For the first nine months of 2003, Japanese issuance stood at US$25.6 billion, slightly down compared to US$27 billion recorded last year, according to figures provided by Merrill Lynch. Deutsche Securities' numbers nearly match, indicating that total issuance from January to September 2003 stood at Y2964.5 trillion (US$27.13 billion). See table 1.

Deutsche Securities is the Japan-based investment banking and brokerage arm of Deutsche Bank.

According to Deutsche's research, if short-term products are excluded from the figures for the first nine months (as they are in the figure quoted above), then issuance is down 13% from the corresponding period in 2002. However, it is worth noting that many deals in Japan are privately issued, and therefore there may be more to the story.

"Fundamentally, we are still in a positive growth state, and issuance volumes seem to have decreased slightly because of the disappearance of the mega-balance sheet CDOs of large banks that we saw between September of last year and March of this year," says Yukio Egawa, director in the global securitization research group of Deutsche.

The largest sectors of growth are represented by RMBS with Y740.8 trillion (US$6.78 billion), followed by CDOs, Y589.40 trillion (US$5.39 billion); equipment leases, Y503.2 trillion (US$5.032 billion) credit receivables, Y444.9 trillion (US$4.07 billion); and real estate, Y352.3 trillion (US$3.22 billion).

According to Deutsche, the RMBS and CDO sectors are the ones with the strongest growth potential. More activity could also come from the real estate sector, as a result of refinancing CMBS products issued since 1999, and the securitization of non-recourse loans.


Although from September 2002 until March 2003, synthetic balance-sheet CDOs and cash-flow CDOs from Japanese banks seeking regulatory capital relief were rife, this activity slowed. As Keiko Kurasaki, senior vice president at Moody's Investors Service in Tokyo, explains, "We have not seen much bank balance-sheet CDOs, after the end of the last fiscal year in March 2003."

Another reason for a decrease in CDO volume, offers Kurasaki, is that spreads are tightening and therefore there is less incentive for arbitrage CDOs, which capture the asset/liability spread between corporates and CDO funding.

Instead this has paved the way for the start of a new trend, CDOs of ABS, which has been the dominant theme in other parts of the world, such as the U.S.

"CDOs of ABS is one new trend that we are seeing in Japan," explained Kurasaki. "We have rated one public deal, and we believe that this is a future trend, where we will see growth. We also view this as a good tool for regional investors to gain familiarity with ABS and a first step towards investing in ABS."

Nevertheless, Deutsche is expecting activity to pick up in the near future for more arbitrage synthetic CDOs and cash-flow CLOs. The CDO market is also expected to be fuelled by the fact that some of the uncertainty in the credit derivatives market has been removed, by eliminating old restructuring' as a credit event. The market now operates with just failure to pay' and bankruptcy'.


According to Egawa, we should see more activity from government-owned financial institutions, as these will look to securitize their loans to small- and medium-sized companies (SMEs). These banks have come under pressure to reduce asset size while at the same time provide credit to this business sector and individuals.

The Shoko Chukin Bank, 79% owned by the government, has tapped the securitization market three times this year, with SME loan securitizations. Another government-owned financial institution, Japan Finance Corporation, is also looking to securitize in 2004, and others are expected to follow suit. Egawa believes that the public sector may emerge as one of the leading securitizers in the next 12 to 18 months.

In the RMBS sector, the largest securitizer continues to be the Government Housing Loan Corporation, described as the only regular issuer in the market. However, there will be more interest from the local regional banks to tap the RMBS market. An example of this is the recent deal from the Bank of Yokohama launched this August.

According to Egawa, there has been talk of securitizing sub-performing loans (SPLs), as banks are very keen to get these assets off balance sheet.

SPLs are loans in arrears (no more than 90 days), or loans to insolvent borrowers (where the borrower is still making payments), or even restructured loans. SPLs are difficult to properly evaluate, as they are still generating cash flows (for instance interest payments) but the borrower is obviously under great financial stress, if not insolvent. There are diverging opinions on how to analyze these deals: for instance, should the valuation be based on expected cash flow or liquidation value? At this stage there has been a lot of talk but deals have yet to materialize.

"These are difficult transactions to structure," says Egawa. "One obstacle could be the large gap in pricing terms, with respect to what the market is prepared to pay for these types of assets, as they view them as non-performing loans, while the banks that are selling them view them essentially as performing."

Consumer loans

On a more somber note, we may see the first downgrade, due to pool performance, of Japanese ABS backed by a portfolio of diversified consumer receivables, Deutsche commented. This refers to the AEL Corp. and Nice Co. Ltd. companies which originated various transactions as well as acting as servicers on these deals. These transactions have now been placed on review for downgrade by the three rating agencies, and the two companies filed for corporate reorganization in Tokyo District Court in September of this year.

Deutsche believes that all outstanding ABS of these servicers will enter a rapid amortization period, because of servicer bankruptcy. Further, they believe that we could see these deals being downgraded, because of the sharp deterioration in pool performance.

In a recent press release (Oct. 16), Moody's said that their review on the affected deals was ongoing and would continue to incorporate scenarios regarding future servicing arrangements and the pool's performance into its ratings. On a more positive note, they added that the conclusion of the ratings might also be the confirmation of the current ratings in certain transactions, as credit enhancement is also a key factor in determining any rating action.


Another ongoing issue facing the Japanese ABS market is the level of information disclosure on transactions. Historically, this has been lacking, especially when compared to the U.S., and this obviously has great effect on the transparency of secondary pricing.

Deutsche predicts that the Japanese market will most likely segment into those sectors with better transparency, rather than those that are inferior in this respect. They add in their report that spreads are likely to tighten for ABS backed by housing loans and credit card receivables for which there is good, consistent information flow.

On another comparative note, although the Japanese market has seen overall spread tightening from April of this year, supported by good investor demand, the spreads are still wider for certain asset classes, such as credit card receivables and housing loans, when compared to pricing in the U.S. and Europe.

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