The needle skipped but the record’s still playing

Despite claims that all is still rosy in Japan’s domestic bond market, several borrowers have recently pulled deals through lack of investor demand. Bankers in Tokyo say this is only a temporary blip. Philip Moore assesses whether they are right.

  • 07 Jul 2010
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"In contrast to some other markets, in Japan’s domestic bond market the music is still playing," says Jasper Tans, head of the Japan financing group at Goldman Sachs in Tokyo. "We’re seeing evidence of that on a weekly basis in the municipal market and also seeing signs of it in the corporate market."

As examples of that corporate activity, Tans points to recent transactions in which Goldman has had a lead role for leading local companies such as Nissan Motor and NEC, which raised ¥100bn each. Both were three-tranche deals, with Nissan raising funding in five, seven and 10 year tranches, while NEC’s first issue since August 2008 was in three, five and seven year maturities.

While many would share Tans’s view, recent indications from Japan suggest that the music may not be quite as harmonious today as in the first few months of 2010. In recent weeks, a number of borrowers including Sapporo Holdings, Kajima Corp and JACCS all postponed domestic bond issues in response to weak investor demand. Others pushed ahead with transactions despite uncertain demand, often leaving underwriters with unwanted excess bonds on their books.

Bankers in Tokyo say that this weakness in the primary market will be no more than a temporary phenomenon. "The correction in recent weeks was mainly because credit spreads had tightened too rapidly between January and the end of April. The general trend is that Japanese investors remain very cash-rich," says Kenichi Osawa, who runs the Japan syndicate desk at BNP Paribas in Tokyo. "So unless the overseas turmoil matches the Lehman crisis in terms of its severity, the domestic market will see a continuously strong bid for corporate credits."

The speed with which Japan’s domestic bond market recovered from the crisis of 2008 was certainly impressive. "As we saw all over the world, the market here quickly recovered its pre-Lehman status," says Gen Nakahara, head of Japanese debt capital markets at Bank of America Merrill Lynch in Tokyo. "The credit spreads of the highest rated utility companies in the 10 year tenor, for example, were between 20bp and 30bp at the time of the Lehman crisis. They have now come down to the single digits, so we have reached a historic low even compared to before the Lehman shock."

Spread tightening, says Nakahara, accelerated in the early months of 2010. "Most single-A rated borrowers enjoyed a very strong credit environment between January and the end of April," he says. "Orix, for example, accessed fixed rate five year funding at the beginning of April at Libor plus 175bp. More recently, it has returned to the market at around 100bp for a four year transaction, so we’ve seen a tightening of 75bp in two months. Softbank has had a similar experience. It printed a transaction in February at Libor plus 260bp and the most recent deal it launched was at a double digit spread."

Higher end demand

While demand for domestic corporate bonds has been concentrated at the higher end of the credit spectrum, bankers in Tokyo say that there has also been encouraging demand for borrowers in sectors that may have been thought less stable recently, such as real estate.

Yutaka Fukushi, head of debt syndicate at Mizuho Securities in Tokyo, concedes that activity in the domestic market has been lower since the highly successful transactions in 2009 for companies such as Japan Tobacco and Panasonic, which still holds the record it established last year for launching the largest ever corporate bond in the yen market.

But Fukushi says that diminishing volumes from such names are creating opportunities for others. "In the first quarter of fiscal 2010, shrinking corporate issuance is encouraging institutions such as Japanese pension funds to look for other names in the lower single-A spectrum and Reits," says Fukushi.

He points to Mizuho-led issues in March for Japan Excellent (rated AA- by R&I), which was a ¥12bn four year deal, and the unlisted Mori Building, which in February issued a debut ¥13bn three year transaction.

"We priced Japan Excellent at 88bp over Libor and Mori at 103bp, which helped to generate a lot of demand from pension funds looking to increase their portfolios of credit products and regional banks aiming to enhance their rates of return," he says.

