April 10, 2019 / 7:40 AM / 4 months ago

In hunt for yield, Japan's banks snap up leveraged U.S. debt

    * CLO investments among top Japanese banks increase sharply 
    * They buy only senior tranches, say risk managed
    * Analysts expect holdings to increase amid lack of
alternatives
    * Similar products trigger of financial crisis decade ago

    By Takahiko Wada
    TOKYO, April 10 (Reuters) - Japanese banks have stepped up
investments in highly illiquid, securitised loans, mostly in the
U.S. market, as it becomes increasingly difficult to earn decent
interest income from conventional products like government
bonds.
    A Reuters survey showed some of Japan's biggest banks, led
by Norinchukin Bank          , have nearly doubled their
investment in collateralised loan obligations (CLOs) in the nine
months to December.
 While the increased exposure brings back memories of similar,
complex products made up of subprime mortgages that triggered a
global financial crisis a decade ago, banks say they are
managing risks carefully.
    Moreover, analysts expect institutions to continue buying
such assets as Japanese investors seek returns amid a zero
interest rate environment at home and a shrinking pool of
stable, high yield income abroad.    
    "We are controlling risks and returns from our major asset
classes -- bonds, stocks and credit products -- by looking at
their correlations and with proper checks by our risk control
desk," said a spokesman for the Norinchukin Bank, by far the
biggest CLO buyer among Japanese banks.
    CLOs are essentially an investment in a pool of loans to
high-risk, low-credit companies. But not all investors share the
same return and risk.
    Those who invest in the "equity" part, typically up to 10
percent of the entire pool, enjoy very high yields but have to
take losses from borrowers default first.
    When defaults increase more than the equity investors can
absorb, investors in "junior" tranches are next in line to
suffer losses, followed by "mezzanine" tranche holders.
    The rest, typically about 60-70 percent of the total pool,
are called "senior" tranches and normally come with AAA credit
ratings because their repayments are at risk only when the other
three classes fail to cover losses.
     That means they suffer losses only when more than 30-40
percent of loans default, an unlikely scenario even under a
severe economic downturn, at least based on historical records.
    All the Japanese banks Reuters contacted said they have
bought only AAA tranches.
    Senior CLOs are attractive because they typically yield
about 100 basis points or more above U.S. Treasuries despite
their high credit ratings.
   The hefty yield spread is the premium issuers need to pay
investors for holding illiquid assets.
    "As long as we can earn appropriate spreads, we plan to deal
with CLO issues that will be resilient to risks," said spokesman
at Sumitomo Mitsui Trust Holdings.
    The size of securitised debt market shrank after the crisis.
In the United States, it fell from over $1 trillion to around
$600 billion in 2013. But since then it has gradually recovered
to around $800 billion.
    Market players say CLOs today are considered less risky than
the notorious collateralised debt obligations, or CDOs, which
caused a massive market shock in 2007-08 after subprime
borrowers' default jumped.
    Regulations have become tighter since then and borrowers in
CLOs are companies, whose financial records are easier to
analyse for investors, rather than thousands of subprime
mortgage borrowers.
    Still, analysts say they cannot rule out the possibility
that CLO prices would fall if an unexpected economic downturn
prompted investor panic.
    "When the economy deteriorates, we could have a vicious
cycle of rising funding costs increasing defaults further," said
Yukichi Shimosato, market analyst at SMBC Nikko Securities. "And
because the CLO market is illiquid, if investors pull out some
money, the price of CLOs could fall to extreme levels."
    
    Responses from Japanese banks to Reuters' questions about
their holdings of U.S. CLOs:
 Bank                       Mar 2018         Dec 2018
                       (billion yen)    (billion yen)
 Norinchukin Bank*             3,800            6,800
 MUFG Group**          n/a                      2,500
 Japan Post Bank                 496            1,006
 Mizuho Bank                     400              500
 Sumitomo Mitsui                 265              305
 Trust                                
 Sumitomo Mitsui       n/a                         77
 Bank***                              
    *Figures include European CLOs
    **No March 2018 figure provided. MUFG said outstanding no
higher than in 2015
    ***No March 2018 figure provided. Sumitomo Mitsui Bank said
no major change since March 2018

    
 (Additional reporting and writing by Hideyuki Sano; Editing by
Sam Holmes)
  
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