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Beyond Japan: taking RMBS to the world

07 Dec 2010

With JHF being able to rely on its domestic investor base to snap up its mortgage backed securities, foreign investors have shown little interest in its RMBS. Nevertheless, JHF will have to reach out to international buyers sooner rather than later.

To date, foreign investor interest in JHF’s MBS has been close to zero. As with other Japanese borrowers in the fixed income market, that has hardly mattered, given that JHF’s primary market supply is routinely oversubscribed by a domestic investor base with precious few alternative sources of a meaningful pick-up over JGBs.

Other public sector borrowers, including the government itself and Japan’s municipal borrowers, have also built dependable reservoirs of demand among local investors and have historically seen little need to boost international participation in their issuance.

Japanese corporate borrowers, meanwhile, have very limited requirements to tap into fixed income investors either overseas or domestically. Bank lending to the corporate sector has been on the decline for most of 2010, while bond issuance from Japanese companies is also expected to remain quiet, reflecting very tepid demand for funding.

Disturbingly, the September BOJ Tankan reports that large companies are projecting a feeble 2.4% increase in capex in FY2010, down from 2.7% predicted in the June survey. As a consequence, corporate bond issuance is likely to remain very thin on the ground, and any transactions that do surface are likely to be swallowed up voraciously by a domestic investor base in desperate need of yield.

A common theme across the Japanese public sector, however, is the very clear recognition that apparently limitless domestic demand for their bonds has a finite shelf life. The government in particular is keenly alive to the dangers presented by the twin trends of a rising stock of national debt on the one hand and an ageing population — meaning a sharply declining savings rate — on the other. That is not a new threat and it is one that may be slower to show its hand than many have forecast.

As Brendan Brown of Mitsubishi UFJ Securities noted in a recent research bulletin: "Though some economists continue to project some decline in Japanese overall savings propensities (corporate and household combined), that projection... has been around for a long time and as yet is unfulfilled."

Not taking any chances

Maybe so. But the government is not taking any chances, and has made no secret of its desire to increase the share of foreign investor participation in the JGB market from its modest current level. Although this inched up from 4.1% in December 2004 to 6.1% in 2009, foreign ownership of Japanese government bonds remains exceptionally low compared with the role they play in the markets for other government securities such as US Treasuries and German bunds.

As the Advisory Council on Government Debt Management commented in a discussion paper published in December 2009: "JGBs are absorbed smoothly by domestic investors. However, taking into consideration [Japan’s] declining birth-rate and ageing population [and] globalisation of fund transactions, as well as the fact that there are some developed countries that are raising funds overseas, it may be considered... an option to study the cases of these countries, with the possibility of such fund-raising in mind from a mid- to long-term viewpoint."

Much like the government and the leading municipal issuers, there is no highly pressing need for JHF to cast its net further afield in search of a broader and more diversified investor base. Its new issues in straight as well as RMBS format are routinely oversubscribed, meaning that for the time being the main challenge for JHF is to ensure that domestic demand can be satisfied through a fair allocation procedure.

Nevertheless, JHF recognises the importance of reaching out to new investors sooner rather than later. "Investor pool diversification is very important for an issuer like JHF," says Katsuhiko Maeda, director general of JHF’s market operations department. "Our JHF MBS is priced every month and the issuance volume is increasing, reflecting the strength of demand for Flat 35 mortgages. There is no assurance that domestic demand will always remain strong, so we continue our effort to reach out to overseas investors and discuss the attractiveness of JHF bonds for them. We also believe the diversification of our investor pool will increase liquidity in the secondary market, which is good both for investors and for JHF."

Certainly, all the necessary technical groundwork has been done to ensure that non-resident institutions can invest in JHF MBS. The securities have been exempt from withholding tax since June 2010, for example, while JHF MBS can now be settled through Euroclear. "We believe that the two major roadblocks for overseas investors looking at JHF bonds are now gone," says Maeda. "Because of this, we anticipate more discussions with overseas investors compared to one year ago. The marketability of JHF bonds has increased significantly."

