Japanese investors may have long been a coveted mainstay of the SSA investor base, but there are signs that domestic economic policy has set them on the march.
Japan’s prime minister, Shinzō Abe launched his plan for economic reform over a year ago in an effort reignite the country’s economy. One of the first steps of Abenomics was to increase inflation to 2% by next year, which the Bank of Japan (BoJ) is looking to achieve by buying up Japanese Government Bonds (JGBs) in an effort to double its monetary base. That is forcing Japanese investors to put their cash in new instruments, and SSA borrowers are benefiting.
“Abenomics has had a clear effect,” says Malek Benfetima, London-based EMTN trader at Commerzbank. “The SSA market has significantly improved — Japanese investors are looking for more non-Japanese bonds, and European SSAs are able to achieve low spreads.”
The BoJ’s feeding frenzy has depressed JGB yields so low that Japanese investors must look abroad to earn any sort of yield. Further, it is credited with the recent rise in the Nikkei225 index, which rallied from February 4 from 14,000 to about 14,800 in early March, and for forcing the yen to depreciate by around 35% against the dollar since the policy was unveiled in 2012.
Unusually, bankers say, it is some of the lesser-rated SSA credits — particularly from Europe’s periphery — that have been prime beneficiaries of the increasing external focus of Japanese investors. This is noteworthy because Japanese investors had traditionally maintained their focus on only the best rated SSA credits. So as the periphery’s economic fortunes have begun to improve, so has this prized investor group come down the credit spectrum to meet them, augmenting the rally in peripheral spreads.
“Abenomics has been particularly positive for peripheral names. Spain and Spanish sub-sovereigns have preformed incredibly well in recent months,” says Benfetima.
Peripheral bonds have tightened 100bp-150bp in the past year.
Uridashi fear
But while peripheral European borrowers may have benefited from Abenomics, it may spell trouble for the top-rated credits which have in years gone by been able to monopolise the attentions of Japanese bond buyers. Several such borrowers have come to rely on the Uridashi market — bonds aimed at Japanese retail buyers — and will need to find a way to entice investors back who are now finding more lucrative opportunities elsewhere.
“The market is becoming more competitive as there are more issuers looking to get their share of the market,” says Joakim Holmström in Helsinki, head of funding at Municipality Finance, which has a long history of raising large chunks of its funding need from Japan. “The low volatility and low interest rates have meant that some investors have moved down the credit curve to accept bank names instead of traditional triple-A names.”
To add to the problem of new money being put into different credits, an increase in redemptions as a result of the effects of Abenomics has made the need to maintain the interest of Japanese investors even more urgent. “Last year there was a big change, when the stock market rallied and the yen depreciated in value,” says Holmström. “A lot of callable transactions were redeemed early.”
Swedish Export Credit Corporation (SEK) saw as similar trend but says it has at least seen some of that money reinvested in the name. It is rated Aa1 by Moody’s and AA+ by Standard & Poor’s, compared to Aaa and AAA for MuniFin, suggesting that it is benefiting from having lower rated credit by having to offer better yields to investors that might previously have only considered triple-A names.
“For SEK, the weakening of the yen and the increase of the Nikkei meant that we got more early redemptions from Japan than expected during 2013,” says Petra Mellor, SEK’s director in funding and treasury. “On the other hand, many investors seemed happy to use the funds they got back early to reinvest in new Uridashis. SEK printed a considerable amount more new Uridashis in 2013 than in 2012.”
In 2013, SEK placed about $3bn into Japan, compared to less than $1bn in the previous year.
But some bankers doubt all borrowers can be as successful as SEK and must now, like Japanese investors appear to be doing, force their way more into international markets.
“We saw a number of notes being called last year and the issuers can’t refund all of them using Uridashi so they are looking to the international market,” says Kerr Finlayson, head of SSA syndicate at RBC Capital Markets in London.
This was the case for MuniFin.
“We were able to refinance a large proportion of [the Japanese notes that were called with Japanese investors] but it wasn’t possible to refinance [all the called notes] through the retail market, hence we had to rely more on the public markets,” says Holmström.
A rose by any other name
But the first battlefront in the quest for cash for many SSA borrowers remains in Japan. It is an old trick that harks back to the pre-crisis era, but issuers have been dusting off their structured note playbooks in an attempt to offer Uridashi buyers better coupons by ramping up the complexity of their bonds.
