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Investors eye covered bonds, Australia for life beyond JHF

07 Dec 2010

While the prospect of covered bonds is unlikely, observers believe they would be extremely popular and would be offer a welcome alternative, given the increasing interest in Australian RMBS, due to the shortage of private sector supply in Japan.

Japan has had an active RMBS market for more than 10 years, with Sanwa Bank kick-starting issuance in 1999 with a transaction led by Bear Stearns named Sanwa Housing Loan 1.

The team that structured the Sanwa curtain-raiser moved in 2000 to Shinsei Bank, the entity that was formed in June 2000 following the nationalisation, rebirth and rebranding of the Long-Term Credit Bank (LTCB) of Japan. In 2001, Shinsei built on the success of the Sanwa transaction when it managed Dreams Funding, a ¥73.5bn securitisation of a portfolio of residential mortgage loans purchased from Daihyaku Mutual Life Insurance. Packaged into a number of fixed and floating rate tranches and backed by almost 6300 floating rate residential mortgage loans, Dreams Funding was placed with some 34 domestic institutions.

Widely recognised as a standard-bearer for securitisation in Japan, Shinsei followed its initiative in the RMBS market with the launch in November 2001 of the Shinsei Bank Master Trust programme backed by loans to Japanese corporate borrowers.

A number of other large Japanese banks enthusiastically embraced the RMBS option in the early years of the market’s evolution, with Mizuho Bank launching its first transaction in July 2004. At the time, the ¥294.2bn Mizuho Bank Residential Mortgage Loan Trust was the largest Japanese RMBS ever issued, with the notes again distributed exclusively among local institutions.

More recently, Shinsei appeared poised to launch another very important transaction in the broader Japanese mortgage backed market when it completed the necessary groundwork for Japan’s first covered bond. Provisionally rated Aaa by Moody’s, this was to have been a ¥30bn ($280m) 10 year transaction launched in the summer of 2008. The deal was shelved, however, because of concerns over downgrade risk arising from Shinsei’s acquisition of GE’s consumer finance units in Japan, since when no other would-be issuer has stepped up to the plate.

Nor, say bankers, is there much prospect of a revival of interest in covered bonds in Japan as long as there is no formal legislative framework governing issuance, although this would clearly be well received by Japanese bankers. "A covered bond law would be very positive for the market, and would be very easy to pass," says one.

The Japanese credit rating agency, R&I, agrees. "Real estate loans and public sector loans... which are the target of covered bonds are areas where, in Japan, public finance, such as fiscal investment and loans programmes, has traditionally played the key role," R&I notes in a 2009 report.

"The fact that Japan has such a large outstanding volume of public debts means that there are limits to the future capacity of public finance to provide the necessary funding. In particular, if the object were to ensure the recovery of medium-to-long term financial intermediaries, it would surely be worthwhile for private banks to consider utilizing a covered bond framework."

Private trickle

Today, for investors looking for exposure to Japanese RMBS, there is no more than a tiny handful of private sector issues arising from the JHF Guarantee Programme. Under the JHF Purchase Programme, the agency buys loans from private sector lenders, whereas under the guarantee scheme, JHF provides a guarantee to private sector financial institutions which covers their own asset backed issuance.

"We would say that tThe guarantee programme is favoured by those private institutions that prefer to take control of their housing loan business," says Katsuhiko Maeda, director general of the market operations department at JHF’s Tokyo headquarters. "We have four renowned institutions, including Bank of Tokyo Mitsubishi (BTMU), participating in our guarantee programme, but the other three banks are now temporarily suspending the origination of housing loans under the programme."

"Around December 2008," Maeda explains, "the Japanese securitisation market contracted, since when the private financial institutions have had difficulty in issuing private label MBS. The three banks other than BTMU now prefer the purchase programme to the guarantee programme."

According to Bank of America Merrill Lynch, RMBS issuance under the guarantee programme has been very small relative to JHF’s mainstream issuance under the loan purchase programme, with total issuance over the 3-1/2 years having reached around a modest ¥300bn ($3.6bn).

While there is still a trickle of private sector issuance under the guarantee programme, new issue sizes are minuscule relative to JHF’s primary market supply. A recent example was the ¥3bn BTMU Mortgage Trust Series 6, arranged by BNP Paribas in August. The Mortgage Beneficial interests in this series are backed by residential Flat 35 mortgage loans originated by BTMU and insured by JHF. The BTMU Mortgage Trust Series is rated Aa2 by Moody’s, which explains that it assigned the rating "based solely on JHF’s guarantee capability. The rating of the Mortgage Beneficial Interests is linked to that of JHF in principle. The rating does not factor in the credit quality of the underlying residential mortgage loan pool."

