Securitisation the only game in town
The innovation of intermediaries such as Shinsei Bank and increasingly adventurous issuers and investors has set the stage for securitisation in Japan to move into the spotlight. Mark B Johnson reports on a blockbuster year for the asset class.
In recent years, the story in the Japanese securitisation market has been the imaginative securitisation of commercial property assets, residential mortgage transactions and secured consumer finance assets, such as auto or shopping loans.
More recently the arrival of unsecured consumer finance assets has allowed the market to make another jump forward. But the real excitement of the past 12 months has been the arrival of the bank originated securitisation
"The removal of risk off the balance sheet will continue to be a key factor for the securitisation market's growth," says Takeo Sumino, head of global merchant banking planning at Nomura in Tokyo.
"Given the current sluggish stock market, large banks are having to reduce their risk-weighted assets to improve their respective BIS ratios," says John Macfarlane, country head of Deutsche Securities in Japan. "In fact, we have seen quite a lot of activity from the Japanese banking sector with many transactions aimed at improving their capital ratios."
However, future growth will require the market to face up to certain challenges. Many banks continue to offer loans to the bigger companies at razor thin spreads. These are often more attractive than the rates the borrowers can achieve in the bond market but they do not accurately reflect the risk involved.
Meanwhile, bond market investors are becoming increasingly averse to lower rated issuers and are demanding high spreads. "To achieve further growth, the investor market for the residual and mezzanine pieces must grow, as it is currently quite limited in depth," says Sumino.
Of course, there is growing demand among Japanese investors for the highly rated securitised paper. Yield on a five year securitised issue might be 45bp over JGBs, which is appealing when other triple-A credits, such as government entities, trade at roughly 5bp-8bp over JGBs in the straight bond market.
And there is also improving appetite for lower rated paper as investors search the asset spectrum and move down the credit curve hunting for return. But the current appetite is too low for the vast scale of the problems that need to be tackled.
The arrival of bank sponsored deals is linked directly to the restructuring that is taking place throughout the country. The government, corporates and financial institutions are reorganising their balance sheets and strategies to reposition themselves for the decades ahead.
Securitisation is central to this process as it helps accelerate the process of disintermediation and drives the Japanese financial system to a market-based pricing system. This results, theoretically at least, in diversification of economic risk and capital.
One of the champions of securitisation has been Shinsei Bank, reborn out of the former Long Term Credit Bank of Japan. Shinsei last year inaugurated its residential mortgage and collateralised loan securitisation programmes.
In late June, Shinsei Bank raised, through a vehicle called Shinsei Funding Four, Eu150m and $100m through the two tranche sale of credit-linked bonds out of its ¥1.4tr CLO master trust. Citigroup/SSB and Nomura were responsible for placing them, selling the 2.83 year average life bonds at 45bp over their respective interbank rates, spreads that were in line with those Shinsei achieved with a ¥40bn issue a week earlier, also arranged by Citigroup and Nomura. That issue, divided into three and five year notes, had been sold largely to the Japanese domestic market.
Shinsei Funding Four was the fourth issue from the bank's ¥1.4tr Shinsei Bank Master Trust, which agglomerates some 2,300 loans to over 600 Japanese companies.
The programme was launched in November 2001 and its intricate structure gives it some of the characteristics of a US credit card transaction.
In a structure inspired by the securitisers of US credit card receivables, Shinsei's corporate loans master trust was designed to give the bank multi-currency issuance alternatives at short notice and with pre-agreed and constantly monitored triple-A ratings from all three international agencies.
The aim of the deals was not capital relief - Shinsei's BIS ratio stood at 17% when the first deal launched - but to give the bank an additional reliable avenue of funding.
"When we set out we knew that there was strong foreign and local distrust of Japanese originated transactions and the CLO has for some time not been in favour globally as an asset class," says Ernie Olsen, general manager in the structured trading division at Shinsei.
Accordingly, the large pool achieves credit diversification. Eligibility criteria have been defined that, roughly speaking, capture all loans that would be rated investment grade by Japanese rating agencies.
The programme also incorporates synthetic loss reallocation techniques, allowing for the rebalancing of the total asset pool on a dynamic basis to ensure that the investors' risk profile remains within predefined limits.
"This means that the structure can handle the potential migration of credit quality and industry concentration to keep the pool within certain set limits, for the benefit of investors," says Olsen.
The first deal secured about 20% of orders from international buyers. As Shinsei has made more issues, it has gained additional support from foreign investors, first by packaging more floating rate issues (local buyers prefer soft bullet fixed rate paper) and more recently by issuing in dollars and euros.
