Demand for traditional structured credit products in Japan is slowing this year, a development that may lead to a large increase in equity-default linked deals, according to Moody's Investors Service and Rating and Investment Information, Japan's primary domestic credit rating agency. "There's very few deals in the pipeline compared with last year," said Ichinori Kitahara, chief analyst in the structured finance ratings group at R&I in Tokyo, explaining that although last year was difficult for banks to structure credit products in Japan due to tight credit spreads, this year is even more frustrating. Yusuke Seki, v.p. in the structured finance group at Moody's, concurred. "We're not seeing balance sheet CDOs because banks are not interested and it's difficult for arbitrage deals due to the tight spreads," he said.
In the first quarter last year, R&I rated five multi-tranched Japanese CDOs, versus three-single tranche deals this year. Similarly, Moody's rated about eight deals in the first quarter last year, compared to three this year. "There are a few more deals in the works but this market won't return until credit spreads improve," R&I's Kitahara added, explaining that Japan's chronically tight spreads have impeded the development of a larger CDO market.
The slowdown could, however, stimulate demand for equity-default swap structures, which are still seen as a novel product in Japan. "EDS may become a new trend," said Seki.
"Given that CDOs are harder to do here than in the other major markets, Japan is particularly ripe for equity-default swap deals," said Paul Cluley, partner at Allen & Overy in Tokyo, explaining that investors have less appetite for diversified or managed CDO risk and prefer structures linked to familiar domestic names. Cluley added that hybrid deals combining equity-default and the more familiar credit risk will likely lead the way.
Following Daiwa Securities SMBC's recent first-of-a-kind collateralized equity obligation in Japan, which was rated by Moody's (DW, 3/22), R&I is now considering establishing ratings criteria for equity-default products in Japan, noted Kitahara. "This is now under study," he continued.