Hope returns for Japanese RMBS

Whisper it quietly but the Japanese property market is displaying signs of life. Debt and equity markets are showing an interest in it, while further quantitative easing from the Bank of Japan could provide an extra boost. However, caution remains the watchword.

  • 07 Dec 2010
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You either have to be extraordinarily brave, or foolish (and probably both) to call the bottom of Japan's real estate market with any conviction.

There have been any number of false dawns for property as well as for other Japanese asset classes since they peaked in the early 1990s.

Today, commercial land is worth 60% of what it was in 1991, while residential property is valued at a little over a third of its 1991 value.

Recently, however, there have been a growing number of straws for real estate optimists to clutch. Japan’s Land Ministry announced in September that housing starts shot up by 20.5% in August, reaching almost 72,000 units, which is the steepest rise since September 2008 and translates into 829,000 units on an annualised basis. That would compare with about 780,000 in the year to March 31 2010, when housing starts plunged by 24.5%, with declines of more than 30% posted for six dismal consecutive months between April-September 2009.

The figure for the rise in housing starts in August 2010 was the second highest on record. It also came in comfortably above the consensus forecast of a 10.9% rise, and well ahead of the highest forecast of 15.8%. Condominium and houses for sale led the way, with a 35% rise, followed by houses for rent (up 16.9%) and owner-occupied houses (up 15.5%).

There have also been encouraging signs of life in both the bank market for real estate lending and in the capital market. Take the findings of the survey on privately placed real estate funds published by the STB Research Institute in March 2010, which polled 61 real estate investment funds with a market value of ¥13.9tr.

Of these, 55% said the circumstances for debt financing had "slightly improved", with 43% describing them as "unchanged" and only 2% saying they were "more severe". Some 46%, meanwhile had noticed an increase in lenders considering new lending. "This change," noted STB, "is considered to be a clear indication that the worst time is over and that debt financing circumstances are improving."

The same appears true of equity financing. Some 31% of respondents to the March 2010 survey said that appetite for real estate equity financing was rising, compared with just 20% in July 2009 and a microscopic 2% in January 2009.

This improvement in sentiment towards Japanese property appears to dovetail with the recent pick-up in the fortunes of Japanese real estate investment trusts (J-Reits) and other listed property plays. In the six months to the end of August, while the Nikkei-225 declined by 12.9% and the Topix fell by 10%, the TSE real estate index was down by just 7.3%.

This is hardly a ringing endorsement of the performance of Japanese real estate. But it is perhaps a signal that the outlook for the sector is not quite as barren as it appeared to be in the immediate aftermath of the Lehman shock.

There may even be more good news for investors in J-Reits, following the announcement of additional monetary easing measures by the Bank of Japan at the start of October, which include the establishment of a new programme to buy some ¥5tr of various financial assets, potentially including real estate investment trusts. Nomura calculates that there may be room for purchases of up to ¥500bn worth of ETFs and Reits, although it cautions that there may be "practical issues in terms of criteria for Reit selection, purchase methods and the formation of exit strategies."

How relevant or encouraging any of this is likely to be for prospective home-buyers in Japan is open to question. Today, Japan’s would-be first time buyers have a super-abundance of good reasons for not committing themselves to the millstone of a mortgage, even if home loans are now being made available at virtually give-away terms and conditions.

Foremost among these is that the outlook for economic growth in Japan remains decidedly off-colour, and although the unemployment rate inched down from 5.2% in July to 5.1% in August, analysts warn against reading too much into modest monthly fluctuations. "While the August labour statistics pointed to overall improvement in employment conditions, other employment-related statistics released in September suggest there may be a lull in the improvement," warns a recent update published by Nomura.

These statistics included a decline in the employment index in August and September as well as negative pointers to future employment trends in the August Economy Watchers Survey. "And the employment environment within the Consumer Confidence Index turned down in August after improving for seven consecutive months since the start of the year," Nomura advises. "All of which points to spreading uncertainty about the employment outlook. Given also clear evidence of economic slowing in such areas as falling industrial production, we think employment conditions could fluctuate around the current level in the near term."

