Originators are embracing securitisation as never before in Japan and investor demand at home seems almost limitless. The prospects for a vibrant RMBS market to finally develop are good. But competition for agency mandates is intense and new structures rapidly become commoditised. Only the smartest and most patient houses can stay ahead of the pack and make a solid return on their investment in the market. Mark B Johnson reports.
By early October, new issuance in the Japanese securitisation market in 2001 had reached ¥2tr, equivalent to $16.7bn. As Japan restructures, more companies and banks are employing securitisation as a corporate finance tool. With so much liquidity in the local market, there is plenty of appetite for jumbo deals, even in new asset classes.
Earlier this year, Morgan Stanley arranged the acquisition financing scheme for leading Japanese consumer loan company Aiful's purchase of Life, a shinpan (consumer instalments and finance) company. Life was under court-administered rehabilitation. Following a difficult two month due diligence on more than 2m customer accounts, Morgan Stanley and co-lender Sumitomo Trust & Banking Co proceeded with the non-recourse funding in late March. The ¥273bn ($2.18bn) loan was collateralised by a ¥300bn portfolio of Life's consumer finance receivables, and Aiful beat around 10 competitors to take over Life's assets.
Then, in early October, Morgan Stanley priced a ¥245bn securitisation of Life's consumer finance assets, which had been acquired by Aiful Corp. The deal is a milestone in the development of the Japanese securitisation market. It is the first Japanese asset backed transaction to achieve ratings from triple-A to triple-B from four rating agencies: Standard & Poor's (S&P), Moody's, Fitch and R&I.
Additionally, it is the first transaction to be cross-collateralised by a portfolio of four different asset types, all of which are held in one master trust, providing the utmost flexibility for the issuer for serial issuance under the same scheme.
"The benefit of a master trust with so many asset types bunched together is clearly the large size of the deal," says Alexander Batcharov, global head of structured finance research at Merrill Lynch in London. "The diversification aspect is not so much a positive, since all of the assets in this particular case are consumer related, and is correlated to some extent. In any case, this transaction is an innovative deal in many aspects, and a landmark in the history of Japanese consumer loan ABS."
RMBS MARKET BOOST
The Government Housing Loan Corporation (GHLC) finally inaugurated its long awaited residential mortgage backed securitisation (RMBS) programme in March, when Credit Suisse First Boston arranged a ¥50bn deal with joint lead managers Goldman Sachs and Sanwa Securities.
The structure GHLC opted for is more like a secured bond than a classic securitisation. There is no special purpose vehicle, so the structure does not involve a true sale of the assets at closing. The structure was used mainly because GHLC would gain no capital advantage from taking the loans off balance sheet and it is cheaper for the corporation not to engage in a true sale.
Unusually, rather than the soft bullet structures used on many Japanese RMBS deals, the transaction offered straightforward passthrough notes that amortise monthly. Consequently, the leads spent plenty of time educating investors about the product.
GHLC's activities are vital to the development of the RMBS market in Japan, because the corporation can provide so much precise data on the Japanese mortgage market. Established in 1950, GHLC has more than 5.5m customers and almost almost ¥77tr ($636bn) in total assets.
It announced recently that it plans to double its amount of issuance next year, from the current ¥200bn annually to ¥400bn, and ultimately develop the market to the size of ¥3tr. GHLC also said that, for the immediate future, it will continue to use the current structure - the credit linked MBS with triggers for de-linkage, quite familiar to investors by now.
The announcement confirms the view in some quarters in Tokyo that GHLC will aim to transform itself into a Fannie Mae-type entity as the government tries to privatise, or quasi-privatise, many leading government agencies, thereby diminishing its contingent exposures.
In late July, Shinsei Bank launched a ¥73.5bn RMBS issue backed by a portfolio of residential mortgages it acquired when it bought Daihyaku Mutual Life Insurance in 2000.
Shinsei Bank is the new entity formed out of the failed Long Term Credit Bank, which in March 2000 was taken over by a group of investors including 10 international banks led by US private equity group Ripplewood. The deal was lead managed by distribution arm Shinsei Securities, only set up in May this year.
