Friday, 18 January 2019

Mixed FIG fortunes in Japan

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  • Basis against dollar/yen and 10y JGB

By the middle of June, the Samurai market was in a healthy state and looking ready to challenge established records.

Having recovered from the devastating March 11 earthquake, the relatively stable Japanese fixed income market was attracting a wide range of overseas financial institutions, its insulation from the deepening world problems offering a rich seam of investor diversification. Sentiment soured quickly, however, and the dream of accessing the market is now a distant memory for many.

Global FIGs stormed the market in June, with European banks at the helm. As these financial institutions offered Japanese investors a better investment opportunity compared with what was otherwise available amid shrinking domestic primary supply, buyers lined up to take advantage of the pick-up on offer from well-known high-grade Western FIGs.

The global sell-off in the aftermath of S&P’s downgrade of US debt to AA+ and the intensifying market talk surrounding European banks, coupled with the ever-worsening European sovereign situation, catapulted these volatile Western credits into the headlines. And as they fell out of favour with the cash-rich Japanese investor base, the Samurai market almost dried up completely overnight. 

In mid-September, overall Samurai issuance – the core funding tool for foreign borrowers in Japan – stood at slightly over ¥1.75trn (US$21.4bn) from 64 tranches, according to Thomson Reuters data, or about 85% of last year’s volume. While this was already more than the ¥1.55trn seen in the whole of 2009, more had been expected, especially from the financial sector.

The right conditions

In the middle of June, the market appeared to be offering the ultimate win-win scenario and this led to the largest monthly issuance volume since the FIG rush in September 2010. European banks were relatively new to the game, having only recently entered the yen market, traditionally a happy hunting ground for US banks – at least until the collapse of Lehman Brothers in 2008.

However, a wave of negative events then conspired to derail several would-be notable deals. The perceived aggressive approach of Societe Generale, which saw it pin pricing down to a single number early on – an unusual mode of operation in this market that left it no room to manoeuvre when Moody’s placed it on review for downgrade – meant that the bank had to postpone its Samurai debut. Meanwhile, Bank of America’s last-minute cancellation of the ¥48bn multi-tranche self-led transaction that would have marked its first appearance since 2007 left bitter after-taste. However, while these events dented sentiment, they did not stop the FIG fundraising in yen entirely.

What really stopped the investment flows was the significant deterioration in the major offshore markets following the sell-off after the US downgrade.

With almost no tolerance for headline risk, Japanese investors watched in agony as overseas FIG secondary yen levels pushed out as a result of worsening global sentiment and worries about these institutions’ exposure to peripheral European sovereigns. Even so, there were no mass liquidations, although part of this could be explained by a relative lack of liquidity.

“The US and European FIGs’ spreads are at pretty wide levels, secondaries are wide, CDS are wide. Everything outside of yen is wide, making it tricky for investors to bite. It would make accounts question the reasons behind such wide-level funding and make it seem a desperate measure, in turn deterring them from buying even more,” said one Tokyo-based syndicate head at a foreign house.

“On the other hand, unless the top-tier European banks are really in serious need of funds they would not come out, say, at yen swaps plus 300bp. They would first approach their home markets through the likes of the tighter covered bond issuance we have recently seen, or other try funding methods.”

Prior to the market freeze, well-recognised top-tier banks, such as RBS, Barclays, Credit Suisse, Deutsche Bank and UBS were suggested as potential candidates. Some had even soft-sounded the market earlier on in the year – sometimes on more than once occasion – to gauge investor interest. 

“The issuing conditions are not excellent for FIGs; there is just too much headline risk and Japanese investors can’t take it. Some might still be willing to buy, but then there is the reputational side to a deal: would there be enough demand to convince a global FIG to issue? It may be way below what a FIG issuer considers to constitute a public benchmark trade, as the yen market has its own dynamics,” said a syndicate official at a Japanese bank.

The Samurai pipeline has also dramatically lightened because of the increased funding costs of swapping out yen proceeds due to the US dollar/yen cross-currency basis swap’s free-fall. However, levels have somewhat recovered to the mid-minus 60s from the minus 73bp historical low reached in August for the most frequently tapped five-year maturity.Even so, this is more than a 10bp drop from the minus 53.875bp of August 5.

