Japan firms face credit crunch as crisis hits home

TOKYO (Reuters) - The global credit crunch is starting to chill lending in Japan, squeezing companies that have so far escaped the worst of the crisis gripping the much of the industrialized world.

With credit markets seizing up and banks cutting back lending, small businesses, which together employ about 70 percent of the Japanese workforce, could suffer the most, analysts said.

This credit squeeze pales in comparison to crisis that gripped Japan in the 1990s after a stock and property bubble collapsed. But the timing could not be worse, with Japan in recession, exports crumbling, and the risk of deflation rising.

For much of the credit crisis sparked by U.S. mortgage defaults in last year, Japan has been an oasis of calm; its banks and investors serving as a vital source of liquidity for credit-starved companies around the world.

That began to change in September when the crisis wrecked banks from the United States to Iceland and spread panic among investors, triggering a stock market crash in Tokyo.

Japan's corporate bond market has almost seized up after U.S. investment bank Lehman Brothers (LEHMQ.PK) and Kaupthing KAUP.IC, Iceland's largest bank, defaulted on yen-denominated Samurai bonds, the first Samurai default since Argentina in 2002. The defaults shocked investors who had favored Samurais, or yen bonds sold in Japan by non-Japanese borrowers, because of their customarily strong credit ratings.

The collapse in global stocks also sapped their appetite for risk. Japan's Nikkei share average .N225 plunged 24 percent in October, its biggest fall in its 58-year history.

"They've taken on too many credit risks and got burned. They can't take on more credit risks," said Takeo Okuhara, economist at Daiwa SB Asset Management.

Until September the Japanese bond market was one of the few funding sources available to Western banks wounded by credit market losses.

Over the past two years, an average of about 750 billion yen ($7.87 billion) of corporate bonds were sold every month. Nearly one trillion yen worth of bonds were issued in September alone.

But new issues have dwindled over the past few weeks.

As of Thursday, eight utility companies had sold a total of 225 billion yen of bonds in the past two weeks after a one-month lull in issuance from private corporate bonds.

BANKS CAUTIOUS

While there are some signs that issuance is recovering, companies with low credit ratings will likely struggle to raise funds via the bond market, analysts said.

"Investors are not buying bonds unless they are issued by companies with high credit ratings, said Okuhara.

Credit default swaps, used to insure bonds against default, show the fear of defaults is rising. The five-year iTraxx CJ index -- made up of credit default swap spreads on 50 Japanese investment-grade companies -- rose to 330 basis points on Thursday, matching a record high hit in late October.

"Because the issuance of bonds has virtually stopped, companies are rushing to banks. But banks can't increase their loan portfolio all of a sudden, so they are selective in lending," said Soichi Okuda, chief economist at Sumitomo Shoji Research.

"As a result, some companies may have to delay their new spending plans," he added.

Bank of Japan data show lending to small firms dropped 3.2 percent in September, the largest fall in 3- years.

Some analysts said the number may be exaggerated because of cut backs in loans to real estate investment trusts.

BOJ board member Seiji Nakamura said this month that Japanese banks' approach to lending is turning cautious after domestic share prices plunged in October. The three largest Japanese banks have been forced to raise cash to replenish capital wiped out by stock market losses.

With conditions in the commercial paper market also tight, speculation is rising that the central bank Japan may increase its commercial paper buying operation.

The situation is not as dire as the crisis that started in Japan in late 1990s. Bank lending kept falling for seven years as banks sold off bad debts. Debt-laden Japanese companies cut back on borrowing.

"At that time, Japanese banks were facing the threat of bankruptcy themselves, so they were trying to reduce loans sharply. That is not the case today," said Takumi Tsunoda, senior economist at Shinkin Central Bank.

($1=95.2 yen)

(Additional reporting by Rika Otsuka)

(Editing by Kazunori Takada)