"Securitisation is central as a tool for the bank's management," says Robert Sheehy, general manager in charge of the securitisation group at Shinsei Bank. "Our mission is to help the bank make the total balance sheet as liquid as possible. We want the ability to expand or contract the balance sheet at will, to create the potential of having a totally liquid asset base."
Sheehy joined the bank in August 2000, along with the other members of his team from Bear Stearns. They joined a group of bankers in the existing Shinsei securitisation team. The group reports to Brian Prince, head of financial engineering.
"Many companies in Japan are recognising that the continuing economic troubles require that they streamline their balance sheets and focus on their core businesses," says Prince. "We are diversifying our funding sources as widely as possible, including building our retail operations and therefore our deposit base."
Dan Shireman, general manager responsible for mortgage related products, says that the quickest way for Shinsei to expand its presence in the retail market is to buy up portfolios of assets, as in the Daihyaku deal. "We decided the most effective way of hedging the risk of these assets was through securitisation," he adds. "Securitisation addresses both prepayment and straight default risk."
BEAR EXPERIENCE TELLS
The template for Shinsei's structure came from the Sanwa Bank RMBS deal that Bear Stearns arranged in 1999. That was the first such securitisation out of Japan. "The structural element of the deal was not that difficult," says Shireman. "In the Sanwa deal there was set-off risk to address, but in this case we only acquired the mortgages. The key to the deal, as in 1999, was how to bring the mortgage and the property deeds into one trust, to give investors the ability to foreclose. But as we demonstrated in 1999 and as other deals have shown, this is a surmountable problem."
In Japan, it has generally been the case that the residential mortgage lender buys a guarantee from an affiliate and lodges the deeds to the property with that entity. It is well known that these guarantor affiliates would in most cases not have sufficient financial capability to honour the guarantees, making the relationship both incestuous and cosmetic.
Shinsei repackaged the mortgages it acquired into Dreams Funding Corp, which offered two fixed and five floating rate tranches comprising five triple-A pieces and two triple-B pieces rated by Fitch and S&P's, backed by some 6,294 fixed and floating rate residential mortgages. No swap is used on the deal and the fixed or floating rate underlying assets exactly match the fixed or floating rate notes issued.
Pricing on all tranches came slightly tighter than expected. The two largest tranches were a ¥32.1bn, 2.2 year triple-A piece priced at 15bp over one month Libor and a ¥23.7bn, 8.4 year piece that came in at 40bp over. Some 34 investors participated in the deal, sold exclusively in Japan.
"We were delighted with the outcome," says Yoshitaka Hata, product manager responsible for distribution at Shinsei Bank. "It is our first large transaction and it went off without a whisper. Investors liked the deal and all the bonds were sold. The real sweet spot was the short floating piece that came 5bp tighter than expected."
STRONG DEMAND, TIGHT PRICING
In some deals in Japan nowadays, the demand is so strong that the arrangers are telling investors they can only have the subordinated strips if they take some of the senior paper as well.
"It is remarkable how much the market for structured products has changed since the bank sector recapitalisation of a couple of years ago," says Hata. "Our new securities arm has a relatively short track record, but it achieved very tight pricing and very rapidly. It is worth noting how strong the bid tone is locally for the mezzanine paper, largely because there is so much liquidity in the system, so little spread product and because structured paper is viewed as less risky."
The tightest pricing in the international RMBS market for plain vanilla deals in dollars from the Asia Pacific region emerged in the first week of September when Australia's St George Bank achieved a spread of 17.5bp for its global dollar issue with an average life of slightly over three years. But St George has become a regular offshore issuer in recent years and the Australian mortgage product is widely recognised as one of the best in the world.
Shinsei will keep an open mind concerning the possibility of selling future deals offshore. "Although the local market is so liquid and reasonably priced, we will always keep an eye on the offshore market because we would like to build up as diverse a funding base as possible," says Hata. "We will want to go offshore to demonstrate our commitment to those investors and to familiarise them with what should become a structural template that they can rely on in terms of legal and regulatory integrity."
