For Japanese companies and government agencies, the domestic yen bond market is still nearly always a cheaper option than issuing overseas. But the gap is closing, as foreign perceptions of Japan improve. There was room in 2006 for a few successful offshore financings, especially when issuers wanted super-long funding.
Japanese banks and finance companies remain big issuers of international bonds, but for public sector bodies and ordinary companies, the domestic markets are so attractive that there are not many temptations to entice them away from their home markets.
However there were still some notable deals in 2006: benchmark issues from the government agencies, niche deals in Swiss francs, and some euro and sterling transactions designed to tap rising demand for super-long dated paper.
"The offshore markets remain the province mainly of the top Japanese corporate names that value [investor] diversification," says Makoto Kaihara, managing director of debt capital markets at Nikko Citigroup in Tokyo. "Domestic rates and spreads have for so long been so low and the local market generally so stable that there is little incentive for offshore issuance. There is a gradual cost improvement in the offshore markets, but going overseas will remain a diversification play for the foreseeable future."
Another obstacle to overseas issuance last year was the emergence of the European Union's Prospectus Directive. This is troubling for Japanese companies, which report largely in Japanese GAAP, a format that seems to be about to become unacceptable to the EU.
"The requirement seems to be for filing the prospectus under IFRS and that would mean a lot of work and cost for the Japanese names," explains Kaihara. "This is obviously sidestepped by listing [bond issues] in Switzerland or Singapore rather than London or Luxembourg, but that will limit the investors."
Oodles of cash at home
The domestic financial market remains swamped with cash, as it has been for several years.
After the Bank of Japan signalled in spring 2006 that it would end its zero interest rate policy, there was considerably greater volatility than in recent years and spreads widened. But as summer turned to autumn that volatility toned down, spreads stabilised and liquidity returned, allowing for some very large corporate issues at home.
Corporate profitability remains strong and companies are cash-rich, so they are not looking for medium or long term funding — and it is in that part of the maturity curve that the offshore markets have the best chance to be cost-competitive.
"Companies expect to repay debt fast, causing their ratings to rise," says Kaihara. "Hence, they do not want to lock in medium to long term funds if their ratings and therefore cost of funds are likely to improve. Some Japanese issuers are looking overseas, even at the Yankee market, but mostly at the shorter end of the curve."
From government bodies such as the Development Bank of Japan, Japan Bank for International Co-operation and the Metropolis of Tokyo, there has been only modest offshore issuance, and then mostly in yen.
"Swap spreads for offshore issuance are not encouraging, unless in niche windows such as super-long dated sterling," explains Koji Omachi, director of debt capital markets at Nikko Citigroup in Tokyo.
Pricing offshore not a magnet
Reiko Hayashi carries two business cards at Merrill Lynch, one as the debt origination banker for frequent public and private sector issuers, the other as head of public sector origination. "Many major issuers in Japan are interested in overseas issuance and foreign buyers would welcome them, but the pricing rationale is not yet there for most of them," she says.
Investment banks wanting to arrange offshore deals had hoped that the domestic market would become less cost-effective for the government lenders — at least for their non-guaranteed [FILP or Zaito] bonds. They are issuing a lot and there is uncertainty surrounding their future restructuring, rationalisation and privatisation. One agency in particular is sure to be privatised — DBJ.
"There was considerable uncertainty over the government's plans for structural reform of the government agency sector, causing investors to demand more spread last year," reports Tetsuya Kodama, head of debt capital markets Japan at Deutsche Securities in Tokyo. "Coupled with the general volatility in the market mid-year, this created a generally difficult environment domestically for the agency issuers."
In the domestic market, the Japanese government-guaranteed issuers (JGGIs) pay a premium over JGBs for their guaranteed issues and unguaranteed Zaito bonds.
The premium for both has been rising — partly because spreads are widening across the board, as they are for corporate credit, and partly because the government's reform plans mean that local investors are facing uncertainty. But more than either of those factors, the spread widening has been caused by the JGGIs' high issuance and volatile market conditions.
"There has been a sea change in the attitude of domestic investors since the Bank of Japan ended its zero rate policy," says Yoichiro Yokoyama, director general of the treasury department at the Development Bank of Japan in Tokyo.
Since July, Zaito bonds have been trading at 20bp or more over JGBs, up from less than 10bp in 2005. Moreover, JGGIs have even widened to trade several points wider than top corporate issuers, mostly due to the large supply of Zaito paper.
But any hopes from international investment banks that this spread widening would make the offshore market more attractive to the agencies, especially DBJ, proved shortlived.
