Yearning for yen

IFR IMF/World Bank Special Report 2018
10 min read
Jonathan Rogers

The yen bond market has sprung back to life after years of drought, thanks to a tightening of swap spreads and the retreat of long-dated JGBs from deeply negative yield territory. Issuance volume has been the highest since the start of the Global Financial Crisis and the bonanza looks set to continue.

Yields on Japanese government bonds from the seven-year tenor point out to 10 years have risen by an average 6bp so far this year, moving from negative to positive, albeit to relatively scant returns of 0.01% and 0.12%, respectively.

While those government bond returns remain meagre, the additional spread issuers in Samurais and Euroyen transactions are able to provide has been sufficiently attractive to pique investor appetite and get the primary market for offshore banks and corporates on the move again.

And judging by the deals which have printed in yen so far this year, whether in Samurai, Euroyen, Pro-bond or private placement format, the investor base is increasingly willing to book lower-rated paper – loss-absorbing subordinated debt included – as well as to move further out to longer tenors on the yield curve.

Onshore liquidity in Japan is flush after a prolonged “buyers’ strike” due to the low yields implied on any theoretical new issuance – primary issuance was crimped for a prolonged period. Even if there had been takers for paper at the low yields available, a deeply negative basis swap into US dollars meant that on a hedged basis issuance was not an attractive proposition for dollar-based offshore issuers.

But the basis swap has become relatively benign; the yen/dollar basis has moved from 90bp negative just over a year ago to around minus 40bp as of early September.

“The contraction of the yen/dollar basis swap has undoubtedly been a factor in spurring yen bond issuance this year as the term funding cost for dollar-based issuers on a hedged basis has become more competitive than it’s been for around three years,” said Kazuhide Tanaka, head of yen funding at Rabobank in Tokyo.*

If there were any clear signal that the yen bond market is definitively open for business, it would be the ¥160bn (US$1.4bn) total loss-absorbing capacity (TLAC) callable Samurai bond that HSBC Holdings priced in early September.

The three-tranche deal was overwhelmed with ¥200bn of orders, allowing the multi-tranche print; the bank had mooted that it might simply issue in a one or two-tranche format, based on demand. Such was the appetite that a print at the full level of the book was viable, but HSBC decided to cap the size at its original target.

Traction was achieved on the deal thanks to clarification on guidelines for TLAC issuance from Japan’s Financial Services Agency published in April which stipulated that higher risk weightings for TLAC bonds would kick in by April 2019, opening a window for issuance.

“Clearly defined rules on TLAC issuance which Japan’s Financial Services Agency put out earlier this year has drawn Japanese investors to paper issued by global systemically important banks. These instruments will carry a risk weight of 20%, something which has produced great relief among Japanese investors and prompted them to invest in the newly issued paper,” said Tanaka.

“The issuance we have seen this year in Samurais and Euroyen has been driven by the quest for yield spread over the scant rates available in the JGB market. A notable phenomenon has been the high participation rate of regional Japanese investors, wherein up to 40%–50% of new Samurai paper from banks has been booked by regional banks.”

Indeed, the placement of HSBC’s deal was anchored by regional banks, shinkin banks and trust banks, as well as a spread of asset managers, life insurers, central cooperatives and corporates. The callable TLAC format was not new to the onshore investor base – Credit Suisse introduced the product in late 2017 with a ¥57bn Pro-bond Euroyen deal.

“Japan is an over-banked country and the loan market offers scant returns, so anything with a decent yield from the debt market has been a godsend to the banks, hence explaining the frothy demand for new issues we have seen this year,” said Tanaka.

Moving with the times

The yen bond market may have been reinvigorated by the repricing of the basis swap, but against this, there are signs that issuers are able to uncover demand outside the somewhat cumbersome Samurai issuance format – in Euroyen or in Pro-bond form – allowing for quicker execution times.

For example, in late August, BNP Paribas, a familiar name in the Samurai market, managed quick-fire execution on a Euroyen deal that was initially conceived in relatively modest size terms but which pulled in ¥100bn of demand. In the execution process, BNPP managed to obviate the drawn-out documentation process required for Samurai issuance – including onerous translation into Japanese – which has often been accused of compromising price tension in that corner of the yen bond market.

Meanwhile, another Samurai bond stalwart, the Republic of Poland, recently filed for issuance in Pro-bond format, an arena developed under the auspices of Barclays, wherein deals are targeted specifically at professional investors and marketed electronically.

Perhaps the definitive return of yen bond issuance onto the radar screen came in August, when ultra-savvy issuer Goldman Sachs issued in the currency after an absence of six years – a ¥40bn Euroyen trade. And Denmark’s Danske Bank was able to find depth and the availability of tenor in the private placement market with a ¥10bn 20-year.

Danske underlined the attractiveness of issuance against its implied term funding rate in euros, taking advantage of the negative 30bp basis swap from yen back to euros. Relative pricing was also attractive given the recent widening of European credit spreads, by around 25bp from the start of the year, as measured by the iTraxx Europe five-year CDS index.

The viability of the private placement market was also underscored by successful prints from Nordea and Standard Chartered, which raised seven and 11NC10 funds earlier in August.

“There is a sense that issuers are looking to move with the times and that the ultra-long marketing period and translation into reams of documents required for Samurai issuance is becoming archaic. Still, I doubt that driveby Euroyen or Pro-bond issuance will become the norm,” said a Tokyo-based syndicate head.

“To reach the full complement of yen bond issuers onshore, you need to knock on doors across the full investor base, and the mindset is still traditional in that regard. But new ways of doing things in keeping with digitisation and the information age will become a fashionable accessory for opportunistic issuers.”

Indeed, the Samurai market remains the arena of choice of issuers looking to tap in chunky size and reach the most diversified investor base.

That was evidenced in August, when the Republic of the Philippines priced Asia’s largest Samurai bond via a ¥154.2bn three-tranche deal that represented the country’s first standalone issuance in the format since 2000. If it proved the market’s ability to deliver in huge size, it also demonstrated the willingness of Japan’s notoriously conservative investor base to embrace the lower reaches of the emerging market credit curve – in this case by booking Triple B rated paper.

The Philippines managed to print optically competitive coupon rates of 0.38% at three years, 0.54% at five years and 0.99% at 10 years. Korea Development Bank was trumped in the size stakes by the blockbusting deal, having previously set the record in the previous month with a ¥120bn dual-tranche trade.

Perhaps the most significant element of the Philippines’ deal was its standalone nature. The country issued into the Samurai market in 2010, but with the need for political risk insurance cover from the Japan Bank for International Cooperation.

The question remains whether this year’s primary yen bond revival has staying power. There is persistent market speculation that the Bank of Japaan’s quantitative easing programme will be tapered, in which case higher JGB yields will be the undoubted outcome. Should the basis swap hold its currently attractive levels, that should tease out further issuance as demand grows exponentially.

With the Bank of Japan still undershooting its explicitly stated 2% inflation target, the odds appear to favour the continuation of the QE programme. And the economic drag of the recent earthquake and typhoon in the country also suggests that there is no likely imminent monetary tightening on the horizon.

Another positive is confidence in the yen against a backdrop of a generalised risk-off mentality. The Japanese unit has appreciated by around 5% against the US dollar so far this year, and the prospect of foreign exchange gains from investing in yen-denominated debt is also prolonging investor demand.

“Barring major accidents, it looks as if the pace of issuance will continue and international issuers will continue to take advantage of the yen bond market as an arena of stability and newly competitive pricing,” said the syndicate head.

* This sentence was changed to correct the spelling of Kazuhide Tanaka’s name

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Yearning for yen