DCM 2006 - Fewer players, newer dynamics
In Japan, where the number of major underwriters fell to just four after the October merger of Mitsubishi-Tokyo Financial Group and UFJ, a new era of rising interest rates and regulatory changes have injected fresh dynamics into the game of sizing up the markets. Brad Frischkorn reports.
With much of Japan now switching back to growth mode, it comes as no small relief that the domestic primary issue market is poised to grow again. Fiscal 2005's ¥11trn in new corporate, municipal, and agency paper included some ¥6.2trn in straight bonds from listed companies, a 5% rise year on year and the first increase since 2001. Subtracting financials, some experts say the domestic bond count could rise by 20% in 2006.
The historic termination of the BOJ's super-easy monetary policy is seen as one stimulus to this effect, as it officially opened the door to potentially higher interest rates. Indeed, through the first quarter of the calendar year, a flurry of corporates was seen coming to market ahead of the central bank's March 9 announcement. Buyers were greeted with a rare palette of choices as big-ticket offers from the likes of MUFG (¥150bn) and Sony (¥100bn), as well as first-time deals from Fuji TV and E*Trade Securities (¥50bn each), and even Triple-B rated, triple-digit spread paper all printed within a few weeks of each other.
"Fear of higher rates will continue to push the domestic market as DCM financing lures some borrowers away from loans," said one Japanese fixed-income head. "We'll see more 30 and 40-year paper, especially on the agency and municipal sides."
Bond yields are already headed up; five-year JGBs are at their highest level in six years, while late March saw the 10s break 1.80% for the first time since August 2004. The Ministry of Finance is telegraphing the first-ever 50-year sovereign bond. Players are now focused on when the central bank will end its zero interest rate policy; many say it could be as early as this summer.
Among the larger houses, Nikko Citigroup has made more noise than most with high-profile additions to its Tokyo staff, most of whom started during the first quarter of 2006. Its obvious belief that Japan will be an important source of revenue has seen it move senior staff on both the primary and secondary sides to Tokyo from New York and Sydney as well as recruiting locally. Talk is that at least another dozen hirings are in the pipeline.
Some of the new talent reflects the firm's perception that corporate takeover activity will continue to increase, and that the LBO industry will develop, possibly leading to a viable high-yield market. Successful cross-border deals have already been concluded this year between Toshiba and Westinghouse, and between Nippon Sheet Glass and Pilkington Plc. SoftBank's ¥18trn bid for cell phone carrier Vodafone Japan was far and away the largest Japanese LBO offer ever seen.
Among Japanese corporates, all of this has been made possible by years of cross-shareholding de-leveraging, improving credit levels and reduction of interest-bearing debt. Lingering inefficiencies have also been addressed and limited growth opportunities at home are improving.
Brian McCappin, MD and Nikko Citigroup's co-head of fixed income, sees much of corporate Japan coming up for sale. "Japan has the benefit of lower financing rates, higher leverage multiples and greater potential upside in equities three to five years out. There are still efficiencies to be extracted, and managers will want to outperform stocks under private management."
A stage-by-stage build-up to high-yield market development may start with corporate credit repricing based on ownership structure rather than fundamentals. The issuance of new high-yield credits then allows for a mapping of a curve, after which credit is repackaged, as was seen in Europe and the US from 2003 with CDO and CLO products.
The doctrine has its naysayers. "The high-yield market for bonds will begin with a high-yield market for loans: right now the secondary market in that sector has got to pick up for it to work," said Yosuke Inaida, executive director at Nomura's debt syndicate. "Triple B financing is easier now than a few years ago, but so illiquid that the choices and comparisons are not yet there to stimulate trading."
Other bankers also expressed doubt that Japanese investors have fully awakened to the possibilities of the broader high-yield picture.
On the international circuit, yen-denominated bond issuance has been bullish for the last few years, although the numbers have started to flatten lately at the ¥4trn per annum pace. Among Euroyen, Global yen and Samurai markets, the last remains the most dynamic and volume rose dramatically from ¥776bn in fiscal 2003 to ¥1.6trn in fiscal 2005.
