Euroweek Japan report: international issues

Euroweek – Japan capital markets report, October 2011

Late September was a miserable time in global capital markets. Stock markets were falling; all news from the eurozone seemed to be bad; and the IMF annual meeting was punctuated by disappointment at a lack of clear leadership, and a generally toxic mood. Yet in its slipstream, Development Bank of Japan opted to launch a bold US$1 billion five-year bond issue.

The result was positive: a coupon of 1.625% and a yield of just 45 basis points over mid-swaps. Both borrower and bookrunners – HSBC, JP Morgan and Nomura – were delighted, and Japanese agencies had once again proven that the world sees them as safe havens, a welcome diversification away from the challenges of Europe and the USA.

It is perhaps surprising that this should be the case. Japan’s debt to GDP, at over 200%, is among the highest in the world, and is clearly going to become a challenge even if the vast levels of Japanese savings prevent it being a problem today. Japan is still working out a path to recovery from the terrible Great East Japan Earthquake in March, and has not yet passed the multi-trillion yen budget it is expected to need. It has been downgraded twice this year, and until recently had to wrestle with political uncertainty as well, until Prime Minister Noda brought some welcome direction to government. It seems an unlikely safe haven. But it’s not Europe, and it’s not America, and those are two vital commodities at the moment. “It’s a geographical thing,” says Gyo Sato, in the treasury department at DBJ. “It’s not Europe. It’s not the USA.”

Partly this may also have to do with scarcity. “There is a lot of media use of the term safe haven,” says Alexandre Sautour at BNP Paribas. “When you look at the reality of things, Japan remains the country with the highest debt to GDP ratio, yet the yen continues to be perceived as a safe haven in the international community. I think it’s fair to say there is a shortage of Japanese name issuance in the international market, and the rarity means investors are attracted as a diversification play. Rarity of issuance is really the key here.” Correspondingly he expects more of the same. “We’ve seen these deals print regularly inside guidance, and with a reasonable amount of interest from investors.”

And it is, after all, a select handful who can access this liquidity in these markets. “Issuers like DBJ, JBIC and JFM are the most sophisticated investors in Japan,” says Minoru Shinohara, senior managing director, investment banking at Nomura. Shinohara had been at the Washington IMF meeting and had a clear sense of just how bad the mood was. “But we talked with DBJ; it is sophisticated enough that once it sees the small window, it can go through it, as the quality is there.” DBJ was alongside KfW and UK Gilts in raising capital that week. “They are leaders in the market: professional enough to go out when it’s very stormy and to see some bright sky in the storm.”

Sato says the DBJ deal attracted just over US$1.1 billion of demand, which does not appear well covered, but bookrunners say this was a function of closing the book almost as soon as capacity was reached in order to avoid allocation problems. In any event, the DBJ issue, along with the two US$2 billion JBIC jumbos (see box), and JFM’s US$1 billion deal in January (see muni section), clearly show the continuing appetite towards Japanese agency paper.

JBIC still has budget for a further US$3.2 billion of issuance this financial year; for DBJ’s part, Sato says the agency has budget for Y150 billion of international government-guaranteed issuance, which would imply room for another deal of a similar size to the one just completed, “but we haven’t yet decided on any additional issue. We are going to consider that depending on our asset demand and the market situation.”Much will presumably depend on demand for DBJ’s services. “We are now conducting the crisis response business for the clients damaged by the earthquake, as well as our ordinary business. So depending on the development of those businesses, we will decide our bond issuances for the rest of this fiscal year.”

He adds: “We are always looking at the international capital markets, both government-guaranteed and non-guaranteed bonds, in every currency, but under the current market situation, mainly in US dollars.”

Outside the agencies, the banks have also found a favourable response when they have attempted to issue internationally. SMBC has been the standout in 2011, raising US$2 billion  in July in a three-tranche fixed and floating rate bond issue, following a US$1.5 billion issue in January. One of the most significant elements of the July fund-raising was that it incorporated a floating-rate element for the first time.

Other banks have been less active: Bank of Tokyo-Mitsubishi UFJ has raised twice, for US$1 billion in February and US$544 million in January, while Nomura has also raised funds through its holding company and a European vehicle, but Mizuho has been curiously absent. “Banks have been fairly quiet recently, but we expect they will come to the market,” Sautour says. Increased expectations of bank liquidity should be a prompt for further issuance, but changing bank regulation may instead have a bigger impact on corporate issuance. “Basel 3 regulations mean that banks will probably have to downsize their balance sheet and reduce lending, and as a natural consequence corporate borrowers will have to turn to the capital markets to meet their funding requirements,” Sautour says.

The corporate issuers are a tricky sector to read. Much has been made of the strong yen prompting Japanese corporations to look overseas for acquisition targets, particularly since asset values are subdued in Europe and the USA; so far it has been more theory than substance, but if it starts to happen in earnest, that could boost international issuance from the corporate sector. Auto funding vehicles Toyota Motor Credit and American Honda Finance are perennially active, but the only standout example of pure corporate financing in the international debt markets lately is Mitsubishi Corps $500 million raising in early September.