Consumer spending may also be flattering to deceive, according to Nomura. Again, it urges caution on the apparently encouraging data that emerged about household spending in the summer, underpinned in part by economic stimulus measures. "While the consumer spending figures for August appear reasonably strong, we think it unlikely that spending is now on a pronounced upward trend, given the large contributions from the rush in demand before the end of government subsidies and the impact of the hot weather," Nomura warns.

Income worries

Another more downbeat indicator for housing demand in Japan is stagnant, or falling, income. "The difficult employment conditions are... reflected in workers’ income," notes a recent Bank of America Merrill Lynch report. "Household survey results show that the average base salary in 2009 is lower across all age groups as compared to 2005. Annual bonuses are also falling, particularly in the main homebuyer age groups."

The BofA Merrill update adds that "monthly disposable income of workers’ households showed some improvement in 2006-2008, but declined once again in 2009 by 3% YoY. The savings rate also fell steeply in the last year in line with this trend, indicating the stress on the financial situation of Japanese households."

For the foreseeable future, it seems unlikely that there will be much respite from this stress for Japanese households in the form of a rise in income. Quite the reverse. In early October, Nomura published a detailed analysis on the outlook for nominal wages in Japan, the direction of which will play a pivotal role in determine how quickly — if at all — the economy can escape from the economic quicksand of deflation. Its findings were not encouraging. Wages, says Nomura, have been falling in Japan since their 1997 peak and a range of structural factors are likely to put further downward pressure on pay levels.

A more positive trend, adds the BofA Merrill report, is that in spite of this decline in household income levels, overall household indebtedness has been unchanged over the last three years. "Though the latest figures are as of 2008, [the] interest burden is likely to be improving also, in light of the low interest rate environment and the regulatory changes in the consumer loan sector and lower usury rates," BofA Merrill comments. "This appears to support our view [that] housing loan performance, assuming that underwriting standards are consistent, should remain stable despite high unemployment and lower household income."

That may be. But there also seems to be a division of opinion about how attitudes towards home ownership are changing in Japan. "It is still the dream of most young Japanese to own their own home," says one Tokyo banker. But others disagree, saying that there is increasingly widespread disenchantment in Japan at the recent performance of residential property as an investment, leading many younger people to conclude that renting may be a preferable option.

A recent enquiry into the comparative benefits of renting and buying, published in September by the English language daily, The Japan Times, was inconclusive on the subject, but unenthusiastic about both options. This piece reviewed a Japanese television programme that suggested that the costs of renting and buying a 66 square metre condominium would be broadly similar over a 35 year period. The downbeat conclusion of The Japan Times' piece was that "buy or rent, you’re screwed".

Small wonder, then, that activity in Japan’s home loan market has been muted in recent years, with the home ownership level remaining stable at around 60%, which is modest by international standards.

According to an analysis published by Standard & Poor’s (S&P) in August, Japan’s housing loan market for individual borrowers had an outstanding balance of ¥176tr at the end of December 2009. "In the second half of the 1980s, the market grew by about 10% every year, and continued to grow steadily in the 1990s," S&P reports. "However, the market, which had remained flat since fiscal 2000, has been shrinking over the past few years. On a year-on-year basis, the market contracted by 0.1% in fiscal 2007 and 0.3% in fiscal 2008. In addition, the size of the market as of the end of the third quarter of fiscal 2009 (end of December 2009) declined 1.3% from the same period in the previous year."

Powerful weapon

None of this will make encouraging reading for Japan’s government as it continues to grapple with the apparently endless conundrum of weak growth twinned with deflation. Encouraging an increase in home ownership has long been regarded by the government as a potentially powerful weapon in the fight against deflation, because theoretically the ripple effect created by a vibrant housing market stimulates economic activity across the board. Not only would a more buoyant housing market support Japan’s moribund construction sector. It would also encourage increased consumer spending, given the range of additional purchases necessarily made by first-time buyers of everything from furniture to wallpaper.