FIRST ABS DEFAULT
The year has not been without its shocks. One of Japan's largest corporate failures emerged when retailing giant Mycal filed for protection under the Civil Rehabilitation Law on September 14. This lead to the first ever Japanese ABS default - the default of Multiple Asset Funding, an ABS based on Mycal's credit quality rating, which was issued in 1997. Mycal's CMBS transactions were also immediately placed on negative watch by Moody's, but no action has been taken yet.
Daiei Corp, another big retailer in Japan, was also downgraded from B2 to Caa1 by Moody's on September 21. Daiei has two ABS transactions outstanding, similar to those concluded by Mycal.
On the other hand, there were also some positive actions in ABS ratings. The mezzanine ratings of last year's landmark J-CMBS transaction were upgraded by Fitch based on the improved cashflow from the underlying office properties.
"The Mycal default has attracted investors' attention to links between originator credit and ABS," says Batcharov at Merrill Lynch. "We have often drawn attention to such linkages where they exist, and such linkages must be understood and priced. In the case of Mycal deals, most ABS investors appear to have understood them and there seems to be no immediate reaction in the ABS spreads."
However, most agree that investors are likely to become more cautious about the tenant credit quality in CMBS transactions, particularly for sale and leaseback CMBS. "In the event of Mycal's failure, we should witness widening in CMBS spreads - especially in the mezzanine/subordinated tranches," Batcharov concludes.
BANKS MISSING A TRICK
The Mycal failure, concerns over Daiei and the extremely weak stock market are also drawing attention to the banks' balance sheets. Despite the injection of some ¥9tr in public money, the 1999 bailout of bank bad debt has achieved far less than hoped. The sector remains burdened with massive bad loans. Some analysts estimate the total amount to be as high as ¥33tr, about 6% of the country's gross domestic product. Rising bankruptcies are increasing this figure.
Most believe that Japan's central problem remains the unwillingness of its banks to recognise losses on assets deflated by the collapse of the speculative boom of the late 1980s. Although large scale consolidation means that Japan's banks are no longer on the brink of collapse, as they seemed to be in the late 1990s, the sector remains dysfunctional.
It is therefore surprising that Japan's banking sector does not follow Shinsei's lead. Perhaps it will eventually, but it is likely to be a slow process. Somehow, Japanese banks still believe that it is an admission of failure to take performing assets off balance sheet, even though it could be a catalyst for recovery, or greater success.
"Return on assets and return on equity levels of Japanese banks are lower than on many international comparables," says Shinsei's Prince. "Shinsei's core ROA and ROE levels for fiscal 2000 were at the higher end of the range for Japanese banks and our goal is to lift these levels to international levels over the coming years."
In accessing any securitisation opportunity Shinsei weighs the all-in cost of the funding but also looks at the impact on its customer base present and future. Japanese banks appear fearful that by securitising performing retail or corporate assets, they will upset their customers. This does not need to be the case.
Prince believes that securitisation is a vital tool because it is so much more efficient than other alternatives. "For example," he says, "the secondary market for loans is highly imperfect and produces lower returns on average. Securitisation allows us to keep the customer relationship through the continuance of the servicer role. This in turns allows the bank to monitor the performance of the customer base and the assets and therefore to build assets where appropriate."
CONSUMER FINANCE GROWTH
The consumer, auto and equipment finance sector has far less funding flexibility than the banks, which can borrow at virtually zero from the Bank of Japan and raise extremely low cost funds in the domestic bond market. Consumer finance assets consequently continue to grow as an asset class in the Japanese securitisation market.
The perennial, almost benchmark issuer is Japanese finance company Orient Corp (Orico). It has identified securitisation as central to its funding strategy and has regularly securitised its portfolio of auto loans through its Oscar programme since early 1998. In late September, it launched its largest ever securitisation with a Mizuho-led deal offering notes in both dollars and euros.
Both tranches of the deal were priced at 28bp over Euribor/Libor, roughly in line with the slightly wider spreads that many other asset backed deals are experiencing post-September 11. Orico's previous two deals - one in March this year and the other in September 2000 - were priced at 26bp over, and spreads might have been expected to tighten further on this transaction.
