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Morningstar | Acom’s Kabarai Provision Won’t Prevent Mitsubishi UFG Financial From Meeting Its Full-Year Guidance. See Updated Analyst Note from 22 Apr 2019

Mitsubishi UFJ Financial Group’s (MUFG) 40%-owned Acom announced it is provisioning an additional JPY 39.4 billion for future losses on claims of overpaid interest, or kabarai, resulting in a loss of around JPY 15 billion in the March quarter. For MUFG, Acom’s provision should mean additional costs in the March quarter of around JPY 10 billion recognized as “other non-recurring losses” rather than as credit costs. We do not see the loss as likely to put MUFG’s achievement of its full-year net profit guidance of JPY 950 billion at risk because MUFG has already earned JPY 872 billion, or 92% of its goal, in the first three quarters of the year.

Acom’s decision to increase its kabarai provisioning is a small negative surprise relative to our expectations at the beginning of the year. Acom started the year with a reserve of JPY 104 billion for kabarai payments and we had thought that it would probably not need to make further provisions because new claims would peter out well before the JPY 104 billion reserve was exhausted. However, more than 20,000 new claims were filed in the April-December period, down only 25% year on year, and if the current pace were maintained with no reduction, Acom’s existing JPY 104 billion reserve would only last until December 2021. Hence, given the risk that the reserve could be insufficient, Acom is increasing its provision.

Acom’s move suggests the possibility of a similar decision by Sumitomo Mitsui Financial Group’s (SMFG) SMBC Consumer Finance business, which operates under the Promise brand name. Promise started the year with a kabarai reserve of JPY 109 billion (down to JPY 84 billion by December 2018), so it too only has until around the end of 2021 at the current pace of new claim generation. Like MUFG, SMFG already achieved 91% of its full-year profit guidance in the first three quarters, so even if Promise decides to make a similar provision, it should not put at risk SMFG’s achievement of its guidance.

The kabarai claims are the legacy of a so-called “grey zone” between 20% and 29.2% that existed prior to a revision of the Money Lending Business Act enacted in December 2006. Before the legal revision, Japan had two contradictory laws regulating maximum interest rates: one making it a criminal offense to charge interest rates above 29.2% and another one in principle capping interest rates at 20% but leaving a loophole that the lender could charge more than 20% so long as the borrower voluntarily agreed to pay the excess interest.

Prior to 2006, there was an industrywide practice for moneylenders to obtain written consent from borrowers to charge more than 20%, but the validity of this practice was overturned by an unexpected Supreme Court decision in January 2006. After the decision, some law firms began advertising prominently to attract borrowers seeking refunds of all interest they had ever paid above 20%. These huge refunds, together with the new law placing the maximum interest rate between 15% and 18%, dramatically affected the industry, leading to the bankruptcy of market leader Takefuji in 2010 and a close call by major lender Aiful, which entered an alternative dispute resolution process in 2009 and avoided bankruptcy with the support of its main bank Sumitomo Mitsui Trust. Formerly independent Acom and Promise agreed to become part of MUFG and SMFG, respectively, around the same time.

The reason that we previously saw Acom’s reserve as sufficient is that there is a 10-year statute of limitations on making a claim which starts from the borrower’s last transaction date. Most borrowers who paid grey-zone interest prior to 2006 have presumably already filed claims, so new claims that arise now come from plaintiffs that continued to maintain a loan balance and never filed a claim. The incentive for law firms to advertise to find such borrowers is diminishing over time as the number of potential plaintiffs diminishes, so although new claims won’t disappear entirely, within the next few years they should fall off substantially, and there remains the possibility of Acom writing back part of its reserve in the future.