DBJ, which is heading towards corporatisation by 2011 and privatisation by 2015 at the latest, had absented itself from the domestic bond market in Zaito bond format until a heavily oversubscribed ¥35bn deal in late August and then an ¥80bn issue in mid-October. Both deals underlined how markedly local investors had recovered their confidence.
"Investors had been frustrated at the seeming lack of clarity [about the reform programme]," explains Yokoyama, "but after the system design for government financial institutions including DBJ was announced by the government at the end of June, we visited over 50 investors individually, as well as holding regular investor meetings to explain the future process towards privatisation. The result was an improvement in sentiment and pricing that indicated no premium for [DBJ because of our] future privatisation over other public financial institutions."
Listening to this encouraging feedback from investors, DBJ issued a five year bond in late August at 24bp over JGBs. By the time it brought its second five year deal of ¥80bn in mid-October, the spread had tightened to 21bp. "That even placed us tighter than other public financial institutions in terms of secondary market trading levels," says Yokoyama.
Agency lenders fly the flag
Nevertheless, the JGGIs did not desert the international markets, but maintained their established ambassadorial role.
The agencies' international bonds are always government-guaranteed, and as the guarantee is on the bonds, not the issuer, foreign investors can largely ignore the subtleties of the government's reform programme for the lenders.
Last year's offshore deals, one in dollars and two in yen, proved without doubt that international investors still valued Japanese names, and helped continue the trend of recent years — that Japanese issuers' spreads are catching up with their peer group again.
JGBs are still trading at a slight premium over other G7 government bonds, but are comfortably through Libor.
"From the late 1990s to late 2004, the JGGIs priced and traded well above Libor [in the international market]," explains Kodama. "Since then, the economic and stockmarket momentum has started to turn more favourable and a variety of JGGI issues have been priced attractively, for example the February 2005 JBIC deal at Treasuries plus 32bp, which was equivalent to sub-Libor. Since then, several JGGI issues offshore have sold well and priced attractively, setting new benchmarks for the sector."
Kodama at Deutsche says that Japan is very much back in favour on the international scene, especially the banks, but also the municipal sector and others.
"The JGGIs have now moved much closer in line with their G7 peer group and, for example, trade very close to Fannie Mae or Freddie Mac," says Kodama. "A few years ago the benchmarks were closer to weaker rated non-OECD or non-G7 sovereigns, such had been the erosion of the ratings and investor confidence in Japan."
JGGIs are now trading in the secondary market around 10bp below dollar Libor, and the premium over triple-A rated European agencies has fallen to 5bp-10bp. In the yen market that differential has virtually disappeared.
Nevertheless, Kodama does not yet expect the guaranteed issuers to return to deep sub-Libor funding until Japan itself is restored to full triple-A status at home and abroad.
The growth in issuance of highly rated covered bonds in Europe is another barrier stopping non-triple-A issuers achieving deep sub-Libor funding.
The government requires that international issuance by the JGGIs, post-swap if the issuer needs yen, should match the funding cost in the domestic market, or that there should be a reason for issuing in foreign currency, due to budgetary requirements or the need for foreign currency liabilities to match assets.
As spreads in the local bond market have been extraordinarily tight for several years, the overseas market has only sometimes been able to compete directly on cost. Domestic JGGI deals are priced over JGBs, and as the spread between JGBs and yen Libor has widened, the JGGIs can fund in yen very tightly relative to Libor.
Moreover, movements in the yen/dollar basis swap have increased the cost of issuing in dollars or euros and swapping back to yen. Apart from the Japan Bank for International Cooperation (JBIC), which needs to match-fund dollar loans, the other JGGIs typically swap back to fixed yen.
JBIC, JFM and DBJ play their part
The three offshore issues by JGGIs in 2006 began in March, when JBIC sold $650m of 10 year bonds at 47.5bp over Treasuries. That equated to about 4bp-5bp through dollar Libor, or 4bp-5bp over JGBs.
But that springtime window closed as the year progressed. Spreads over Treasuries widened, and with them the theoretical post-swap cost over JGBs.
The offshore yen market was the most receptive international market for the JGGIs in 2006.
In late April Japan Finance Corp for Municipal Enterprises (JFM) launched a ¥120bn 10 year global bond. It was priced at almost precisely the same level as a similar domestic issue would have been — 6bp over the JGB 278. JFM got investor diversification and lessened the demands on its local investor base.
In euros, the story is even less attractive, as by some estimates the JGGIs might need to pay about 25bp-27bp over Bunds. After swapping into yen that would not be sub-Libor. The euro is priced out of the JGGIs' thinking for the moment.