Only game in town

Alongside these attractions, bankers point out that international investors looking for exposure to Asian RMBS have precious few alternatives. "Although there is an active Australian market and limited issuance in Korea, Japan has the appeal of being the most liquid and best-developed market in the region," says Kauru Kondo, structured finance analyst at Bank of America Merrill Lynch.

That may be. But bankers and analysts concede that persuading foreign institutions to invest in JHF MBS is a formidable challenge, principally because of the exceptionally low yields offered in the market. Bankers say that a pick-up of 40bp over JGBs in the primary market, and an even tighter spread at the secondary level, are unlikely even to put Japanese RMBS on the radar for credit investors building a global ABS portfolio, especially as a European market re-emerges.

"Our European sales force is telling us that investors are interested in the liquidity and stability of JHF MBS, especially now that the withholding tax problem has been solved and settlement has been made simpler via Euroclear," says Reiko Hayashi, managing director and head of corporate and public finance debt capital markets at BofA Merrill in Tokyo. "The biggest challenge is the tightness of the spread relative to Europe."

Toru Kuraoka, associate in the debt capital markets group at BofA Merrill, agrees. "The feedback we have is that coupons of less than 2% are too low at the moment," he says. "But with the spread between US and Japanese government notes continuing to narrow, we expect interest among overseas investors to grow."

Others agree that low yields are probably the only stumbling block for international investors. "Liquidity, disclosure and settlement procedures are now all perfect, but for global investors this is still not enough given that the yield curve is so low and so flat," says Yoichiro Nakai, executive vice president at Shinsei Securities in Tokyo.

Nevertheless, JHF is channelling time and resources into marketing its name to global investors. "We believe that there is no short cut to finding investors, so we conduct non-deal roadshows in Asia and Europe," says Maeda. "However, we believe that investors with a yen portfolio should have an affinity towards investing in JHF bonds. Also, as JHF MBS is a monthly pass-through security, we believe investors in the US agency MBS market should also be interested in investing in JHF MBS. So any investors with a yen and/or a US agency MBS portfolio will be our target. These could be any central banks, commercial banks, insurance companies and/or mutual funds. We are open to discussions with all potential investors."

Alternative currencies

That openness could, in theory, extend to issuing in dollars or euros, which would clearly extend the breadth of the potential investor base. Maeda says that JHF has not ruled out an issue in a currency other than yen, but he says that given that the agency’s loan portfolio is purely yen-based, any issue in dollars or euros would have to deliver demonstrable cost savings relative to a yen deal.

In Asia at least, JHF’s discussions with investors may soon start to pay dividends, say bankers. "Central banks in Asia, including the Bank of China, are known to be major investors in US Treasuries," says Yukio Egawa, head of the financial strategy division at Shinsei Securities and one of Japan’s most experienced securitisation bankers. "But as concerns have grown over the US economy and as the yen has strengthened we are aware that Chinese and other Asian investors have been quietly buying a substantial amount of Japanese bonds.

"For the time being, they have been restricting these purchases to the JGB market, but there is no reason why Asian investors who used to buy Fannie Mae and Freddie Mac should not start looking for the yield pick-up that JHF MBS can give to their yen holdings."

This view seems to be corroborated by a recent update from Moody's on the Japanese CMBS market. Although the CMBS asset class is very different to RMBS, the agency’s observations on Asian demand for Japanese real estate ought to bode well for the broader mortgage backed market. "Asian money has essentially revitalised Japan’s property investment market," notes the Moody’s report. It adds that "an overheated Chinese property market and Japan’s solid legal system and infrastructure have made the idea of investing in Japan more attractive."

Others agree that Asian investors are likely to be the first non-Japanese institutions to show a meaningful interest in JHF MBS. "Asia may be the best source of support for JHF MBS, because it is a fixed rate, pass-through product, and European investors tend to prefer floating rate RMBS," says Manabu Watanabe, a director at Barclays Capital in Tokyo.

Barclays has first hand evidence of the growth of interest among international investors in JHF MBS, having recently hosted a conference on the subject in Tokyo which was well attended by Asian as well as Japanese investors.
07 Dec 2010