The market backdrop could hardly have been much worse for Development Bank of Japan as it set out to sell a bold $1bn five year bond in late September.
Global capital markets were enduring a miserable time. Stock markets were falling, all the news from the eurozone seemed to be bad and the IMFs annual meeting was punctuated by disappointment at a lack of clear leadership and a generally toxic mood.
Yet despite all this, DBJ pulled off a positive result: a coupon of 1.625% and a yield of just 45bp over mid-swaps. The borrower and its bookrunners HSBC, JP Morgan and Nomura were delighted, and Japanese agencies had once again proved that, to the outside world, they are safe havens a welcome diversification away from the challenges of Europe and the US.
It is surprising that this should be the case. Japans 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 would seem an unlikely safe haven but crucially it has two things in its favour: its disconnection from the troubles in the eurozone and the US. "Its a geographical thing," says Gyo Sato, in the treasury department at DBJ. "Its not Europe. Its not the US."
On top of this, there is also the scarcity factor. "The term safe haven gets a lot of use in the media," says Alexandre Sautour, head of primary markets at BNP Paribas Securities (Japan). "In reality, 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. Its 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. "Weve seen these deals print regularly inside guidance, and with a reasonable amount of interest from investors."
After all, only a select handful can access this liquidity in these markets. "Issuers like DBJ, JBIC [Japan Bank for International Cooperation] and JFM [Japan Finance Organisation for Municipalities] are the most sophisticated investors in Japan," says Minoru Shinohara, senior managing director, investment banking at Nomura. Shinohara was at the IMF meeting in Washington and gained 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 its very stormy and to see some bright sky in the storm."
Avoiding problemsSato says the DBJ deal attracted just over $1.1bn of demand, which might not appear well covered, but bookrunners say this was a function of closing the book almost as soon as capacity was reached to avoid allocation problems. In any event, the DBJ issue, along with the two $2bn JBIC jumbos (see box), and JFMs $1bn deal in January (see Muni section), clearly show the continuing appetite for Japanese agency paper.
JBIC still has budget for a further $3.2bn of issuance this financial year; for DBJs part, Sato says the agency has budget for ¥150bn of international government-guaranteed issuance, which would imply room for another deal of a similar size to the one just completed, "but we havent 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 DBJs services. "We are conducting crisis response for the clients damaged by the earthquake, as well as our ordinary business. So depending on the development of our business, we will adjust our funding plans for the fiscal year."
He adds: "We are always looking at the international capital markets, both government-guaranteed and non-guaranteed bonds, in every currency, but 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 $2bn in July in a three tranche fixed and floating rate bond issue, following a $1.5bn issue in January. One of the most important 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 been to the markets twice for $1bn in February and $544m 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 III 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.
Hard to read
The corporate issuers are a tricky bunch 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 US; 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 $500m raising in early September.
"We saw Mitsubishi Corp in September, but since Japanese domestic markets have been very stable, there are no strong incentives for Japanese issuers to tap international markets unless they need to use the money in the international arena," says Reiko Hayashi, head of debt capital markets, Merrill Lynch Japan Securities in Tokyo. "There is a lot of discussion about how cross-border M&A should be happening because of the highly appreciating yen. But normally they would borrow the money in yen and conduct foreign exchange. Japanese banks are very happy to provide highly competitive yen loans."
Theodore Lo, RBSs head of debt capital markets in Japan, 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 Corp 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, Japans 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 wont 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 Japan 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 JGBs may change." And that, unarguably, would be bad news for Japan.
|Heavyweight JBIC is Japans standard bearer|
|Japan Bank for International Cooperation (JBIC) is the heavyweight of Japanese agency borrowers. Above all others, it is the name that international bond 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 $2bn in a five year global through Bank of America Merrill Lynch, Barclays Capital, Citi and HSBC, with a 2.5% coupon, and pricing of 45bp over mid-swaps. The deal came not long after the devastating March earthquake, and the subsequent rating downgrade on Japan, yet received over $5bn 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 JBICs 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 $2bn in a global five year deal with a 2.25% coupon, pricing at 34bp over mid-swaps, and led by BofA Merrill, BNP Paribas, Daiwa and JP Morgan. Bookrunners said the deal attracted more than $3.4bn 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 Japans 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 $7.2bn for government guaranteed bonds in the international market in this financial year, so still has $3.2bn 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 a longer maturity than five years, but in volatile markets, it depends on the timing of the situation."