For the time being, however, bankers say that the prospects for a substantial rise in issuance in the domestic bond market are muted. Theoretically, a revival in M&A ought to trigger an increase in funding requirements and therefore potentially underpin rising demand for bond issuance.

Recently however, appetite for growth by acquisition outside the financial services sector has been conspicuous by its absence. According to Dealogic figures, Japan-targeted M&A has fallen by 32% year-on-year to $34.9bn, which is the lowest level since 2002 when deals worth $22.1bn were announced in the same period.

Simple arithmetic

Even those few Japanese companies looking to make acquisitions have an embarrassment of riches in the domestic banking market, which is keeping the cost of bank lending very low. The maths are easy enough to grasp. According to research published recently by HSBC, in the first five months of 2010, deposits and CDs in the Japanese banking system increased by ¥12.6tr, while total loans shrank by ¥6.1tr, meaning that the gap between the two widened by ¥18.6bn. To put that figure into perspective, it is more than 40% of the total new issuance scheduled for the entire year in the JGB market.

"The bank market is flooded with cash, and in any case a number of companies pre-funded or ensured that they were long of cash in 2009," says Kodama at Deutsche. "The net effect is that although there are plenty of companies wondering what to do with their cash, I can’t think of a single major Japanese company that is wondering how it should fund itself."

Nevertheless, as bankers in Tokyo point out, refinancing requirements should also underpin a certain level of issuance in the Japanese corporate bond market over the coming 12 months. Hidenobu Shirota, of the debt syndicate at Daiwa Capital Markets in Tokyo, says that some ¥7tr needs to be refinanced in fiscal 2010 according Daiwa’s calculations.

Although that would be a fall from the ¥10tr of refinancings issued in FY 2009/2010, Shirota says that this should support healthy issuance in the domestic market, much of it accounted for by banks and utilities. 

Underwhelming but undervalued

Equity capital markets bankers had high hopes for Japan this year. Initial promise has turned to disappointment but bankers remain optimistic for the market’s prospects, writes Philip Moore.

Takeo Kusunose, managing director and head of capital markets at Bank of America Merrill Lynch in Tokyo, began the year with very high hopes that the Nikkei-225 Index had built a floor at the 10,000 level.

That was a brave hope, given how consistently the Japanese equity market has disappointed investors since peaking at just short of 39,000 at the end of December 1989. But as Kusunose says, it was a hope underpinned both by the recovery in global equity markets in the last quarter of 2009 and by the strength of Japanese balance sheets.

Salim Salam, co-head of international equity syndicate at Nomura in London, agrees that there were grounds for optimism at the start of the year, given a series of very successful equity and equity-linked deals led by Nomura in 2009 for companies such as Nippon Yusen, Toshiba, ANA, Hitachi, Asahi Glass, Takashimaya, MUFG and Nomura itself.

Bankers’ optimism on the prospects for Japanese equity issuance in 2010 appeared justified following the success of two jumbo transactions early in the year from the banking sector.

The first of these, in January, was the ¥968bn ($10.7bn) capital raising by Sumitomo Mitsui Financial Group (SMFG), on which Citigroup, Goldman Sachs and Nikko Cordial acted as joint global co-ordinators. The SMFG offering complemented a follow-on offering in 2009, bringing total equity issuance by the group to more than $20bn in seven months.

Then in March came the ¥994.9bn ($11bn) global IPO by the Dai-Ichi Mutual Life Insurance Co, which was the largest IPO in the Japanese market since the NTT DoCoMo listing in 1998. Extensively marketed on an 11 day roadshow across 19 cities, the IPO generated demand of ¥2.5tr ($27.8bn) from 400 orders, 60 of which were for more than $500m.

"The Dai-Ichi issue was a very successful deal on a global scale that was launched at a time when IPOs were being pulled all around the world, especially in the US," says Salam at Nomura, one of the three joint global co-ordinators for the IPO, alongside Mizuho and Bank of America Merrill Lynch.