More diversification in the Japanese securitisation market would certainly be welcome, with local bankers reporting that demand among Japanese institutions is strong. "We are seeing high demand among Japanese investors for Australian RMBS because of the shortage of supply in Japan," says Manabu Watanabe, a director at Barclays Capital in Tokyo.

Others agree that for many investors there is clearly a shortage of accessible private sector RMBS. "For investors without access to very private club-based deals there are very few alternatives to JHF MBS in the Japanese ABS market," says Kaoru Kondo, structured finance analyst at Bank of America Merrill Lynch Global Research in Tokyo. Where alternatives are available, disclosure standards are feeble and liquidity non-existent.

Poor disclosure, says one local banker, has been part of the DNA of the RMBS market since its early days. "Shinsei put all its early deals on Bloomberg, but I think it was the only bank to do so," says one Tokyo banker. "There has simply never been a culture of transparency in this market."

Shafts of light

Some respite for investors starved of opportunities in the ABS sector may now be materialising, because securitisation activity in appears to be mounting a comeback globally. As Germany’s KfW notes in its half yearly report, "the first pleasing chinks of light can be seen" in the European securitisation market, and the same may be true in Japan.

According to figures compiled by Deutsche Bank’s securitisation products research team in Tokyo, there were 33 Japanese securitised product issues worth ¥538.5bn in September, up 5.1% from a year earlier. "Monthly issuance thus moved past the ¥500bn mark for the first time in 2010, surpassing the previous high set in March," notes Deutsche. Although issuance between January and September was down by over 25% compared to 2009, Deutsche comments that "primary market activity is clearly still on the road to recovery, but the slight year-on-year increase in issuance for September can perhaps be viewed as a ray of hope."

One area of the Japanese securitisation market that is providing one of these rays of hope is the CMBS market, which was a quite vibrant pocket of the Japanese capital market before the Lehman collapse. "Between 2006 and 2008, which were the bubble years for the market, there was a lot of international investor participation in the CMBS market," says BofA Merrill’s Kondo.

Unsurprisingly, investor demand for CMBS nose-dived as a result, although bankers say that there is now no shortage of investors increasingly attracted by distressed opportunities in the secondary market. "There may now be more buyers than sellers in the CMBS market, but many of the sellers are holding out for better prices," says one local banker. "We’re seeing some trading activity, but it has been difficult to find pricing that suits sellers as well as buyers."

However, signs of life have also started to materialise at the primary level of the CMBS market. Barclays Capital, for example, recently arranged the first CMBS transaction in the Japanese market since 2008, B-CAP 1 Trust Certificates, and although bankers warn that too much should not be read into the deal, given its tiny size (¥8bn), the transaction certainly seems to be a step in the right direction.

One local banker explains that the CMBS formed part of the ¥33.2bn bid for Kenedix for a package of real estate assets. "¥25bn of the Kenedix bid was arranged by Barclays Capital," he says, "of which ¥17bn was a senior piece and ¥8bn was the CMBS portion."

"The difference between this and previous CMBS deals in Japan was that we made certain that mezzanine lenders were given more influence, more leverage in any workout procedure and more clarity about the exit strategy," he adds.

Bankers say that the prospects for the CMBS market are much better than they were six months ago. "The outlook for the new issue market is definitely improving," says Kondo at BofA Merrill.

"We certainly won’t see a return to aggressively structured CMBS with high leverage and high LTVs. But there will be growing demand for conservatively structured, single borrower transactions. Tokyo-centric real estate, in particular, continues to attract investor interest, although I don’t think we’ll be seeing investors buying deals backed by regional hotels, as they did back in 2006 and 2007."

The view that the outlook for CMBS is on the mend appears to be shared by Moody’s. In an update published in September, the agency commented that "given the recent growth in property transactions this year, the resolution of specially serviced loans (through the sale of either properties or loans) has accelerated — which could lead to lower expected losses in CMBS loans."

Others seem more hesitant to forecast a strong and sustainable revival in the broader Japanese mortgage-backed market. "This year’s ratings actions are becoming less significant than last year’s, but I’m not sure that many people believe the commercial real estate market has definitely hit the bottom," says Masaaki Kudo, managing director of structured finance at Fitch Ratings in Tokyo.

"On the investment side, the key element is banks’ appetite for providing acquisition finance. We have observed an increase in banks’ appetite for financing acquisitions of offices and multifamily apartments. But it remains relatively difficult to obtain financing for properties like hotels or suburban shopping centres. That will make it more difficult for investors to dispose of these kinds of properties, which may have a negative impact on the CMBS market."


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07 Dec 2010