"Spreads in Japan for securitised paper have been tighter than offshore and therefore there is an economic logic to selling more onshore," says Robert Sheehy, chief operating officer at Shinsei Securities. "However, we want investor diversification and are prepared to pay the modest price required to achieve that."
"We have made a great effort to develop name recognition overseas by meeting with investors," adds Sheehy. "We have tried to make the structure and the management as transparent as possible, in order to help overcome fears on corporate and financial risk in Japan."
More recently Mizuho's ¥1.266tr CLO launched in September, proves that the desire to improve bank ratios is far from synthetic. Mizuho Financial Group is the world's largest financial institution, with total assets equivalent to $1.2tr. It was formed officially in April this year and comprises Mizuho Corporate Bank, Mizuho Bank and Mizuho Asset Trust & Banking.
In September Mizuho Corporate Bank launched its ¥1.266tr ($10.17bn) synthetic CLO transaction, CuBic One. It was the first from a programme sized at a staggering ¥10tr ($80.3bn).
Yoichiro Nakai, general manager of the business arrangement and development department at Mizuho Securities in Tokyo, told EuroWeek that the bank wanted to reduce its vast loan assets and improve its BIS ratios.
CuBic One was in Euroyen documentation, but was sold in Japan under private placement rules so that the issuer could avoid the disclosure required for a public offering. As a result Mizuho International, which placed the bond part of the deal, did not reveal the pricing.
Beneath the super-senior tranche, rated by Moody's and S&P, the deal offered five tranches of notes rated only by Moody's from Aaa down to Ba2. The senior swap will amortise, but the notes are all 2-1/2 year soft bullets due April 2005.
The upper four-fifths of the risk was transferred with a ¥1tr super-senior credit default swap placed by Merrill Lynch, joint bookrunner on the transaction with Mizuho International.
The bank will be allowed to treat that portion of the portfolio as 20% risk weighted, and will achieve complete capital relief on the ¥242bn layer of risk that was transferred with funded notes.
The result of the deal left Mizuho Corporate Bank with just ¥24bn of first loss exposure to the portfolio of loans to 151 Japanese corporates. The capital treatment of the retained first loss tranche was not disclosed.
In a reversal of the usual practice in Europe, the junior notes (those rated triple-B and double-B) are collateralised with Japanese government bonds, while the other tranches are secured on eligible bank deposits.
"There was strong demand for the deal from insurance companies and regional banks," Nakai at Mizuho said shortly after the deal. "It is an excellent portfolio of Japanese corporates from around 30 industries, which investors were keen to access. The definition of a credit event is also simple and investor-friendly - only bankruptcy and failure to pay, not restructuring."
Synthetic structures are still relatively new to Japan; deals have been done in private since 1998, but it is only this year that a substantial market is developing.
The deal proves that Japanese banks have growing interest in collateralised debt obligations (CDOs) as a means to improve returns on capital and ease pressure on their BIS ratios. The pressure from problem loans and losses on cross-shareholdings are compressing capital.
Moody's reported in July that 12 balance sheet CDOs had been issued by Japanese banks in the first half of 2002 - six synthetic and six cashflow deals. Seven of the deals were public. Including five arbitrage CDOs, Moody's estimates total Japanese CDO issuance in the first half of 2002 was ¥1.46tr, including super-senior and subordinated tranches not rated by Moody's.
But bank originated securitisation is not yet widespread in Japan. Shinsei has become a trendsetter in a notoriously conservative, some would say recalcitrant, Japanese banking sector. Mizuho's deal was synthetic and to some extent underscores the continued obsession with assets. Many Japanese banks still believe that it is an admission of failure to move assets off balance sheet, rather than a public demonstration of the will to improve returns.
The way in which the former LTCB had funded itself was so fragile that its collapse was almost inevitable. The new management team at Shinsei had a stated mission to employ securitisation as the key mechanism to make the total balance sheet as liquid as possible. "We wanted the ability to expand or contract the balance sheet at will, to create the potential of having a totally liquid asset base," says Brian Prince, head of the institutional banking group at Shinsei.
The collapse of the stock market again this year and the growth of bankruptcies, continued deflation and rising unemployment has led the government to conclude that massive state assistance is required for the banks.
In effect, they are saying that the sector remains dysfunctional, incapable of efficiently managing its assets and liabilities, and unwilling or unable to appropriately allocate and price credit.
In the future, informed observers hope that the government will demand management change. If used effectively, securitisation can help banks reshape and expand their balance sheets at the same time as helping maximise returns.
Teruaki Yamamoto, managing director of Shinsei Bank, expanded this view in an interview earlier this year with EuroWeek's sister publication, Structured Finance International. "Japanese banks have for decades held on to the belief that asset expansion is the number one priority," he said. "Despite the traumatic events of recent years, it is clear that most of the major banks still cling to this policy, hoping that holding on to or growing assets will make them too big to fail. We differ from that perspective completely - we believe that the quality of assets is paramount and also seek out the highest quality new customers."
