Japanese business looks outward, funding follows suit
Japan’s mature, growth-starved economy has little slack for its banks and corporations to enjoy. Expansion seems possible only through the pursuit of opportunities abroad, and as a result, Japanese borrowers are turning to the international market in unprecedented numbers. The global economy, which has its own problems of slowing growth, brings new challenges and opportunities. Lewis McLellan reports
Japan’s GDP growth, although back in positive territory after three quarters of contraction, is still lacklustre. Yield on its 10 year government debt is hovering around minus 26bp, and its base rate is minus 0.1%. Though still not as deeply negative as the European market, Japan’s eight years or so of zero or negative rates has been deadly for bank profitability.
Accordingly, Japan’s banks have been desperately looking offshore for opportunities to lend at better rates and, in late 2018, outdid US and European firms to become the top international lenders. Partially the top spot came thanks to a pullback from big players in the US and Germany, but there can be no denying that the torpor gripping the Japanese economy has driven lenders to look abroad.
“Banks are increasingly lending abroad to take advantage of the higher interest rates elsewhere,” says Tatsuya Maruyama, head of Japan DCM at Barclays. “The Japanese market is overbanked, so there isn’t much scope for growth in domestic lending.”
The situation is the same for Japanese corporations. “A lot of Japanese borrowers are internationalising their businesses,” says Maruyama. “Many are seeking new opportunities abroad because of the saturated Japanese market. That’s meant we’ve seen several significant M&A transactions.”
Nakayama Yasumasa, Japan DCM at Mizuho agrees: “Given the fact that the Japanese population will not grow, Japanese companies are looking for growth opportunities outside of Japan, and are pursuing M&A transactions.”
The pace of Japanese M&A is staggering, with almost $200bn of deals in 2018 and a 30% year on year increase in the first half of 2019.
One standout example is Japanese drinks manufacturer Asahi’s purchase of the Australian business of AB InBev for $11.3bn in July this year.
Asahi’s purchase of AB InBev’s Australian operations came soon after its acquisition of the Pilsner Urquell brand, also from AB InBev, and Peroni and Grolsch from SABMiller in 2016 and 2017.
Another is Takeda, which finalised its $62bn merger with fellow pharmaceutical manufacturer Shire of the UK in January this year, creating one of the world’s largest pharma groups.
The increase in activity overseas has resulted in a commensurate increase in the demand for foreign currency funding.
Banks, as well as lending to international clients, find themselves lending more in foreign currencies to finance the global expansion of Japanese corporates. “With Japanese companies expanding overseas, they have a much larger natural need to tap dollars and euros,” says Maruyama. “The banks are supporting that expansion, which means they have to fund internationally too.”
Dealogic data shows that Japanese borrowing in the international market has climbed steadily since the global financial crisis, jumping up rapidly to a peak in 2017, when there was $120bn of international borrowing.
The Japan Bank for International Cooperation contributed heavily to the 2017 peak, raising $16bn internationally in dollars. “It supports M&A transactions and the push for corporate internationalisation,” says Maruyama.
We could be in for another heavy year of borrowing from JBIC, which is set to face $9.6bn in redemptions in 2020 — its biggest year ever, according to Dealogic.
Indeed, Japan as a whole is set for a torrid redemption schedule. After $60bn of redemptions in 2019, the biggest year ever, Japanese borrowers will face $75bn of international maturities in 2020, and $77bn each in 2021 and 2022. By contrast, 2017, which had the highest level of issuance, had only $57bn of redemptions. Much of this is concentrated in the public sector.
However, with global growth flagging, the corporate M&A-driven borrowing could take a hit. “It’s true, slowing global growth could prevent us seeing some of the big transactions that have made up a lot of corporate supply.”
Supply from banks and the public sector is unlikely to slow down in line with global economic growth.
“The public sector institutions will keep borrowing and lending,” says a syndicate banker focussed on the region. “And the banks will continue to meet their TLAC needs internationally.” Since Japanese banks have a requirement to demonstrate stable sources of long term foreign funding, their demand for dollar capital remains steady.
Growth on the decline
Japan isn’t the only country dealing with flagging growth. All over the world, forecasts of economic activity are shrivelling thanks, in no small part, to US president Donald Trump’s trade dispute with China. Accordingly, investors have piled into rates products, pushing US Treasury yields down 50bp in the month of August alone.
For Japanese borrowers, who tend to cluster around the upper end of the credit spectrum, this has been a blessing. “Recently, given the trade war and economic slowdown, we’re seeing investor demand to diversify their portfolios to mitigate geopolitical risks,” says Yasumasa. “Japanese credit is a good fit for diversification purposes.”
Guy Reid, head of public sector DCM at Mizuho, agrees. “Japanese issuers have access to investors all across Europe and the US. These investors are keen on geographical diversification, have limited opportunity to purchase highly rated Asian and Japanese names so they’re in strong demand.”
Around 90% of the proceeds from international funding operations meet a natural need in the currency, according to research analysts. Many of these issuers are focussed on the absolute yield, so with fears around falling growth bringing yields down, the international market appears cheaper for those borrowers. “So far, the rush to safe haven trades has just made debt cheaper for the high quality Japanese borrowers,” says the syndicate banker.
But for banks and agencies in particular, the spread is more important than the absolute yield. Thus far, the rush into rates products has not blown credit spreads much wider.
However, if the global economy falls into recession, spreads could widen rapidly. “As long as the market remains competitive, Japanese issuers will access it,” says Maruyama.
Reid adds:“Japanese investors’ reluctance to buy negative yielding domestic Yen-denominated paper can make international markets more attractive for issuers and open up opportunities for arbitrage when swapped back to yen."
For borrowers choosing between issuing domestically and issuing internationally, sometimes the answer does not come from where the best cost of funds is. “Issuers can raise money in the domestic yen market at a very low cost, but size is limited to around $100m-$200m per tranche,” says Yasamusa. “Issuers needing larger amounts generally have to look at the international market.”
The value equation for the deals raising cash to swap into yen is more complicated. While the yen market is a stable and reliable source of financing for Japanese borrowers, the low rate environment in Japan is causing problems.
“Rates in Japan are very deeply negative, but so far, it’s very difficult to issue bonds with a negative yield, which means there’s a yield floor,” says Maruyama.
Outside of Japanese government bonds, very few assets have been sold with a negative yield. “There was one government agency that did a negative yielding two year, but it’s very rare,” says Yasumasa.
With the zero floor effectively shattered in the euro market, and yields still comfortably positive for dollar debt, on a swapped basis, dollar or euro transactions can frequently offer Japanese issuers cheaper funding than would be available domestically. The scale of that segment of Japanese borrowing will likely be determined by the cross-currency basis swap market.
Japanese investors’ reluctance to buy negative yielding domestic yen-denominated paper can make international markets more attractive for issuers and open up opportunities for arbitrage when swapped back to yen," says Reid.
“The cost difference between the domestic and the international market is a big factor for issuers swapping the proceeds,” says Maruyama.
The expansion of the Japanese presence in international bond markets is likely to continue. Neither Japan’s sluggish domestic economy, nor its international debt burden will permit it to retreat. While corporate activity may slow in line with global growth, the appetite for international investors for high quality Japanese names will likely ensure a warm welcome for those issuers that seek to access the international market.