Against the Tide: Japan bond issues: Breaking out of bondage

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Japanese bond issuance sharply increased in the first nine months of this year as borrowers rushed to raise funds before interest rates rose. But the revival might fade next year. Charles Olivier reports from Tokyo on changing attitudes to capital-raising

It had to come. After years of disappointingly low issuance, the Japanese domestic bond market has at last begun to bloom. Japanese companies issued more than ¥6,950 billion ($69 billion) of bonds and ¥189 billion of private debt placements in the first nine months of 1996, according to the Bond Underwriters Association of Japan. Total issuance for the year could be as much as ¥10,000 billion, nearly double the ¥5,046 billion that was issued in the whole of 1995.

Local bankers believe the spate of issuance will continue as more electricity utility companies begin to tap the market. "We have seen historically high levels of issuance this year," says Noriyki Ushiyama, deputy general manager of capital markets at Nomura Securities in Tokyo. "And I think we will see similar amounts next year." Capital expenditure increased by more than 7% in the first half of 1996 and corporate investment levels are rising.

International issuance by Japanese borrowers has also increased, although at a less spectacular rate. Between January and September 1996, more than $38.4 billion of debt was issued by Japanese borrowers according to Capital DATA Bondware, close to the $44.6 billion raised in the whole of 1995. In addition, there was a queue of corporate borrowers considering Eurobond deals, including Tokyo Electric Power Company (Tepco), Kansai Electric and NTT, which are all reported to be considering launching Eurobond deals in the next two months. Chugu Electric is believed to be considering a EuroFrench franc issue.

The dramatic rise in issuance, particularly in the domestic market, has raised hopes that Japanese companies at last might be breaking free from the banks that have provided the bulk of local financing needs for the past 50 years. Of all external financing for companies listed on the Tokyo Stock Exchange, 46% is now believed to come from the capital markets, up from 24% in 1974. "Issuers are definitely moving away from bank loans to the capital markets," reports Keiichi Mitake, general manager of capital markets at Yamaichi Securities.

The rise in domestic issuance has occurred for three reasons: low interest rates, the de-regulation of Japanese capital markets and the changing relationship between banks and borrowers.

At 0.5%, Japan's official discount rate has never been lower. This has encouraged investors, both institutional and retail, to move out of bank deposits and bank debentures into the bond market. Corporate bond yields have dipped from 4.52% in May 1995 to 2.8% in October 1996 as a result. The decline in bond yields has not been smooth. The bond market fell sharply in the early months of the year after strong growth figures raised fears that an interest rate rise was in the offing. However, most local economists now believe that interest rates will remain at 0.5% until the middle of next year. On October 21, the central bank governor announced that rates would not be increased this year.

Broken bonds

The close ties that have linked banks and borrowers in the past, to the detriment of the local capital markets, have also begun to weaken. Having taken big write-downs on bad loans, Japanese banks are lending less. In July 1996, outstanding bank loans to corporates fell to around ¥11 trillion, a marked decline on the ¥31 trillion figure for December 1994. Many are now demanding tighter covenants on the loans that they do make in an attempt to avoid the mistakes of previous years.

The three big banks lending to corporates ­ the Industrial Bank of Japan (IBJ), the Long-Term Credit Bank and Norinchukin ­ which were allowed to underwrite bond issues for the first time in 1993, are now encouraging corporate borrowers to refinance their loans in the bond markets in an attempt to provide more business for their fledgling securities operations. "The balance of power between banks and corporates is definitely changing," says Hiro Suzuki, executive director of Morgan Stanley's Tokyo office.

"In the past, many banks encouraged companies to remain on bank borrowing, that is, to roll over their loans. Now, the parent bank is suggesting that they refinance the loan with a bond issue using their securities arm. It's like a deal between the borrower and the bank."

The recent deregulation of the Japanese capital markets has increased the delay on issuance, more so than these previous factors, but its long-term effects are likely to be of increased significance. In January 1996, non-investment-grade companies were permitted to issue domestic bonds for the first time. Regulations on the amount of collateral required, such as promises on future dividend ratios, and the total size of issuance, have also been removed. In February 1996, the government announced that it would allow asset-backed deals. Two months later, the regulations stifling the repo market were also lifted.

The removal of restrictions has yet to have much impact on debt issuance. However, there are signs that it will. Fuji, a supermarket chain from northern Japan, is planning an equity-linked bond, the first non-investment-grade bond issue in the Japanese domestic market. Ushiyama at Nomura believes that there will be more junk issues in future. "Most Japanese investors don't like to buy non-investment-grade issues. However, they are finding it very difficult to find good investments. So they are becoming more conscious of [the possibilities of] higher-yielding paper. Securities companies are putting more emphasis on promoting the junk bond market," he says.