The other global issue of the year, besides JFM's, was from DBJ, which launched a ¥50bn 20 year issue in June, led by Nikko Citigroup and UBS. It was priced with a 2.3% coupon at 10bp over the JGB 87, roughly in line with the domestic market.
"The very positive response underlines how solid the DBJ name is for overseas investors," says Yokoyama. "There was little concern voiced about the possible reform plans for DBJ or other institutions."
The deal was DBJ's first global yen transaction since June 2004, and the first 20 year global yen issue from a JGGI since June 2003. The lack of longer dated JGGI issuance added to demand.
DBJ wanted to secure longer term funds because interest rates are expected to rise, but also chose yen and the longer maturity to maximise demand and price tension.
Still, with the JGB market volatile after the Bank of Japan's monetary policy change in March, the price guidance was conservatively managed to maximise investor demand.
Fund managers took 65% of the paper, banks and central banks 30% and other buyers 5%. Investors in the UK bought 55% of the bonds, other European accounts 34%, US funds 10% and buyers in Asia 1%.
Tight pricing, long maturities
The context for the JFM and DBJ yen globals was a smattering of deals from triple-A rated US and European issuers.
In mid-February 2006, Pfizer, the US drug company, and German state development bank KfW had issued in yen.
Pfizer sold ¥115bn of bonds in two global tranches (see global issuers chapter) and KfW a ¥50bn 20 year issue at 1bp over JGBs. That was about 2bp wider than a similar size issue the EIB had sold.
When DBJ launched its 20 year issue in June, it set price guidance at JGBs plus 10bp area. This took into account the need to pay a small concession to secondary market spreads and the likelihood that new supply would reprice comparable outstanding issues.
DBJ had two issues outstanding at the long end, the 1.7% of 2022 and the 1.05% of 2023. Both were trading at 8bp/6bp over JGBs shortly before the new issue was launched, and widened to 10bp/9bp as guidance emerged for the new issue.
KfW's recently issued 2.05% 2026 was trading at plus 5bp/4bp, and also widened shortly before DBJ launched.
As the deal had been rumoured to be for ¥75bn and emerged at ¥50bn, the market drew the conclusion that there was limited demand for paper of this maturity and rating at such a tight spread to KfW, especially as that issue had itself been a struggle.
"The [JFM and DBJ] issues proved that the offshore yen market was attractive last year," says Reiko Hayashi at Merrill Lynch. "Meanwhile, the issuance by JBIC and Jasme in dollars and Swiss francs last year also achieved attractive pricing, although to achieve the best result against domestic market spreads the yen is a better option."
Japan Finance Corp for Small Business (Jasme) is one of the leading Japanese borrowers in the offshore debt markets. It will also be merged into the single new government policy lender when it is created in fiscal 2008.
In 2006 Jasme went into the Swiss franc market to raise Sfr250m in a six year issue carrying a coupon of 2.125% and an issue price of 100.388 to yield 12.5bp through mid-swaps. Credit Suisse managed the deal, which was the first JGGI issue in Swiss francs since 1999, thereby virtually guaranteeing solid demand from investors.
JR East looks far down the track
Perhaps the most enticing draw to the international markets for Japanese issuers was the ready availability of super-long dated funding in sterling and euros.
East Japan Railway (JR East) and the Metropolis of Tokyo both tapped into this investor demand, the former funding twice in sterling, the latter once in euros.
JR East, now a pure private sector company rated Aa2/AA-/AA-, raised £250m of 30 year money in January and the same amount of 28 year funds in early June. The deals were priced at 63bp and 58bp over Gilts and were both arranged by BNP Paribas (bookrunner) and Mizuho.
The January deal was JR East's first overseas issue since 1996. It enabled the company to fund more tightly after the basis swap than it could have in the domestic market. Both deals were bought largely by UK funds, with a sprinkling of continental European money.
The Metropolis of Tokyo chose euros for its Eu344m issue (equivalent to ¥50bn) in June, led by Merrill Lynch, Mitsubishi UFJ Securities and Nomura.
Tokyo exports its fashionable brand
Tokyo's issue in 2006 was its fourth overseas deal in recent years. It is leading the effort to become the first municipality in Japan to obtain formal credit ratings, but the lack of such credentials has not held Tokyo back so far, either at home or abroad, where it has been very well received since its debut issue.
The 27 year issue was re-offered at 99.864 with a coupon of 4.7% to yield 41.2bp over the 4.75% July 2034 Bund. It was placed with leading institutional investors in Europe, mainly from France and Germany.
"There are plenty of European investors looking at long dated assets to match their liabilities and Tokyo needs funding in the range of 25-30 years," says Hayashi.
