February 28, 2014 / 9:52 AM / in 4 years

Rare 30-year floater shows Japanese investors changing tack

* Tokyo bond buyers seek rate rise protection

* BOJ pushes fixed-rate spreads to record lows

* Need for higher spread prompts creation of very long FRN

By Frances Yoon

HONG KONG, Feb 28 (IFR) - The longest floating-rate note in Japan’s domestic debt market has provided an early indication that the country’s economic reforms are prompting a change in investment strategy.

In a market dominated by fixed-rate government bonds, the 30-year FRN from government-owned Japan Finance Organization for Municipalities is a sign that some investors are betting that Prime Minister Shinzo Abe’s policies will usher in an era of higher interest rates and succeed in pulling the country out of 15 years of deflation.

JFM, one of Japan’s most frequent quasi-sovereign borrowers, printed a ¥10bn (US$97.7m) 30-year floater on February 19 at 16bp over three-month yen Libor, equal to about 20bp over Japanese Government bonds. Bank of America Merrill Lynch acted as sole bookrunner.

The deal came as a surprise to market participants, as local buyers have long preferred fixed coupons. JFM has only printed one floater in the past five years, a ¥15bn (US$182.5m) 10-year senior secured bond in January 2011, according to Thomson Reuters data.

“Investors are considering that interest rates are going up going forward and floating-rate notes match this situation,” said Masahiro Takenaka, director of JFM’s finance department, speaking through a translator.

“When the Bank of Japan puts out a time frame for inflation and as the US also moves towards tapering, investors are thinking about what would happen if rates go up and are starting to prepare and hedge,” he said. “Every investor has fixed-rate notes on their books. If rates go up, their portfolio values will go down.”

JFM was able to meets its funding costs, even after it swapped the proceeds to fixed rate liabilities, according to Takenaka.


Dealers were surprised investors would buy such a long tenor instead of venturing into floaters of 10 or 20 years, which would still provide protection against rising rates.

Floating-rate notes longer than five-years are relatively rare given the pitfalls of predicting the direction of benchmark rates.

Others argued that the answer may be that Japanese investors are in a conundrum: they want rate protection, but still want higher spreads. Such a combination may only be achieved with such a rare structure as the one JFM adopted.

“Investors can buy floaters that are shorter than 30 years but they can enjoy higher spreads (on longer bonds) than on short maturities,” said Takenaka. “Also, investors are not concerned about the JFM credit, even though the maturity is very long.”

“Japan’s domestic markets have 10-year agency bonds that are priced very tight, and that’s the case for 20-year bonds as well,” said one banker not on the transaction. “When the tenor jumps above 20 years, it offers a better spread.”

Longer floaters could become more attractive as the Bank of Japan continues to inject money and drive JGB spreads tighter, making them more expensive for Japanese investors.

”Investors have been buying JGBs for a very long time and the rates on them have fallen a lot since May,“ said another banker away from the deal. ”They’re now afraid of interest rates going up, and whenever they buy new bonds, they are always concerned about this rate risk.

“But, at the same time, they need to buy something with a good spread and good size. So, this 30-year floater does make sense.”

Initial fears that the so-called Abenomics reforms would send JGB yields soaring have subsided in recent months. After jumping to a 12-month peak last May, a month after the BOJ announced its unprecedented quantitative easing programme, the yield on the 10-year JGB benchmark has tightened 35bp . The yield on the 30-year JGB has tightened about 26bp during that period.

Analysts now expect the BOJ to increase its bond purchases by the summer to add momentum to the economic stimulus, according to a Reuters survey, which may compress yields further. Additional bond-buying comes as Japan’s economy grew more slowly than expected in the fourth quarter, at an annual 1.0%, failing to beat a 2.8% median forecast.

Still, Japan is highly unlikely to see a wave of similar trades - at least in the coming months.

Only a few issuers like JFM have the flexibility to print such long-dated deals, and bankers say only the top-rated credits will be able to attract investors to long-term floaters. JFM, which provides funding for local governments, is rated Aa3/AA-, in line with the Japanese government. (Reporting By Frances Yoon; editing by Steve Garton)

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