Less godly MoF

In April, Daiwa Securities lead-managed the first asset-backed deal, a ¥20 billion receivables-backed for Orico, a local consumer-credit company. Rival bankers allege that Daiwa may have been forced to hold on to most of the paper after mispricing the deal. But many senior bankers, such as Hiroshi Suzuki, managing director of IBJ Securities, believe the market will grow in time. "I think we will see more asset-backed deals in future," he says.

Significantly, the influence of the ministry of finance, which has exerted near god-like control over local debt issuance, shows signs of fading. In February 1996, prime minister Ryutaro Hashimoto announced the launch of a study into the possible break-up of the ministry, which has responsibility for tax, budgets, financial supervision and management of state-owned assets.

The majority of issues have been fixed-rate bonds in maturities of three to five years. But with interest rates unlikely to move lower, many borrowers are keen to extend the maturity profile of their debt; however, many have been put off issuing longer-dated bonds by the steepness of the yield curve over five years. Hiro Suzuki at Morgan Stanley believes this is unlikely to change in the near future. "Most banks have been able to stay profitable by taking deposits on the short term, and lending on the long term.

"If the yield curve suddenly became flatter, a lot of the banks would go bust. This is something the ministry of finance is obviously keen to avoid."

But with investors hungry for higher coupons, some of the top-rated companies have been able to extend their maturity profiles considerably by issuing so-called super-long bonds. Tepco and Chubu Electric have both brought 20-year deals to the market, and in October, Nikko Securities did a ¥30 billion 10-year deal for NTT, the state-owned telecoms company.

Significantly, it appears the problem of poor pricing is being overcome. In the past, top-rated companies have been deterred from issuing in the domestic market because AAA-rated bonds were priced at almost the same level as A-rated bonds. Most bonds were priced on a coupon basis according to perceived investor demand. Local securities firms are, however, beginning to price more bonds on a spread to Japanese government bonds. In February 1996, Nomura launched a 10-year deal for Hitachi using this method. At ¥2,000 billion in size, it was also the largest bond issue completed by a private-sector Japanese corporate in the domestic market.

According to Hiroshi Suzuki, of IBJ Securities, pricing is now more transparent that in past years. "Spreads between the different credit ratings have widened considerably this year. The spread between a triple-B-rated issuer and a single-A rated issuer, for example, is now between 30 and 40 basis points. Between double-A and triple-A it is around 15bp," he says.

The increased use of spread-based pricing is indicative of a trend among corporate borrowers to take a sophisticated approach to debt issuance. Some have begun to offer gifts in order to attract retail investors. Orix, Japan's largest leasing company, for example, announced that it would offer lottery tickets and telephone cards to investors who bought its five-year ¥10 billion issue. Tokyo Dome, operator of Tokyo's largest sporting and entertainment venue, is offering lottery prizes on its ¥20 billion issue.

One of the most striking developments in the local market has been the increase in structured deals. A number of foreign issuers have come to the market with highly structured bonds targeted at yield-hungry investors, such as dual-currency bonds, callable notes, swaption callable notes and reverse dual-currency bonds. Many of these borrowers have been able to achieve extraordinary low funding costs in this way. Some dual-currency bonds, for example, are believed to have a post-swap cost of 60bp under Libor.

Japanese borrowers have begun to warm to the advantages of structured deals. Nissho Iwai, for example, launched an Australian dollar-denominated domestic bond in 1993. Marubeni did a dual-currency bond in October 1995. Several firms have completed callable bonds, including Itochu, Nippon Steel, Nissho Iwai and Sumitomo Metal Industries. Mitsubishi has even done an exchangeable bond that can be converted into Japanese government bonds. A number of foreign firms, such as Merrill Lynch (which arranged the first callable bond deal for Itochu), are now putting more resources into marketing these structures to Japanese corporates, but Keni Kawashima, managing director of debt capital markets at Merrill's Tokyo office, admits that it is a slow process.

Most companies remain wary of jeopardizing their relationship with local investors by issuing a bond that goes wrong. "Dual-currency bonds have a currency risk for investors," says Masayoshi Okamura, manager of the debt division at Nikko Securities. "Japanese companies are unwilling to put their investors at risk."