“We saw Mitsubishi Corp in September. However, since Japanese domestic markets have been very stable with new issue spreads trending at historical tight levels, there are no strong incentives for Japanese corporate issuers to tap international markets unless they need to use the money in the international arena,” says Reiko Hayashi, head of Japan DCM at Bank of America Merrill Lynch. “There are many discussions about how cross-border M&A should be happening because of the highly appreciating yen. However, issuers would normally fund in yen and conduct foreign exchange. Japanese banks are very happy to provide highly competitive yen loans.”

Theodore Lo at RBS takes a similar view. “The hard pill to swallow is the actual cost,” he says. “The management at companies [potential issuers] will be trying to justify that. Mitsubishi Corporation got over that hurdle; others are waiting for a better window.” But he describes the combination of a strong yen, depressed international asset prices and cashed-up Japanese corporations as “a once in 10 years situation” that ought to drive M&A.

For the future, though, Japan’s macro conditions are not going to go away, and it is an open question how long it takes before it becomes a potential difficulty. “Japan is a long term problem, and people are not thinking it will be a problem in the next few years,” says Shinohara at Nomura. “But it won’t disappear, and the government has to tackle it – and Prime Minister Noda is already showing some leadership in the right direction.”

Others take a darker view. “Net net, Japan is still cash rich, because the savings of the households and corporate sector exceeds the total borrowing of the public sector,” says Seiichiro Miyaoka, head of debt capital markets at UBS. “According to some researchers, this surplus may last for about two years. After that, if the deficit exceeds the savings, and the Japanese investor cannot sustain the supply of JGBs, the supply and demand for JCBs may change.” And that, unarguably, would be bad news for Japan.

BOX: JBIC

Japan Bank for International Cooperation (JBIC) is the heavyweight of Japanese agency borrowers. Above all others, it is the name whose international bonds investors flock to when they want to play Japan as a safe haven.

“JBIC has clearly come out as the benchmark for Japan in the last five years,” says Theodore Lo at RBS. “It has emerged as the dollar representative for Japan.”

Twice this year, JBIC has proven its strength as a borrower in jumbo issues in increasingly difficult market conditions – and it is likely to need to do so once more in still more trying circumstances.

In May, it raised $2 billion in a five-year global through Bank of America Merrill Lynch, Barclays Capital, Citi and HSBC, with a 2.5% coupon, and pricing of 45 basis points over mid-swaps. The deal came not long after the devastating March earthquake, and the subsequent rating downgrade on Japan, yet received over $5 billion of demand, allowing price guidance to tighten. The deal was seen not only as a statement of support for JBIC, but for post-earthquake Japan itself, and therefore had a far broader importance than just JBIC’s own fundraising. This deal was dominated by Asia, which accounted for 60% of the book; and – by investor type – by central banks and official institutions, also accounting for 60%.

In July it raised a further US$2 billion in a global five-year deal with a 2.25% coupon, pricing at 34 basis points over mid-swaps, and led by Bank of America Merrill Lynch, BNP Paribas, Daiwa and JP Morgan. Bookrunners said the deal attracted more than $3.4 billion of orders from over 100 institutions. Bookrunners also put distribution at 38% Europe, 36% Asia, 15% Middle East/Africa and 11% North America, with central banks accounting for 44% and banks 39%.

It all clearly demonstrates the continued attraction Japan holds for international investors despite its own problems. “We were worried about how investors would see the credit of Japan and JBIC, especially with regard to our first issue,” says Takeshi Sakamoto, division chief for the capital markets and funding division at JBIC. “Soon after the earthquake, we were not sure how investors would see us. But when we went to the market in May, it was a very successful issue, attracting large demand. I thought it was due to investors seeing Japan’s credit as no problem, as a safe haven, and because it offered geographical diversification.”

Is he surprised Japan retains that safe haven status despite its own debt position? “Of course Japan has a huge fiscal deficit, but at the same time it has a large current account surplus, and most of the buyers of Japanese government bonds are domestic Japanese,” he says. “The market thinks it will be no problem. They want to diversify their portfolio away from Europe and America to Japan.”

JBIC is little affected by the soaring yen, since about 80% of its loans are denominated in US dollars anyway. And its remaining borrowing for the year is likely to stay in that currency. JBIC has a total budget of around US$7.2 billion for government guaranteed bonds in the international market in this financial year, so still has $3.2 billion to go, depending on its funding needs. “Considering the current basis swap rate, it is difficult to issue in euros, and considering the size, it is also difficult for us to issue in other currencies,” he says. “So probably it will be US dollars if we go to the markets in the coming months.”

The last four deals from JBIC have been five years, and Sakamoto says he “would like to diversify that tenor. But at the same time, considering current investor demand, the yield on shorter term bonds is too low. If possible, we may seek longer maturity than five years, but in volatile markets, it depends on the timing of the situation.”