Japan Brokers Rethink Repackaged JGBs After Warning
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(Bloomberg) -- Japan’s biggest brokers are having second thoughts about selling so-called structured loans to regional lenders after the nation’s financial regulator declared a sweeping clampdown on the $67 billion market.
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Nomura Holdings Inc. is weighing its approach toward Japanese government bonds repackaged into loans, a representative said in response to a Bloomberg News survey of 15 investment banks. The brokerage arms of Mitsubishi UFJ Financial Group Inc. and Mizuho Financial Group Inc. are also looking into their sales of that product, which is under intense scrutiny from the Financial Services Agency.
Caution has taken hold in the securities industry since a senior FSA official criticized local banks’ increased purchases of repackaged JGBs in an interview last month. While the product complies with Japanese laws, fears of further regulatory scrutiny could cause buyers and sellers to pause, putting the market at the risk of disappearing, according to Bloomberg Intelligence.
Officials are concerned that some of the buyers lack proper risk management for the opaque product and could suffer mounting losses if market interest rates move against them, according to Toshinori Yashiki, director-general of the agency’s strategy development and management bureau. Regulators have also questioned the nature of the instrument: investors aren’t required to mark it to market as opposed to securities investing, hence avoiding booking paper losses, but that makes it difficult for observers to trace where risks lurk.
The agency has reached out to major US, European and Japanese securities houses in recent weeks, requesting details about their relevant transactions with regional banks, according to people familiar with the matter. An FSA official declined to comment.
“We are aware that the FSA is concerned,” said Shigehiro Tomita, a Nomura Holdings spokesman, by phone. “We are deliberating our approach internally.”
Repackaged JGBs, often bundled with derivative contracts to sweeten returns, are among various products sold to regional lenders, a traditionally key set of customers for investment banks. The product allows buyers to receive cash flow in a tailored way and helps reduce burdens associated with derivatives trading, according to Nomura’s Tomita. But it carries the same risk as regular fixed-rate bonds of potentially suffering negative spread, where returns become less than what those lenders pay for deposits, he said.
Mizuho Securities Co. also plans to examine its sales structure, a spokesperson said by email, adding that the firm’s policy is offering products that match clients’ needs.
Mitsubishi UFJ Morgan Stanley Securities Co., a joint venture between Japan’s largest lender and the major US investment bank, is checking its sales and management systems for structured loan products in light of regional lenders’ need to strengthen their risk management, a representative said by email. The company is having discussions toward a sales policy review, he said.
Monitoring the loans’ market prices is essential because their real value could change even though investors aren’t required to mark them to market, he said. The company would inform clients of that risk while offering them the data needed to manage it through after-sales services, he said.
Repackaged JGBs hold allure for regional lenders, many of which lack expertise and scale to pursue more diversified investment portfolios like those of the nation’s largest banks. Their revenue sources are relatively limited, as few operate overseas or do investment banking business.
Sellers include most major brokerages, according to the people. “Our product offering is always based on the needs of our clients, and in alignment with the FSA’s Principles for Customer-Oriented Business Conduct,” Goldman Sachs Group Inc. spokeswoman Hiroko Matsumoto said by email.
Other foreign banks declined to comment on the survey, which included queries such as whether they are selling repackaged JGBs. They are Morgan Stanley, JPMorgan Chase & Co., Citigroup Inc., Barclays Plc, BNP Paribas SA, Deutsche Bank AG, UBS Group AG, Bank of America Corp., and Societe Generale SA.
Demand for repackaged loans began to expand at an “accelerated pace” in 2022 when yen interest rates started climbing amid the Bank of Japan’s policy tweaks, said Hiroshi Toyoda, an executive director at Daiwa Securities Group Inc., by email. Yields on such loan products move in tandem with market rates, offering regional banks relatively high returns until their lending rates catch up.
Repackaged JGBs have begun to lose some of their allure because lending rates in Japan have started rising, Toyoda said. “The market is showing no sign of overheating as it once was,” he said.
The average lending rate among major regional lenders reached a nearly nine-year high of 1.11% in December before falling a little in the following month, according to BOJ data.
Daiwa will “appropriately respond in accordance with our customers’ needs,” Toyoda said in response to a question whether it plans to keep offering repackaged JGBs.
SMBC Nikko Securities Inc., the brokerage unit of Japan’s second-largest banking group, will review its sales policy for individual products as necessary and in accordance with market conditions, a representative said in a reply to the same query. The company is offering clients support so they can properly conduct comprehensive risk management for structured loans purchased from the firm, including repackaged JGBs, he said by email.
Investing remains a crucial pillar of local lenders’ strategy as Japan’s regional economies continue to face a shrinking population and other headwinds, eroding prospects for their mainstay lending business. The nation’s major 62 regional lenders earned a combined ¥631.7 billion in interest and dividends through securities investments during the six months through Sept. 30, the highest in at least 15 years for that period, equivalent to nearly half of the interest earned through lending, based on Regional Banks Association of Japan data.
Mitsubishi UFJ Morgan Stanley Securities for instance offers local lenders interest-rate and foreign-exchange derivatives, structured bonds, structured lending, securitized products, and privately placed investment trusts in addition to Japanese and foreign bonds and stocks.
“If repackaged JGBs become no good to sell, they’ll think of something else,” said Hideyasu Ban, a Bloomberg Intelligence analyst.
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