size, ORIX Bank has committed to finance JPY400 billion of renewable energy and logistics projects this fiscal year. That compares with JPY240 billion over the past two years taken together.
Benefits abound
The advantages of the merchant banking model are manifold. It allows ORIX Bank to diversify into new sectors where demand is strong and to add more corporations to a customer mix currently dominated by individual buy-to-let investors. Through securitizing the loans, it collects annual fees and frees up capital for further lending - a “capital recycling” model that is consistent with ORIX Group’s overall strategic model.
This increase in asset turnover should naturally raise returns and is aided by the fact that even the loans that stay on balance sheet are typically of shorter duration, often just four to five years compared to up to 30 years for real estate investment loans. Again, this should accelerate asset turnover and raise ROA.
On top of that, merchant banking allows the bank to build relationships with a whole new client set - the insurers and local banks that are eager to invest in its trust certificates to raise their own exposure to ESG-related projects. And while other banks are also keen to finance green and sustainable deals, ORIX Bank avoids competition that compresses margins by lending further down the capital structure, including mezzanine and junior debt.
In Japan, many local banks are actively pursuing policies to broaden their ESG investments and lending initiatives, diversifying their portfolios beyond their immediate regions. Expanding their business from their headquarters to nearby major cities is a relatively seamless process for these local banks. However, establishing a network that extends into remote regions and communities poses a considerable challenge.
ORIX Bank, on the other hand, operates without geographical constraints. This unique advantage enables it to invest and lend to renewable energy and logistics projects spanning all of Japan. Furthermore, ORIX Bank serves as a crucial link facilitating the flow of funds from local banks to support investment and lending needs in projects located in distant regions. Tapping into the knowledge of colleagues in the Group’s Real Estate and Environment & Energy business domains allows it to do so without taking on undue credit risk - a valuable synergy. In fact, so far, no project it has extended loans to has encountered a problem.
Facing the future
There are other benefits for ORIX Bank in being a part of ORIX Group. The Group’s reputation in the property sector and its pioneering role in renewable energy, initially in Japan but now also internationally, provides name recognition that helps the bank open doors. This is true both for the energy companies and utilities building renewable projects; and the many international investment and pension funds keen to invest in Japan’s energy and real estate sectors.
However, Mr. Yamagishi is clear that the bank will not finance in-house projects to avoid a concentration of risk. Given the rapid growth in both logistics and environmental facilities there are plenty of other opportunities and ORIX Bank is also researching promising new areas, from wind farms to medical facilities and recycling plants. Even single-person apartments should remain in demand as the flow of young people into the cities outweighs Japan’s otherwise gloomy demographics.
Internally, meanwhile, the bank is improving efficiency and has introduced digital workflows to eliminate the mounds of paper that are still a common feature in Japanese banks. A pivotal part of the efficiency revolution is integrating RPA (Robotic Process Automation) and VBA (Visual Basic for Applications). As of March 2023, ORIX Bank has eliminated 65,000 work hours, equivalent to the collective annual labor of 40 employees. While the banking industry sometimes uses such efficiency measures to downsize the workforce, ORIX Bank has indicated that the adoption of automation is not synonymous with reduction. The bank envisions a future where personnel will transition toward roles with higher value-added work.
ORIX Bank is also developing new, simple savings products for its deposit customers that are akin to corporate bonds for individuals. And it expects to benefit from a gradual rise in interest rates that should allow it to widen its margins.
In addition to its novel savings offerings, ORIX Bank is taking substantial steps towards addressing environmental and social challenges through its financial services. Notably, the bank is issuing sustainability bonds, with the proceeds from these bonds earmarked for investments in ESG projects. Concurrently, the bank has introduced sustainability-linked loans, a financing approach that extends better terms for initiatives aimed at fostering a more sustainable society.
These initiatives align with the rising demand for investment and financing in ESG areas by institutional investors, including regional financial institutions. By accelerating and expanding the cycle of providing funds and investment opportunities in the ESG field, the company aims to contribute to a sustainable society.
Like most 30-year-olds, ORIX Bank has gained a measure of experience but is still full of energy, and therefore looking forward to the future with confidence and enthusiasm.