Equity-linked hope

With the stock market showing negligible gains for most of the year, issuance of equity-linked domestic debt has been lower than straight debt. In the first nine months of the year, convertible bonds, for example, accounted for only ¥2,450 billion of the ¥6,950 billion of total debt issued. However, there are hopes that it will increase in the fourth quarter. "Equity-linked issues are becoming more popular," says Suzuki at IBJ.

"The stock market is showing a steady recovery and most investors now believe it is on an upward path. Some issuers have been able to achieve very low costs with coupons as low as 0.5%."

With the local markets offering such low-cost rates of funding, international debt issuance by Japanese corporates has not shown such a high level of growth. Nevertheless, figures for the first six months show that overseas financing is rising. A total $38.44 billion of debt was issued by Japanese borrowers in the first nine months of the year, compared with $44.67 billion in the whole of 1995. The bulk of issuance was by private companies, which accounted for $22.16 billion of the total raised, although utilities ($3.02 billion) and private banks ($7.2 billion) also issued significant amounts.

As in previous years, the most popular currencies were the yen, which accounted for $15.4 billion of issuance, and the US dollar ($13.3 billion). However, the Swiss franc market continued to provide significant amounts of equity-linked funding for lower-rated companies ($5.05 billion).

However, there has been a greater variety of issuance than before. Following the Japanese Export-Import Bank's EuroFrench franc issue (a Ffr1.5 billion 11-year deal via Banque Paribas), French franc issuance by Japanese borrowers has reached record levels. Four French franc Eurobonds have been launched so far this year, raising a total of $1.96 billion. In July 1996, Toyota Motor Credit Corp (Japan's answer to GECC) launched the first Swedish krona deal by a Japanese borrower: a Skr500 million ($75 million) five-year deal via Deutsche Bank. The following month, it tapped the New Zealand dollar market, the first Japanese issuer to do so since 1989.

Almost all the Euroyen issuance was by overseas finance subsidiaries of large Japanese corporates and banks. With the yen beginning to rise against the dollar, Euroyen bonds have been particularly popular, with a range of international institutional investors looking to make currency gains. However, most Japanese Euroyen issues continue to be bought by Japanese investors.

Eurodollar issuance has been driven by municipal issuers, such as the City of Yokohama and the Metropolis of Tokyo, both of which did 10-year Eurodollar deals in September 1996. Bank borrowers and top-rated corporates from the utility sectors have also been active. However, a number of lesser-known issuers have also tapped the market, such as IG Kogyo, Tampopo, NGK Spark Plug and Royal Ltd, a fast-food restaurant chain.

With so many firms, Japanese and international, issuing Euroyen deals, the swap opportunities for Japanese borrowers issuing dollar-denominated debt are increasing. Suzuki at Morgan Stanley notes: "There has been a record amount of Euroyen issuance this year, which has been swapped back into dollars. This has had a one-way effect on the swap rate, which is 15 or 16 basis points over the basis swap.

"So a Japanese issuer that does the exact opposite, that is, issues in dollars and swaps into yen, can achieve very attractive all-in costs."

Significantly, Japanese borrowers are starting to do bigger deals. In February, Chubu Electric issued a $550 million, five-year deal. This was followed by a $750 million, five-year bond issue by the Export-Import Bank of Japan, the biggest non-yen Eurobond by a Japanese government-backed borrower. It also had the distinction of being one of the first Japanese deals to be marketed simultaneously in Asia, Europe and the US. However, this has since been eclipsed by East Japan Railway's $800 million 10-year deal via Goldman Sachs and IBJ in September.

Striking a new path

In 1996 Japanese borrowers have become more adventurous in the types of issues they are willing to bring to the international markets, a move that coincides with the increasing number setting up MTN programmes. There have been a lot of so-called repackaged bonds, which incorporate currency swaps into standard equity-linked deals. The currency swap concept allows issuers to pay foreign currency coupons in yen.

This structure was first introduced into the Eurodollar market by Nomura in 1995 when Katakura Chicory, Sega Enterprises and Kuraya all launched fixed-rate dollar bonds with warrants. The zero-coupon and deep-discount bond have also made a return to the Japanese Eurobond market: Morgan Stanley has arranged a number of zero-coupon deals for Japanese borrowers, including a ¥1.2 billion, five-year deal for Ricoh Finance Nederland. Morgan Stanley's Suzuki is reluctant to reveal the investor base for these bonds although he insists that it is all "perfectly legal".

Can the rise in debt issuance continue? All the evidence suggests that companies do not need to raise additional funds. In 1994, non-financial corporations ran an excess of savings over investment for the first time in the post-war period. Although capital spending is expected to rise through most of the year, corporate cashflow is expected to cover virtually all of the demand for capital spending and operating funds until late 1997. Suzuki at IBJ says that "80% to 90% of the debt issued has been refinancing existing bank loans rather than new debt".