"Oscar has always been a benchmark Japanese issuer and this deal was again oversubscribed," Richard Tarn, a director in the primary and structured finance group at Mizuho International in London, told EuroWeek after the issue. "Many of the regular investors bought paper, but a number of new accounts also participated. Many investors who choose to add to their exposure to Japan consider this to be a safe way to do so."
ORICO'S OVERSEAS REACH
Many Japanese originators do not have sufficient origination levels and cannot bring the frequency of deals to make it worth their while targeting international investors. Instead, they launch smaller deals in the Japanese domestic market, many of them privately placed.
In comparison, every year a slightly greater proportion of Orico's funding is obtained through securitisation, much of which is sold abroad, and Orico expects this to top 30% of its total funding by March 2005.
Throughout late 1998 and 1999 spreads on deals sold internationally widened increasingly following the collapse of one Japanese originator and general uncertainty in the economy.
Orico stuck with its programme, even when spreads gapped out to 60bp over, however, and in recent years they seem to have levelled off at around the 26bp mark. Because of Orico's long term commitment to this programme investors are now very comfortable buying these notes. "Orico has done a lot of work and devoted a multitude of resources to making themselves a familiar issuer to their overseas investors," said Tarn.
ING BARINGS ACTIVE
One of the few other noteworthy offshore deals in the past year took place in November 2000, when ING Barings arranged the $120m securitisation of Japanese consumer loans originated by Hitachi Shinpan, another respected Japanese consumer finance company.
The special purpose vehicle, HABS Corp, sold two tranches of asset backed notes secured by an initial portfolio of around 35,000 individual loans. Moody's and Fitch rated the $120m floating rate senior tranche Aa2 and AA, respectively. It has an expected final maturity of five years with an average life of three years and was priced at re-offer to yield three month Libor plus 95bp.
The issue was the first series of notes to be issued under a novel master trust structure using Japanese Trust law. In April this year, ING Barings closed a ¥5.35bn deal for the same originator, the second series of Hitachi Shinpan notes to be issued under the novel master trust structure.
"The use of a master trust programme for a second time demonstrates the ease with which clients can use this securitisation technique to facilitate financing," says John Mullins, ING Barings' head of securitisation for Asia and the Americas.
ING Barings has been active again this year in the consumer finance sector. In August, the firm closed a ¥12.5bn deal for Nice, the country's 24th largest originator of consumer finance loans. ING Barings took a 28% stake in Nice through its private equity arm this year.
"We are pleased to have been able to complete this transaction for Nice and to have introduced some structural improvements which resulted in a lower funding cost and greatly reduced operational burden on the company," Mullins adds.
In May, the bank closed a ¥20bn securitisation programme for Shinki, the third largest originator of small business loans in Japan. Unlike Shinki's first securitisation, the transaction did not rely on third party credit enhancement but was rated on a standalone basis using the senior/subordinated structure.
BUILDING FOR THE FUTURE
Banks continue to build their teams in the hope that structured finance will offer great rewards in the future. For the moment, there is not enough 'true securitisation' agency business to stop the intense competition for mandates eroding the fees to uneconomic levels.
"Third party agency business is tough in Japan," says Shinsei Bank's Sheehy. "Most of the international firms can only win business at the innovative end of the market where they need to provide new solutions. Once the template for certain new asset classes is in place, the business rapidly becomes commoditised. In conclusion, there are too few deals because most of the banks are so liquid and arranging what deals arrangers can win is a low margin business."
But most agree that the path to restructuring bank, finance company and corporate balance sheets will continue, and is a necessity if Japan is to grow again.
Declines in the stock market coupled with the introduction of mark to market rules could force some of the banks to reappraise their approach to securitising their own assets.
The government will accelerate the efforts of government agencies to lay off some of their risks into the private sector and thereby diminish the state's direct or contingent liabilities.
The corporate sector is enjoying access to low cost funds while the banks are so flush with cash and the bond market is so liquid. However, that situation will not last forever. Companies across Japan will increasingly use securitisation as a tool for receivables management, even for taking fixed assets of their balance sheets. The future for the securitisation market looks bright, at least for those investment banks with the patience that Japan demands. *
|Japan ABS: new issue volumes|
|Source: Merrill Lynch * as of Oct 26, 2001|