Negative rates push small Japan banks Into structured finance

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Japan’s regional banks have long been relegated to the sidelines in one of the most lucrative corners of the lending market while regular loans got gradually less profitable. Now some are fighting back.

Shizuoka Bank Ltd. has lined up a network of 40 local lenders that will invest in structured assets such as project finance and non-recourse real estate loans. The idea is that the banks get access to a steady stream of higher-yielding assets, while Shizuoka Bank can earn fees for arranging the deals, joining a market dominated by the nation’s largest banks.

“We will be able to originate deals without megabanks and foreign players taking away profits if we can create a secondary market among regional banks,” Shizuoka Bank President Hisashi Shibata said.

The new initiative is a sign of the extreme pressures facing Japan’s regional lenders, who are at the mercy of a negative interest-rate policy that threatens the viability of their mainstay business.

“In this low interest-rate environment, we can’t make money by simply offering domestic corporate loans,” Shibata said in an interview. “We have to earn money somewhere." He said he hopes to be able to arrange overseas deals eventually as well.

Shibata said he plans to add bankers to start arranging transactions and increase its own holdings of structured-finance assets from around 560 billion yen ($5.1 billion) as of March. Its current team of 23 has been focused mostly on getting new deals, “but the portfolio is expanding and we need to have people managing and monitoring it,” he said.

Unlike Japan’s three so-called megabanks, which are under strict international capital rules because of their importance to the global financial system, many regional lenders have less stringent requirements, giving them more room to have risk assets on their balance sheets.

Project finance is more complex than regular corporate lending because the banks rely on cash flows from the assets they are financing -- solar power plants, for example -- to ensure repayment. Non-recourse real estate loans often require the creation of special-purpose vehicles to hold the property assets financed by the lenders.

Growing Portfolio

Shizuoka Bank, Japan’s largest regional lender by market value, has seen its structured-finance portfolio grow more than four times since March 2014. About 60% of the assets are in yen, and the rest are in dollars and other foreign currencies, according to the bank’s figures.

Japanese project finance deals rose 46% to $7.1 billion last year, according to available data compiled by Bloomberg. The main lending units of Mitsubishi UFJ Financial Group Inc., Sumitomo Mitsui Financial Group Inc. and Mizuho Financial Group Inc. led most of them.

To manage risks, Shizuoka Bank has been diversifying its portfolio by lending to various types of projects and assets, Shibata said. Its holdings also include 49.6 billion yen of collateralized loan obligations -- pools of bundled foreign leveraged loans that have become popular among other Japanese banks. Shibata said all of its CLOs are rated triple A.

The bank’s interest and fee income from structured finance was 17.7 billion yen in the year ended March, growing more than 10 times from five years earlier. Overall interest income on loans was 106 billion yen and fees and commissions totaled 15.8 billion yen.

Shibata said the growth of its structured-finance assets has made securing dollar funding a big challenge. The lender is considering various ways to obtain dollars, such as by issuing bonds in the currency to Japanese retail investors, he said. Last year, the bank raised about $600 million by issuing convertible and straight bonds.

Bloomberg News