Up until April 2007, the key agent of Japan’s housing policy was the Government Housing Loan Corporation (GHLC), which was originally set up in 1950 with the primary objective of promoting home ownership through the provision of long-term fixed rate mortgage loans. At its peak in 1994, according to research published by BofA Merrill, GHLC had a 46% share of the market for mortgage origination.

Following an amendment of the GHLC Law in June 2003, however, the agency withdrew from direct lending operations, moving its focus to supporting home ownership by providing securitisation support for private sector lenders. This change of focus brought a change of name and status, with the GHLC transformed on April 1 2007 into Japan Housing Finance (JHF).

Rather than lend directly, the JHF purchases long term fixed rate loans from private financial institutions which it then securitises. It also guarantees the timely repayment of principal and interest on mortgage-backed securities (MBS) collateralised by long-term fixed rate loans originated and pooled by financial institutions. "Today, JHF acts as an agency which does not lend directly but effectively acts as an intermediary between the Japanese mortgage market and the investment community," explains Kaoru Kondo, structured finance analyst at BofAML Global Research in Tokyo.

Business shift

According to JHF, the creation of the new agency represented considerably more than a cosmetic or nominal change. "First of all," it advises, "our legal status as an organisation has changed from a Special Public Corporation to an Incorporated Administrative Agency. Our main business has also changed from ‘loan origination’ to ‘secondary market operation’ with our main product ‘Flat 35’. Furthermore, we shall operate independently with fee income from securitisation, not depending on borrowing and subsidies from the government."

It is too early to judge the extent to which JHF in its new form has helped to promote home ownership in Japan. Certainly, however, the most recent initiative aimed at bolstering home ownership, the Flat 35 scheme, appears to dangle a highly attractive financial carrot in front of borrowers.

Those incentives have been made progressively more attractive since April 2007, when the maximum loan to value (LTV) for Flat 35 loans was raised from 80% to 90%. A series of revisions in October 2007 further strengthened the allure of the Flat 35 mechanism by abolishing the monthly income cap, of at least four times the repayment amount, and introduced different interest rate structures for loans of below and over 20 years. In June 2009, the maximum LTV was raised once again, to 100%, while at the same time Flat 35 was also made eligible for refinancing loans.

Most recently, in February 2010, the preferential reduction in interest rates applicable in the first 10 years of the life of loans for purchasing high quality homes was increased from 0.3% to 1%. By the autumn of 2010, that had brought the cost of these so-called Flat 35 S loans down to around 1.4% for the first 10 years. This very attractive discount was originally due to be available only until the end of 2010, but the scheme has now been extended by a further 15 months and will remain in place until March 2012.

"These Flat 35S loans are targeted towards homes built to certain new criteria aimed at improving the quality of the existing housing stock, so this is creating added demand for new properties," says BofA Merrill’s Kondo. In other words, the preferential rates available for borrowers using Flat 35 S loans is also a good way to support Japan’s beleaguered construction sector.

Flat 35 loans have been marketed intensively to prospective home-buyers, with advertisements placed widely on television as well as in newspapers and magazines.

Unsurprisingly, they have become increasingly popular recently. "The total residential mortgage market in Japan is worth some ¥180tr, with about ¥18tr-¥19tr of new loans originated in 2009," says Manabu Watanabe, a director at Barclays Capital in Tokyo.

"Of that total, we expect that more than ¥2tr will be accounted for by Flat 35 loans this year, which is well over 10%. We believe that next year the share will be even higher. Bear in mind that there is usually a gap of about six months between applications being made and loans being granted, so the strength of demand for loans today won’t be reflected in the banks’ data for a few months."

If they were offered to homebuyers in any country other than Japan, the terms and conditions of Flat 35 loans would appear to be irresistible. But analysts report that competition among private sector lenders is also making floating rate alternatives attractive in a market that is becoming accustomed to interest rates that seem to be in permanent decline.

