After a tough start to the year for the corporate debt market, many managers of specialist investment vehicles backed by risky loans believe that March will be make or break.
This has little to do with the financial health of the companies whose leveraged loans end up in these structures, known as collateralised loan obligations. Instead, the CLO market is on tenterhooks because Japan’s largest agricultural bank is set to finalise its budget for the financial year beginning in April.
Norinchukin Bank, which for nearly 100 years has managed the savings of farmers and fisherman from Hokkaido to Okinawa, has become a giant presence in the rapidly growing market for CLOs, which pool together loans to heavily indebted companies and use them to back a series of bonds of varying degrees of safety.
The bank commonly known as Nochu has piled into the safest of these securities, which carry coveted triple-A credit ratings. Its holdings have more than doubled in just nine months to reach Y6.8tn ($61bn) at the end of 2018. Over the first six weeks of the year, Nochu bought up the top tranches of every European CLO raised, according to people familiar with the deals. As such, its appetite for the year ahead is critical.
“Nochu is the only [Japanese bank] buying right now,” says one European CLO manager.
A Norinchukin spokesman said the bank does not comment on specific products or markets. The spokesman added that the company invests in an international and diversified way and “we maintain a firm control on risk management”.
US and European CLO managers regularly make the long pilgrimage to Nochu’s headquarters, housed in an imposing tower on the edge of Tokyo’s Ginza entertainment district, overlooking the Imperial Palace. The bank is one of many across Japan to have piled in to such debt structures, repelled by years of low and even negative yields on domestic assets such as Japanese government bonds. But the scale of Nochu’s investment in CLOs is striking, given its history.
The bank had to raise emergency funds at the peak of the financial crisis, tapping its agricultural, fishery and forestry co-operative members for the equivalent of tens of billions of dollars, after placing big bets on asset-backed securities based on US subprime mortgages.
In 2009 Nochu took what it termed “aggressive write-offs” across its Y6tn securitisation portfolio, which not only included collateralised debt obligations (CDOs), but also substantial holdings of the “CDO squared” product made infamous by Michael Lewis’s The Big Short.
“Watching it over the years, there have always been positions taken in securities and FX and so on that have question marks all over them,” says Brian Waterhouse, a veteran analyst of Japanese banks.
This experience is crucial to understanding Nochu’s big bet on CLOs. In contrast to the other three-letter acronyms that caused massive loses a decade ago, CLOs have never seen a default on a triple A-rated tranche.
Regulators around the world may have sounded the alarm on the loosening protections and credit standards in the world of CLOs, but managers of the vehicles argue that only catastrophically high loss rates could touch their triple-A tranches.
“CLOs were the one thing that didn’t blow-up in [Nochu’s] portfolio last time around,” says one executive at a London-based loan fund.
Yet while these managers have benefited from the savings of farmers on the other side of the world, many privately grumble about the ways Japanese money is distorting the asset class. CLOs seeking to launch without Nochu’s help are having to offer significantly higher yields on their triple-A tranches.
Nochu, meanwhile, is a demanding buyer, requiring certain features such as caps on how many “covenant-lite” loans managers can buy. Terms like these, while borne out of conservatism, can have unintended consequences.
As nearly every new loan is now “covenant-lite”, for example, Nochu’s stipulation can force CLO managers to buy the very riskiest loans, which still have covenants. As a result, managers say that if Nochu is anchoring a new CLO, it can be harder to find investors for the “equity” portion, which takes the first losses.
In the US, Nochu also buys into so-called “middle market” CLOs, which make loans to smaller American businesses. The triple-A tranches offer higher yields and greater protection against default but the underlying loans are often totally illiquid, meaning they can be extremely hard to sell in a downturn.
People familiar with Nochu’s inner workings say that while at one time employees were largely related to the agricultural industries it serves, today the bank hires graduates from Japan’s top universities who could also secure better-paid jobs in the country’s megabanks.
While Nochu’s conservative culture has seen it stick to triple-As, some other Japanese banks have begun to buy leveraged loans directly. One CLO manager says that Japan Post Bank “saved the market in Europe last year”, as it invested heavily just as banks were looking to syndicate several tricky buyout deals.
And in neighbouring South Korea, banks are not only investing directly in loans but are buying up the riskiest slices of CLOs.
“We spend a lot of time in Korea,” says a US CLO manager. “They like the equity — I don’t see any interest in the triple-A.”