Moreover, corporate attitudes to debt-raising remain as conservative as ever. Many borrowers remain reluctant to refinance all their bank loans in the debt market for fear of alienating their relationship banks. Government financial institutions still provide loans and investment of 30% of GDP versus 0.42% in the US and 0.86% in the UK. Too many still insist on launching equity-linked debt rather than straight debt because it reduces outward cashflow even though it dilutes the value of existing equity.

There is also the danger that the domestic market might become flooded with government paper, making it difficult for corporates to raise funds at these rates for long. In September 1996, the government announced a ¥3,000 billion spending package, and there is talk of another supplementary budget.

International debt issuance is still restricted to a very small group of companies, mainly the electric utilities, municipalities and government-backed issuers. Many Japanese firms remain little known outside Japan and urgently need to improve their overseas marketing campaigns. Recent talk of the tax break on Eurobond issues being removed has also raised fears that international issuance may fall.

Despite the moves towards deregulation, the domestic market remains plagued by poor liquidity, slow settlement and the tendency of local investors to hold on to bonds until maturity, a habit that restricts the growth of the repo market and secondary market trading. Local rating agencies continue to grant high credit ratings to too many companies.

Local security firms remain wary of new market practices. The fixed-price re-offer mechanism introduced to the domestic market by Morgan Stanley in 1991 remains rarely used. Syndicate groups are still too large at 25 to 30 banks an issue, even on small deals, while bond pricing continues to be arbitrary. US bankers working in the Japanese market complain that spreads in the secondary market remain artificially wide; one US bank is reported to have left its prices unchanged for two weeks to see if anyone noticed. Nobody did.

This is not to deny that progress has been made. Local retail investors, who have a mind-boggling ¥1,131 trillion ($11 trillion) in assets, are becoming more adventurous and are now willing to buy bonds issued by sub-investment-grade sovereign issuers, such as Brazil. Many may soon be persuaded to buy a greater range of corporate issues.

The recent shift towards a more deregulated pension fund market may also encourage more firms to raise funds overseas. In February 1996, the government announced that it was lifting many of the restrictions on the use of foreign asset managers: since April trust banks have no longer had to invest over 50% of their assets in fixed-income investments and institutional investors are taking a more professional approach to fixed-income investment. Earlier this year, the Japan Welfare Corporation of pension funds shifted some of its money from the trust banks to outside investment managers with the instruction that the new fund managers should start to evaluate returns on a spread to JGB basis. This is expected to iron out some of the absurd inconsistencies on pricing.

But it is still too early to suggest that Japanese borrowers have fully embraced the concept of capital market funding. Many companies still aim to have at least 60% of their funding in bank loans.

Meanwhile, international funding is likely to remain restricted by the low level of domestic interest rates. As in politics, financial change is likely to come slowly to the land of the rising sun. *

League table of Japanese issuers, 1980 to October 28 1996
RankIssuerAmountNo. ofShare
US$missues%
1 Toyota Motor Corporation 29,877.20 150 4.69
2 Bank of Tokyo-Mitsubishi 18,118.60 202 2.84
3 Export-Import Bank of Japan 10,398.95 34 1.63
4 Nippon Telegraph & Telephone Corporation 10,111.20 56 1.59
5 Sakura Bank 10,009.04 58 1.57
6 Mitsubishi Corporation 9,981.87 81 1.57
7 Marubeni Corporation 8,409.46 193 1.32
8 Tokyo Electric Power Co 8,225.05 30 1.29
9 Nissan Motor Co 7,765.51 63 1.22
10 Sumitomo Bank 7,759.25 56 1.22
11 Fuji Bank 7,725.45 91 1.21
12 Japan Development Bank 7,703.33 39 1.21
13 Sumitomo Realty & Development Co 7,607.92 39 1.19
14 Itochu Corporation 7,028.12 141 1.10
15 Sanwa Bank 6,517.33 55 1.02
16 Long-Term Credit Bank of Japan 6,353.61 67 1.00
17 Dai-Ichi Kangyo Bank 6,279.95 101 0.98
18 Kobe Steel 6,150.78 39 0.96
19 Japan Finance Corporation for Municipal Enterprises 5,752.33 44 0.90
20 Sumitomo Metal Industries 5,658.87 43 0.89
21 Daiwa House Industry Co 5,647.97 26 0.89
22 Sumitomo Corporation 5,587.28 62 0.88
23 Industrial Bank of Japan 5,528.78 74 0.87
24 Japan Airlines Co 5,491.13 45 0.86
25 Canon 5,407.32 33 0.85
26 Nissho Iwai Corporation 5,339.18 150 0.84
27 Mitsui & Co 5,125.09 78 0.80
28 Tokai Bank 4,888.73 38 0.77
29 Kansai Electric Power Co 4,776.69 20 0.75
30 Fujitsu 4,726.75 35 0.74
Source: Capital DATA Bondware