While the new year got off to a promising start with Hyundai Capital Services' (HCS) ¥60bn offer, the quarter as a whole did not represent a sterling follow-through from 2005, despite underlying conditions that begged for more supply.
Each of the issuers that did appear managed to pull off upsized deals, including first-timer and BB+/Baa3/BBB rated Export-Import Bank of India, which went for an extra ¥3bn to top off its originally-mandated ¥20bn. The Republic of Hungary also walked away with ¥50bn, double its initial target.
On both domestic and international sides, however, clouds of doubt over the implementation of Japan's new paperless book-entry transfer system (BETS) are seen holding back issuance until some key issues are resolved. While the system was expected to lower costs for both issuers and investors through reduced custodial fees and tax exemptions, the lack of uniformity in the fee structure caused turmoil among corporates at home.
International issuers, particularly US-based financials, have also been rankled by friction between the IRS and Japanese tax authorities over BETS and conformity with the US Tax Equity and Fiscal Responsibility Act (TEFRA) over certification of bond ownership. Unlike Euroclear's service, Japan's system carries no need to identify the final beneficiary.
Bankers who have been keenly following the issue are aware of the implications, however, as US financials together comprise the meat of the Samurai market. "We can always quote the line: 'they'll have it fixed by 2007', but if issuers don’t buy it, they could go away anyway," said one Japanese origination banker.
Others have warned that any disruption in the funding cycle could trigger a feast-to-famine phenomenon harmful to the market.
Most observers seem to be hopeful that the problems will be solved in a timely fashion, although as of April, the situation remains deep in limbo. Mizuho's David Rudd said of the situation: "I can't imagine that a solution won't be found: Too much business is at risk."
For niche players, Japanese banks, eager to rebuild their balance sheets and restore core capital after years of bad loan cleanup are providing business opportunities. Nowhere was this better illustrated than with Merrill Lynch, which ran joint books for all three tranches of a successful triple currency (US dollar/euro/yen) step-up subordinated SEC-registered perpetual preference share for MTFG Capital Finance in March, which generated proceeds of almost US$5bn equivalent.
The deal followed Mizuho Financial Group's Tier 1 non-cumulative US dollar/euro perpetual non-call 10-year (JPMorgan/Mizuho), and Shinsei Finance's US$775m Tier 1 trade of similar maturity (Morgan Stanley/Goldman Sachs/Shinsei), which drew some US$10bn of orders.
"Now that many of their challenges are behind them, banks are placing more of their focus on how to grow their businesses by using strengthened balance sheets and capital bases," said Ken Niimura, DCM head at Merrill Lynch. "Ours is not a product-push business, but rather a solutions-based business. In that sense we look forward to more cooperation, rather than direct competition, with big Japanese banks.
The total bank cleanup picture is not yet over; struggling Resona and Chuo Mitsui Trust, among others, are also short-list candidates being offered balance sheet help. Refinancing for existing perpetuals may also start as early as 2008.
Merrill Lynch's Niimura went on to cite acquisition finance as the key product focus going forward, singling out general trading companies as major purchasers of oil and coal field rights, as well as associated business lines in refining and infrastructure. All of which may spur risk-hedging opportunities in other areas such as price, currency, and country exposure, he said.
Japanese firms, in fact, may brace for a new takeover storm after more corporate laws designed specifically to facilitate M&A activity take effect in May, giving managers more latitude in making strategic decisions. Next year, laws will be further eased to allow triangular mergers, in which foreign firms seeking to merge a Japanese subsidiary with another company may use their own stock as compensation.
The general consensus of the likely result of such regulatory changes is that cash raising by and for M&A activity can only positively impact yen-based DCM business.
"Even companies that want to avoid being taken over are better off with maintaining high dividend yields, a high stock price, and a high level of debt," said one banker. "The combination presents a more difficult takeover target. As it is still a low-yielding currency, issuing debt in yen should remain a good idea for the time being."