Priced at 18bp over Libor, the deal was about 10bp tighter than Tokyo's previous 27 year issue, a Eu294m bond arranged by Deutsche Bank, Merrill Lynch and Mizuho in May 2005.
"All of Tokyo's four long dated Euromarket deals since 2004, when they began, have been a great success, as evidenced by the continued tightening of spreads against Libor," says Hayashi. "The European investors that take this sort of paper are doing so to buy and hold and are not concerned so much with liquidity, so the issuer is not penalised for what is a relatively small transaction. From the issuer's perspective, it was rather difficult to raise an equivalent sum of super-long dated funding in the domestic market, especially in the first half of last year, when spreads were rising and the market was so volatile."
There is limited money available beyond 25 years in Japan, although arrangers can package deals there on an asset swap basis. June's issue was cheaper than Tokyo could have achieved at home with this size.
Japan's municipal issuers might be more active offshore if they were allowed to raise yen outside Japan, but they are not. In the offshore capital markets, they can only issue in foreign currencies.
The prospects for overseas bond issuance will only improve if spreads widen appreciably at home, in other words if the megabank lenders and bond market investors ask for more yield.
But that seems unlikely to happen when the Bank of Japan will raise rates only modestly, if at all, so as not to throttle the economic recovery.
With corporate balance sheets so strong and net new corporate bond issuance in the domestic market contracting, Japan Inc's treasury and funding officials will likely not be travelling far, or often, during 2007.
|¦ Metropolis of Tokyo: becoming a regular overseas issuer|
In its fourth international bond issue without a guarantee from the government, the Metropolis of Tokyo raised Eu344m of 27 year funds in June, at 41.2bp over the 4.75% July 2034 Bund.
EuroWeek asked Masahiro Seki, director of the bond section, budget division, bureau of finance at the Tokyo metropolitan government, for his views on the deal and future issuance plans.
EuroWeek: Why did you do the deal in June, and why at such a long maturity?
Seki, Metropolis of Tokyo: There has been a change of procedural guidance from the minister for internal affairs and communications which now requires us and the other municipal issuers to consult with the minister on new issues, rather than obtain permission from the minister.
The consultation process for this issue, our first overseas bond in fiscal 2006, took a while, which meant that June was the first opportunity to launch the deal.
EuroWeek: How did the pricing and size of the transaction compare with your domestic issuance?
Seki, Metropolis of Tokyo: This offshore issue was more competitively priced than the domestic market. In the local bond market there is no 27 year maturity available, the closest being 30 years, where we have issued several times before.
The choice of 27 years for the Euromarket issue was determined by our wanting to refinance Tokyo Saisei Tosai [Tokyo Revival Bonds] we had issued to retail investors. Tokyo Saisei Tosai are three year domestic bonds which are sold mainly to citizens who live or work in Tokyo. We refinanced some of these issued in 2003 with this 27 year foreign bond.
EuroWeek: The deal was tightly distributed to less than 10 accounts. What more did you learn this time about the offshore investor demand?
Seki, Metropolis of Tokyo: This is the fourth issue for us in the offshore market and without a guarantee from the government. What we discovered was that demand has been rising significantly, as our name becomes more familiar to investors and as the Japanese economy continues to improve.
Of course, we want to increase the number of investors in our paper, but the outcome of this deal was similar to our previous issues, namely that there were a number of investors from earlier issues that had specifically requested to participate in our next deal.
EuroWeek: Why did you choose euros, rather than, for example, the sterling market, chosen around that time by East Japan Railway, or even dollars in the Yankee market?
Seki, Metropolis of Tokyo: The euro sector has, we believe, the most diverse investor base and also offered the most competitive funding, when factoring in swap costs and other dynamics.
Spreads continue to tighten and we expect that to continue for the near future. For our cost of funds offshore, the Tokyo brand is becoming ever more fashionable with investors.
EuroWeek: What are the key changes to issuance procedures for municipal issuers in Japan?
Seki, Metropolis of Tokyo: The basic change is that municipal issuers are now free to set their own pricing terms with the arrangers and the market. In the previous system pricing was decided unilaterally by the Ministry of Internal Affairs and Communications, at the same price for all municipal issuers. We, however, left the procedural system about two years ago, so these recent changes did not affect us.
EuroWeek: What are your plans for issuance at home and abroad?
Seki, Metropolis of Tokyo: We first planned to issue ¥900bn of bonds at home and abroad in fiscal 2006, but that has since been trimmed back to ¥800bn because our finances have sharply improved and tax income has risen.
We now have plans for obtaining official credit ratings for our overseas issues, we hope within this fiscal year. We are now considering from which agencies we will obtain those ratings. ?