Despite and partly because of the economic backdrop, almost every market proponent is positive about the prospects for securitisation. Estimates for this year's activity range from ¥5tr to ¥8tr. The market is somewhat opaque, as so many of the deals are privately placed and pricing is also obscured by uncertainty over the size of the first loss retention and of the subordinated tranches.
The private placement rule requires that no more than 49 institutions can be contacted for a private deal. For deals up to about ¥30bn, most issuers and intermediaries recognise that there is little to be gained from going the public route.
Most transactions have been targeted at the local market in recent years. The investor base has grown rapidly, there is growing sophistication and appetite for new assets and structures, as well as rising willingness to buy down the credit curve.
One estimate earlier this year by a senior banker put the number of local funds participating in the securitisation market at more than 300, an improvement of roughly 50% on 2000 and 2001.
Foreign investors have become increasingly concerned about Japan and remain largely unwilling to buy Japanese paper on the spreads at which the local market will buy. Hence, most originators targeting offshore buyers are doing so to ensure funding diversity.
Consumer finance company Orient Corporation is the most visible of Japan's small but growing band of regular originators of securitisation issues. The company is a regular visitor to the offshore markets to ensure it maintains access to an ever wider global investor base for its assets.
By the end of September, Orico had completed 32 public ABS issues at home and abroad since 1996. The company is not only a programmatic deal maker, it is a strong advocate of securitisation for corporate Japan.
Orico's Oscar auto loans programme, which was launched in February 1998, is the benchmark for Japanese ABS in the Euromarket. It has never wavered from the original structure, giving investors the comfort of familiarity.
In August, Orico sold its auto deal. Lead manager Mizuho International sold $153m and Eu148m of triple-A notes at 35bp over one month floating rates in the respective currencies with an average life of 1.63 years, slightly wider than the previous deal, which was priced at plus 28bp shortly before the September 11 attacks in the US.
But the pricing was nevertheless well inside the more than 60bp spread Orico was obliged to pay during the Japanese banking crisis of 1998 and early 1999.
"Our assets are in yen, but we aim to complete two Euromarket deals each year and swap back into local currency," says Ichiro Yamamo, manager in the capital markets finance department at Orico.
"The local market has been cheaper since the bank recapitalisation package of spring 1999, but we greatly value diversification and want to maintain our profile with offshore investors."
The offshore markets also offer Orico the opportunity to sell amortising paper, whereas Japanese investors generally prefer bullet issues.
The latest deal was heavily oversubscribed. Richard Tarn, executive director in primary and structured finance at Mizuho in London, explains: "Excessive global spread volatility and growing concerns over Japan in general demanded we err on the side of generosity. Loyalty is required on both sides of the equation and both sides have demonstrated that over the years, helping the Oscar series to become a regular programme of successful deals. This transaction brought new buyers and also some that had drifted away."
Orico is the largest issuer of auto loans in Japan and originates 50,000 loans each month from more than 200 offices across Japan.
"Securitisation is an essential tool in our funding repertoire," says Yamano. "Before 1993, we were entirely reliant on the banks for all our funding. The domestic bond market is liquid but we have too low a rating. Therefore securitisation is ideal as it concentrates the quality of our assets in discrete pools to achieve the highest ratings."
The Japanese finance industry and the rating agencies have more than enough data to prove that the Japanese retail borrower is an excellent credit risk. "The Japanese individual is one who fulfils his or her obligations," says Yamano. "If necessary, the immediate and extended family will help out in times of trouble, for cultural reasons as well as the fear of becoming a credit delinquent."
At the end of the latest financial year, Orico had total bank debt of ¥2.1tr, and had raised ¥590bn through securitisation.
Orico has had its share of financial woes in recent years, the result of corporate loans from years back that went wrong. "Again, securitisation is an ideal tool as it distances our balance sheet from the assets in the programme," says Yamano. "The only exposure investors have is to the underlying cashflows. We have had a cash injection from our major shareholder Mizuho Corporate Bank and we are a viable and profitable enterprise and top quality loan servicer and all our deals feature excellent back-up servicer arrangements."
Orico has also been eyeing the global markets for further investor diversification. "We issue about four deals a year in the domestic bond market, two in the Euromarket and we would like to expand into the US, probably first through the 144A route," explains Yamano. "The US market is the logical target for any regular securitiser from any market, offering greater depth and the opportunity to extend the average life of issues."