But this is not the pre-crisis marketplace and the onerous new issue hedging costs associated with these deals has made banks wary of bidding for them in this era of extended regulation and higher costs of capital.
But some issuers are stealing a march on their competitors by signing swap documentation with their counterparties that keep down the charges associated with, in particular, the sort of long dated cross-currency exotic swaps that drive Uridashi market bond pricing.
The signing of such documentation — namely, two-way credit support annexes (CSAs) — has been a long running bone of contention between SSA issuers and their dealers. But as banks have been forced to pass on higher costs of capital on to issuers that they trade swaps with but who will not post collateral to them when those swaps are in the bank’s favour, so those issuers that have showed the greatest flexibility — and perhaps those with the greatest need — have managed to keep swap costs low enough to keep their bond offerings competitive.
“For SEK, two-way CSAs are working well,” says Mellor. “It means we get good prices on our swaps, which is important for our funding business as we hedge all our structured and fixed rate bonds.”
MuniFin, which has been using the two-way CSAs for some time, has advanced their usage by signing documentation which offers it no benefit in terms of how far out of the money it needs to be on a swap position with a lower-rated counterparty before it has to start posting collateral — called a zero threshold.
It may be something of an affront to a public sector entity’s creditworthiness but it nonetheless ensures that entity can raise the funding it needs.
“We have moved to accepting zero thresholds,” says Hölmstrom. “Many of the transactions are based on reverse enquiries and if we have a good swap line with banks, it makes it easier for them to promote our name.”
Seeking Samurais
The boost in Japanese demand is also forcing issuers to reconsider the Samurai bond market. SEK is one such credit, but it is not necessarily about to pull the trigger on a new trade.
The borrower last printed a Samurai bond in 2009, raising ¥100bn in a two tranche deal, one fixed rate and one floating. The note is due to mature in October. “We would like to come back to the Samurai market some time,” says Mellor. “But we have to be able to justify the funding levels compared to other benchmark markets. In the last few years, the spreads in the Samurai market have not worked for us.”
MuniFin is adamant that now is not the time to go to the Samurai market.
“Issuing a Samurai is costly for a triple-A rated borrower at the moment,” says Hölmstrom. “We would like to diversify into the market but the basis swap rate is not favourable at the moment and we can get more cost-efficient funding elsewhere.”
Instead there is more appeal for credits with lower ratings, such as those from Europe’s periphery.
Spains’s Instituto de Crédito Oficial printed its first Samurai deal since April 2010 on January 30 — a ¥10.5bn ($0.1m) 0.69% February 2017 note through Daiwa.
But not all SSA bankers credit Abenomics with changing Japanese investor behaviour. Rather, it is as much to do with changes in supply with borrowers looking to lock in longer duration in a low rates environment.
“From our perspective, Abenomics hasn’t significantly changed Japanese investor behaviour,” says Bill Northfield, head of SSA origination at Deutsche Bank in London. “They are still buying onshore and offshore paper and have been making their decisions independent of domestic political developments. “Japanese investors have been more active recently in offshore paper, in part because borrowers have been offering the longer dated paper that they traditionally prefer.”
Aiding Japanese names
But what of Japanese SSA borrowers? There is ample evidence, Northfield suggests, to say that they are certainly benefiting from Abenomics.
“Abenomics has helped ease the return of Japanese SSA issuers to the market with far more successful trades,” he says. “In the past, investors were sceptical about the health of the domestic economy. Now the Japanese SSA issuers have a dynamic, positive story to share. From this perspective, Abenomics has been a force for good. It has catalysed greater investor appreciation for these credits across the globe.”
Japan Bank for International Co-operatation printed its first sterling benchmark in 17 years on February 27 and could become a regular sight in the market.
“The major Japanese issuers are beginning to issue in a range of currencies and we expect them to continue to diversify,” says Stuart McGregor, head of European SSA DCM at RBC Capital Markets in London.
Abenomics has been slow to impact the bond markets and the full effect is yet to be seen. But nonetheless, it is starting to shape how SSA borrowers outside of Japan that have been reliant upon Japanese demand for years approach bond markets. Meanwhile, it is opening up markets for Japanese SSA names.
From years as a stagnating economy with a reputation for stodgy investment practice that would entertain only the best rated SSA credits, Japan now looks to be one of the drivers of change in the SSA bond market across the credit spectrum.