"Dai-Ichi is a very defensive company, so investors looked at it as a value trade and many saw it as a proxy for the Japanese equity market as a whole. Global value funds were very comfortable with the story and were attracted by the structure of the deal."

Lean timesStrip out these two big deals from the financial sector, however, and it has once again been a disappointingly lean time for the Japanese equity market at a primary as well as a secondary level, with issuance having slowed down in part for seasonal reasons in the run-up to the Japanese year-end. "Since the Dai-Ichi IPO we have seen a small number of deals for high quality blue chip companies such as Yamaha and Toray," says Salam.

In the second quarter of 2010, equity capital market issuance fell back to $3.9bn, potentially the lowest quarterly level in more than a year, according to Dealogic data.

Equity-linked issuance, meanwhile, has ground to a halt, with zero issuance in the second quarter of 2010, according to Dealogic. That was disappointing, given that the year began with a highly successful ¥35bn convertible for Square Enix Holdings, sole led by Nomura, the books for which were more than five times covered.

Nor is the issuance pipeline in Japan exactly bursting. That is in part because although Mizuho has filed a shelf registration for the issuance of new shares of up to ¥800bn "to be invested in consolidated subsidiaries of MHFG", the process of balance sheet repair in the financial services sector is more or less complete.

Reasons to be cheerfulThere are, however, reasons for investors to feel positive about Japanese equity market prospects. Sentiment towards Japan among international investors has been improving for a number of years, according to bankers in Tokyo.

"International demand has been an important driver of a number of recent transactions," says Doug Howland, head of equity capital markets at JP Morgan in Tokyo. "In a typical global offering, tranches tend to be allocated evenly between local and international investors, but the standard oversubscription level is 1.2 to 1.5 times domestically and anything between three and 10 times among international investors."

Howland says there are plenty of good reasons explaining overseas investors’ growing enthusiasm for Japanese equities. One is the relatively low correlation between Japan and the world’s other big equity markets. Another is the financial management of Japan’s leading companies. "The management of Japanese companies is generally perceived as conservative and committed to maintaining strong balance sheets," says Howland. "That may not be a big attraction in a global bull market, but it is appealing on the back of a crisis when investors are looking for more robust balance sheets."

The liquidity of the Japanese market also enhances its defensive credentials. "Globally market conditions aren’t good at the moment but in a way that has helped Japan because it is a highly liquid market, and in uncertain times investors favour markets they can move in and out of," says Howland.

So much for the potential demand for Japanese equities. The outlook for supply, say bankers, is also brightening, with conditions ripe for Japanese companies to expand through acquisitions, especially overseas. "Think about it," says Howland.

"If you’re a Japanese company and your domestic market isn’t growing, to expand your business you can either look to grow through greenfield investment or by M&A overseas. The financial crisis has obviously knocked back share prices in Europe and the US. At the same time the yen has strengthened, especially against the dollar and the euro. This could be a once in-a-generation opportunity for Japanese companies to make acquisitions internationally, and there may be an increase in equity or equity-linked issuance on the back of that."

Some say that the first signs that Japanese companies are prepared to use equity finance to support growth are already emerging. "On the equity side I would say that 2009 was the year of balance sheet repair both among financial institutions and some of the leading companies such as Toshiba, Hitachi and others," says Jasper Tans, head of the Japan financing group at Goldman Sachs in Tokyo. "But we’re gradually moving towards an increase in acquisition and growth-related financing."

As an example, Tans points to the ¥43.6bn ($484,) follow-on offering led by Goldman Sachs, Mizuho and Nikko Cordial for Mori Trust Sogo Reit in May. This was the largest J-Reit [Japanese Real Estate Investment Trust] offering since the re-opening of the market in early 2009, with the proceeds used to support the acquisition of the Tokyo Shiodome Building, which was the largest acquisition in the history of the J-Reit market.