Auto loans are not the only assets Orico securitises. Orico's most recent funding diversification offshore has been the sale of card loan receivables through the Clare Series (two deals to date). Initial pools for these deals amounted to an aggregate of ¥120bn, and paper has been issued in dollars, euros and yen in Euromarket format.
Beginning in early 1999, the firm has also sold shopping loan receivables, although so far only in the local market. Also in the local market, Orico has securitised a pool of mortgages, via a private placement, and has securitised the subordinated beneficial interests of some of the early Oscar transactions. "There are other receivables we will consider, but these asset classes are more complex and might require a wrap from a monoline insurer and we would not likely consider the offshore markets for these in the near term," says Yamano.
CMBS transactions will continue to spur growth, and the residential mortgage structure is becoming more popular, championed by early deals dating back to 1999 and more recently by the GHLC, the Shinsei Dreams Funding deal and other more recent deals cut off the RMBS template.
An exciting development this year has been the arrival of conduit deals to Japan. Good Loan, a subsidiary of Softbank, is one of the new mortgage providers, competing head on with the traditional source of funds - the government and the commercial banks. But Good Loan is less than 18 months old and has negligible on-balance sheet leverage capability.
This is where Shinsei Bank steps in. "We warehouse the loans Good Loan originates and then securitise them as part of mixed pools," says Dan Shireman, head of the Shinsei Bank's residential and commercial MBS team. "Later we plan to securitise those assets in discrete deals under the Good Loan name." Shireman believes this is the first and only conduit relationship to date between a non-bank and a bank in Japan.
The arrangement is new to Japan but is common practice in Australia, where leading non-bank originators such as Interstar Securities or Rams Home Loans have enjoyed warehousing agreements with banks for more than 20 years. They still use warehousing, but have for many years issued in their own names and many are familiar favourites with global RMBS investors.
Good Loan's typical customer wants to borrow an average of ¥30m ($245,000) to buy new apartments in the Tokyo suburbs, where new units of just 70 square metres sell for an average of ¥40m ($328,000).
These customers must have access to at least 20% as deposit, in order to give Good Loan assets with an average loan to value ratio of below 80%. Income must be at least ¥4m ($32,750) per annum and the customer can have no more than 30% debt to income as a maximum at the time Good Loan agrees to the loan.
"The Japanese individual has one of the best credit records in the world," says Masahito Ito, president of Good Loan. Good Loan is offering these roughly 30-35 year old new customers a 30 year mortgage with a fixed rate of just 3.05%.
Good Loan's typical customer would normally have first approached the Government Housing Loan Corporation, the state controlled mortgage lender that accounts for roughly 35% of the estimated ¥210tr ($1.72tr) Japanese mortgage market.
The corporation's dominance has been built up over decades and it is a tough provider with which to compete, offering 35 year loans with rates fixed for 10 year periods. But it is gradually to be corporatised and offloaded from the state's balance sheet which will open the door to more private sector competition.
"We can compete more effectively with the banks," says Ito, "but the banks have their captive customers and we are the new boys on the block. Nevertheless, we are making good progress and are well above our original targets for assets at this stage of our evolution."
When Good Loan and Shinsei set up their partnership, the rating agencies were closely involved in establishing the criteria for eligible mortgage origination.
A vital element of the process was the analysis of the prepayment. These are especially high in a Japanese society that has a preference to be free of personal debt.
"Caution and professionalism have been the watchwords for us throughout as we want the programme to become known for being associated with the best quality assets in Japan," says Shireman at Shinsei.
Ito is delighted with progress to date. "We have grown form nowhere to become a viable competitor in the market thanks to this innovative wholesale funding partnership," he says.
Unsecured consumer loan assets were the fastest growing sector of the Japanese securitisation market last year. Until May 1999 it was illegal for non-bank consumer finance companies to lend funds raised through the issuance of corporate bonds. New laws have allowed the securitisation of unsecured consumer loans to become a weighty asset class in the Japanese market.
While most originators have been medium sized consumer loan companies, the so-called "Big Four" (Takefuji, Acom, Promise, and Aiful) have started to enter the sector as well. Moreover, companies that have securitised other assets (for example Orico is best known for its auto loans deals) have started to securitise card loan assets and also plan to sell other unsecured consumer loans.
More deals are expected as the result of corporate restructuring, including principal finance transactions where risk takers are refinancing through structured finance deals.
The use of beneficiary trust certificates will also continue to rise as more Japanese investors appear willing to invest in transactions in trust certificate form, leading to some concerns over the future transparency of the market.
The trust structure, which has become widely used since last year, aims to mitigate the burden of notifying obligors of the asset transfer under the Money Lending Law. Although the structure relies on legal opinions, the market generally believes it is acceptable and is a core factor behind the recent growth of the consumer loan ABS market. *