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Banking & Finance

Japanese investors flock to megabanks' subordinated debt

TOKYO -- Yield-hungry Japanese insurance companies and other domestic institutional investors are aggressively pursuing a type of perpetual subordinated bond issued by the country's three megabanks.

Such hybrid subordinated convertible debt is known as aditional tier-1, or AT1. When the issuer's capital is impaired beyond a predetermined trigger level, due to write-offs on bad loans, for instance, these debt instruments are automatically converted into stock. The issuer could arbitrarily stop paying interest as well. The higher risks are compensated by higher returns.

Can't get enough

In mid-September, U.S. Department of Justice demands for a huge fine on Deutsche Bank ignited concerns that the bank's capital may be impaired. Fears that the major German financial institution could stop paying interest sent AT1 yields surging in Europe.

The Japanese market for AT1s, however, hasn't been touched. Yields on megabank AT1 bonds, including those issued by Mizuho Financial Group, keep falling due to strong demand. It is the same story with the AT1 instruments offered by the two other Japanese megabanks --  Mitsubishi UFJ Financial Group and Sumitomo Mitsui Financial Group. Bond yields move in the opposite direction of price.

"Confidence in Japanese megabanks' AT1 securities is unshaken," says Shoko Tsukamoto, a senior credit analyst at Mitsubishi UFJ Morgan Stanley Securities.

Domestic investors can't seem to get enough of the hybrid subordinated bonds because they are one of just a handful of debt instruments that still offer yields above 1%. For insurers and other investors struggling to make returns in an ultralow-interest-rate environment unleashed by the Bank of Japan, AT1 bonds are an asset that they "absolutely must have," one financial analyst said.

Since late September, rumors have been circulating that MUFG is preparing to issue more than 200 billion yen ($1.93 billion) in AT1 bonds at yields of 1.1% to 1.2%.

Coupon rates of megabank AT1 bonds have dropped sharply as domestic investors chase them aggressively. Mizuho issued an AT1 last year carrying a rate in the 2% level, but the figure roughly halved to the 1% level with a recent issuance.

Desperate for yield

AT1 securities count as capital, so major banks around the world have increased issuance in order to meet stricter capital requirements. Investors appear to be overlooking the risks inherent in these instruments because they are so desperate for yield amid the sea of low interest rates across the globe.

Toshiyasu Ohashi, Daiwa Securities' chief credit analyst, says "AT1s are equities disguised as bonds." "We should draw a lesson from the experience in Europe," Ohashi argues, calling attention to the fact that Deutsche Bank's AT1 prices have been fluctuating widely like stocks since concerns about the bank's financial health surfaced.

Many domestic investors do recognize the danger. "We are carefully gauging whether returns would be adequate to justify the risks," says Yasutoyo Takada, head of credit investment at Nippon Life Insurance. But an asset manager at another life insurer concedes that 1% yields in the Japanese debt market are so rare that investors are throwing caution to the wind.  

The BOJ is now shifting the focus of its monetary policy from quantitative easing to interest rates. Many asset managers at insurance companies and pension funds say they are anxious for long-term rates to rise back into positive territory. The unabated appetite for AT1 bonds in Japan may be a reflection of their fundamental lack of confidence in the central bank.

(Nikkei)

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