Jexim eyes global

Japan's Export-Import Bank rules out no source of funding outside Japan, but it's being conservative about structured deals, MTNs and when to do its first global, says director of international funding Mosato Ari

We issue between three and four bonds a year in the international markets. We are not allowed to issue in the domestic market. For the fiscal year ending March 1997 we have a funding need of about $1.8 billion in the capital market. So far this year we have issued a Ffr1.5 billion [around $300 million equivalent] 11-year bond and a $750 million five-year bond. So we will be looking to raise up to $750 million.

What funding benchmarks do you use?

We don't have any specific cost targets. Recently, we have swapped most of our funds into dollars, so you could say we use a US dollar benchmark. This is because the proceeds from bonds are utilized for our foreign-currency denominated loans. Although we'd like to maintain access to cost-effective sources of funding, cost is not the only factor. We consider investors' demand, maturity they are looking at, and so on. If the market conditions are not good, we would not issue. For example, our first French franc deal was issued to meet investors' strong demand in the 11-year sector with our reasonable cost of funding.

What new markets or instruments are you looking at?

We have already tapped most of the major markets. But we are looking at all the others. We don't want to reject any possibility. There are some smaller markets where it will be difficult to issue because we need to issue bonds of a certain size. Because we have only a limited amount of human resources, we tend to do only three, four or five deals a year. We are prepared to decrease the issue size if the terms are attractive, however. We are also interested in doing a global bond. Medium-term notes are another instrument we would like to study.

What about structured deals?

In general we have to be careful with structured deals because we have to maintain future investor demand, and our reputation. We have done some in the past, but we are now concentrating on plain vanilla deals.

Tepco thinks big

Tokyo Electric Power Company (Tepco) can't mess around with small issues such as dual-currency bonds. It has come to the market more than 30 times since 1980, raising $8.2 billion. Now it's moving out of loans further into domestic bonds, and foreign bonds provided the swap works, says senior manager of finance Akira Takahashi

Our borrowing requirement is likely to increase since we see domestic demand for power rising by 2% a year. Our main strategy is to move from the bank to the bond market. We are at the bottom of the interest rate cycle so we are looking at fixed-rate rather than floating-rate deals.

Will you be looking to refinance most of your bank loans in the bond market?

That would present us with too much risk. After the oil shock of the 1970s the bond market was fairly small and it was the banks and life insurance companies that helped us out. We are not saying that it won't happen but it is difficult to say when it will happen. We are aiming to have half our debt in bank loans and half in bonds.

What impact has the rise in private-sector corporate debt issuance in the domestic market had on your access to funds?

Not much. We are triple-A rated; most of the other companies are only double-A rated or single-A rated. We also tend to do bigger issues: ¥150 billion a time, compared with the ¥25 billion issues common at other firms. We try to issue when market conditions are right, so we try to avoid issuing at the same time as the government. But smaller companies don't make much difference.

What kinds of bonds do you prefer?

We always do straight bond issues. We are not interested in dual-currency bonds because you can't issue ¥150 billion deals in that market.

What about doing more targeted issuance?

The size tends to be too small. We have been approached to do some ¥20 billion
10-year deals but we said no. We might consider it if the cost were significantly lower than a public deal.

What about asset-backed deals?

We aren't looking at that market since most of our customers pay by automatic bank transfer. We only have receivables of ¥280 billion, so it is normally better to issue commercial paper.

You have tapped the international markets twice this year, A sfr300 million 10-year deal and a
ffr4 billion deal. How cost-effective have these been compared with domestic funding?

The international market has been cheaper on occasions. For example, the French franc deal was 10 basis points cheaper than we would have been able to get in the local market. It varies according to the swap rates.

Do you intend to increase the proportion of funds raised overseas?

Our outstanding international bonds are now about ¥671 billion, while the total is ¥5,226 billion. So it is about 12%. We don't have a clear idea of how much we want to do internationally. But roughly speaking we would like to have between 20% and 30% of international debt. But the market timing needs to be right.