"Two years ago there was a shift back towards fixed rate loans as borrowers started to believe rates would rise," says Kondo at BofA Merrill. "Now sentiment seems to be swinging the other way with people expecting rates to remain low. That is increasing demand for floating rate loans, especially given that competition among lenders is leading a number of banks to market products such as loans with teaser rates which offer a 1% discount for the first five years."

Red flags

Some believe that the increased leeway now being given to individuals using the Flat 35 facility ought to wave a number of red flags. Inevitably, the progressively more liberal requirements for Flat 35 lending has led to a conspicuous change in the quality of loans advanced under the system, as well as to the credit standing of borrowers taking advantage of the very substantial subsidies effectively being offered to home-buyers.

As S&P comments in analysis published at the end of August: "Among the major attributes [of Flat 35 loans], there has been a consistent increase in the loan-to-value ratio. Similarly, we have also seen an increase in the debt-to-income (DTI) ratio. Although there was a slight dip in the past year, the DTI ratio has risen to about 24% from about 21%."

"Looking at borrower occupation... there has also been a rise in the proportion of loans extended to borrowers who are not corporate employees or civil servants. The ratio has gradually risen from about 15%, peaked at about 30%, and remained in the 20% to 25% range in some of the most recent issuances," notes S&P.

Bankers say they are relaxed about the potential for a deterioration in the quality of mortgage loans in Japan, for several reasons. One of these is that by international standards, mortgage debt in Japan remains very low. As ING points out in a recent research bulletin, "in Japan, household cash deposits are roughly four times larger than household mortgages. In the US, household cash deposits are smaller than their mortgage burden." Specifically, according to the ING data, in 2007 Japan’s households held deposits of $7tr and mortgage debt of just $1.7tr; their counterparts in the US, by vivid contrast, were sitting on deposits of $7.2tr but had mortgage debt of $10.4tr.

Another is that comparisons between the US and Japanese mortgage markets risk underestimating the essential cultural differences between the two societies, which have important implications for the RMBS markets on either side of the Pacific. "One reason that competition for home-lending among private banks is so intense is that Japanese home loans are seen as extremely safe and high quality risk," says one Tokyo banker. "There is a very strong stigma associated with failing to pay your debts on time, and there is an old Japanese maxim that people will give up their rice before defaulting on their loans."
  • 07 Dec 2010

Bookrunners of International Emerging Market DCM

Rank Lead Manager Amount $m No of issues Share %
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1 Citi 19,736.59 102 7.91%
2 HSBC 18,977.38 147 7.60%
3 JPMorgan 18,589.64 89 7.45%
4 Standard Chartered Bank 16,316.66 103 6.54%
5 Deutsche Bank 11,500.06 60 4.61%

Bookrunners of LatAm Emerging Market DCM

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3 Citi 2,873.13 13 10.04%
4 Morgan Stanley 2,678.21 7 9.36%
5 Santander 2,241.90 13 7.84%

Bookrunners of CEEMEA International Bonds

Rank Lead Manager Amount $m No of issues Share %
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1 JPMorgan 10,384.27 32 11.71%
2 Citi 10,180.55 30 11.48%
3 Standard Chartered Bank 9,331.24 32 10.52%
4 HSBC 6,479.00 27 7.30%
5 Deutsche Bank 4,875.44 9 5.50%

EMEA M&A Revenue

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2 Goldman Sachs 162.26 37 8.77%
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5 Citi 95.36 35 5.16%

Bookrunners of Central and Eastern Europe: Loans

Rank Lead Manager Amount $m No of issues Share %
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1 Citi 789.37 4 14.97%
2 MUFG 780.58 3 14.80%
3 Industrial & Commercial Bank of China - ICBC 742.79 3 14.09%
4 JPMorgan 301.80 3 5.72%
5 SG Corporate & Investment Banking 225.64 3 4.28%

Bookrunners of India DCM

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1 Standard Chartered Bank 1,783.30 14 17.83%
2 HSBC 1,156.32 12 11.56%
3 JPMorgan 1,015.66 11 10.15%
4 Citi 906.15 10 9.06%
5 Barclays 767.96 9 7.68%