Others agree about the prospects for equity issuance to support expansion. "There is still some requirement from Japanese corporates for growth equity rather than the defensive equity that we saw in 2009," says Kusunose at Bank of America Merrill Lynch. "So I am optimistic that when markets stabilise we will a see a revival of interest from Japanese issuers."

Further supplyAnother possible source of equity supply is the unwinding of cross-shareholdings. According to Nomura, media reports and company statements suggest that some ¥1tr of cross-shareholdings (mainly at financial institutions) is likely to be unwound in fiscal 2010 on a book-value basis. Nomura is relaxed about the impact that this is likely to have on the Japanese equity market, pointing out that the figure of ¥1tr is modest in comparison with the ¥6.5tr that was unwound in fiscal 2002.

"Such sales will take into account share price trends, and be handled in combination with the use of the Banks Shareholding Purchase Corp (BSPC) and share buybacks," says Nomura which thinks that will prevent a "major deterioration on the supply-demand balance for shares, and cause minimal short-term impact".

The effect of any additional supply, say bankers, is also likely to be low given current valuations in the Japanese equity market. "The Japanese equity market remains very undervalued," says Kusunose. "P/E ratios of 15 or 16 may not make Japanese stocks look super cheap. But many companies are trading below their book values. In the case of Dai-Ichi Life, the ratio of price to embedded value was less than one, which was very compelling value compared with other Asian insurance companies."

Those low valuations, say strategists in Tokyo, will look increasingly compelling in light of the robust balance sheets in the Japanese corporate sector. As UBS noted recently: "Free cashflow is increasing rapidly. Interest-bearing debt is also declining and on hand liquidity is rising sharply, while net debt is declining rapidly. The gap between free cashflow yield and the dividend yield is widening and we see significant scope for shareholder returns."

  • 07 Jul 2010

Bookrunners of International Emerging Market DCM

Rank Lead Manager Amount $m No of issues Share %
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1 Citi 8,563.70 22 14.58%
2 HSBC 7,832.21 25 13.34%
3 Deutsche Bank 6,701.74 14 11.41%
4 JPMorgan 4,850.50 14 8.26%
5 Bank of America Merrill Lynch 2,611.95 12 4.45%

Bookrunners of LatAm Emerging Market DCM

Rank Lead Manager Amount $m No of issues Share %
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3 HSBC 3,768.59 4 16.45%
4 JPMorgan 2,812.07 8 12.28%
5 Bank of America Merrill Lynch 1,683.06 6 7.35%

Bookrunners of CEEMEA International Bonds

Rank Lead Manager Amount $m No of issues Share %
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1 Citi 3,236.25 7 10.30%
2 HSBC 2,253.75 3 7.17%
3 Deutsche Bank 1,703.96 4 5.42%
4 Standard Chartered Bank 1,518.77 3 4.83%
5 JPMorgan 1,341.27 2 4.27%

EMEA M&A Revenue

Rank Lead Manager Amount $m No of issues Share %
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2 Goldman Sachs 162.26 37 8.77%
3 Morgan Stanley 141.22 46 7.64%
4 Bank of America Merrill Lynch 114.20 33 6.18%
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 ING 3,668.64 29 9.07%
2 UniCredit 3,440.98 25 8.50%
3 Sumitomo Mitsui Financial Group 3,156.55 13 7.80%
4 Credit Suisse 2,801.35 8 6.92%
5 SG Corporate & Investment Banking 2,478.18 21 6.12%

Bookrunners of India DCM

Rank Lead Manager Amount $m No of issues Share %
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1 AXIS Bank 77.43 3 24.06%
2 Standard Chartered Bank 45.42 1 14.11%
2 Mitsubishi UFJ Financial Group 45.42 1 14.11%
2 CITIC Securities 45.42 1 14.11%
5 Trust Investment Advisors 31.87 2 9.90%