Foreign borrowers closely track the five-year swap, with a lower number meaning they need to pay a higher premium to swap the proceeds into floating-rate US dollars. The five-year US dollar/yen basis has been in sub-50s territory since about November last year, adding pressure to the funding costs of foreign issuers borrowing in yen.

“The deteriorating basis was a bigger factor and more worrisome for the Samurai market than the negative sentiment in equities in the week after the US downgrade,” noted Kazuhide Tanaka, head of long-term funding for Japan at Rabobank.

Aside from some of the previously rumoured names, banks from Scandinavia may offer some safe-haven appeal, according to DCM bankers, Nordea Bank for one having previously been touted as a potential candidate. Elsewhere, highly rated Rabo is also a likely candidate for its third Samurai offering of the year.

Backdoor funding

Not all funding channels in Japan, however, are as challenging for foreign FIGs.

Plain vanilla yen issuance outside the Samurai market is difficult to track in a timely manner, as deals are generally not public, most euro-yen transactions being issued off MTN programmes on semi-private basis. Unless deals publicly target the institutional investor universe or constitute a private placement of significant size, these can be difficult to monitor.

While a single as opposed to a multi-tranche deal is likely to be relatively small in size and the maturity probably shorter, these transactions can add up to decent amount from frequent issuance. Such private placements have lately generated some arbitrage funding opportunities in senior unsecured format for European banks such as ABN AMRO, ING, Credit Agricole and Pohjola Bank. 

Another increasingly significant funding route is the Uridashi market – MTNs issued in foreign jurisdictions but sold within Japan, relying on the mammoth build-up of Japanese retail deposits.

Traditionally, the retail-targeted market has been reserved for high-grade supranational and agency issuers, which offer minimal credit risk but instead offer FX or index risk through structured derivative issuance.

Japanese houses, however, remain wary of overloading their coveted retail networks with too many high-risk structured deals from non-SSA borrowers. Retail remains a vital funding source for the Japanese FIGs themselves, in both DCM and ECM pre-emergency scenarios.

The format for fundraising in meaningful size for non-supranational and non-agency borrowers is the plain vanilla structure, or one which closely resembles it, denominated in a number of currencies but also in yen.

Most recently, Morgan Stanley has demonstrated this market’s appeal at a time when it is more than challenging for US FIGs to access the wholesale yen market in size. Thanks to this sector,MS has raised more than ¥100bn since the end of August at prices significantly through its US dollar secondary levels.

The retail market is less sensitive to headlines but even more important for MS was its relationship to Mitsubishi UFG. The strength of the relationship gave the US bank the clout to launch two rounds of five-year step-up transactions at aggressive levels, both at least 100bp tighter than its five-year US dollar paper.

The two chunky retail trades were the first done in collaboration with MUFG’s securities arm – Mitsubishi UFJ Morgan Stanley. Morgan Stanley managed the two issues itself, but they were sold through the two local JVs – MUMSS and Morgan Stanley MUFG.

Similar relationship deals sold to non-institutional investors have benefited other Western FIGs too. Combined Uridashi issuance across currencies – yen vanilla or near-vanilla issuance forming the bulk of the volume – is not as large as wholesale Samurai, but the format offers competitive funding levels.

Looking at Uridashi issuance year to date across all currencies, based on IFR calculations, RBS stands out as the top FIG funder with around US$1.5bn-equivalent thanks to the placement capabilities of SMBC Nikko.

Morgan Stanley follows, with its new-found retail love, at about US$1.3bn. Barclays holds third spot with about US$900m worth of Uridashi funding, also benefiting from SMBC’s stake in the UK bank. For example, in 2010, Barclays raised more than US$1bn-equivalent, the lion’s share coming from yen retail placements arranged by SMBC Nikko.

Uridashi funding to mid-September has increased by around 60% from last year, to about US$6.8bn-equivalent for the top 10 FIG borrowers, at a time when accessing any markets at all has become an achievement.

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