Japan's commercial mortgage-backed securities market has been growing at an unprecedented rate this year, but a working group of the Japanese Institute of Certified Public Accountants look set to issue guidelines that may make some potential issuers think twice before turning to CMBS.

The working group, which was formed in November last year, is likely to recommend that a property company that retains more than 5% of the subordinated portion of a CMBS will be required to account for the building or buildings on its balance sheet, bankers and accountants in Tokyo said. The report is expected to be published in June or July.

At the moment, the decision on how to treat CMBS transactions is left to individual accountants, most of whom have allowed property companies to transfer the assets that back a deal off the balance sheet, as long as the senior tranches are sold.

"If the changes are introduced, some originators will give up securitizing," said Kazuhiko Toya, an ABS analyst with J.P. Morgan in Tokyo. He added, however, that it will not stop the market in its tracks, as many issuers will endeavor to sell the subordinated chunks, while others will simply not worry about having to retain the assets on their books as long as they are able to raise the cash they require.

Frederic Drevon, Moody's Investors Service managing director for Asia Pacific structured finance, agreed that it could slow the market, but would not be disastrous. "It could be a set-back for those issuers focusing on reducing their balance sheet, but transactions are not always balance sheet driven: for a number of issuers, CMBS is simply a cost-effective way of raising funds."

Those originators who decide to meet the problem by making a greater effort to sell subordinated chunks, should not find it too difficult, as Japanese investors have become increasingly willing to go down the credit curve, at least as far as CMBS deals are concerned.

With the Japanese government maintaining a zero interest rate policy, investors are keen to find alternative investments that offer a reasonable yield pick-up. The fact that Japanese property prices remain near historic lows, after the property price bubble burst in the 1990s, means that subordinated tranches offer not only relatively lucrative coupons, but also a considerable potential for price appreciation if the property market recovers.

Indeed, this is one reason that many companies have been keen to retain the sub chunks, said Toya: they want that upside for themselves. Also, they know that if they retain the first loss tranches they have much more say in how the buildings are managed.

Even so, there has been increased activity in the market for subordinated CMBS paper over the last few months, perhaps in expectation of the accountants' move. NEC Corp., for example, sold the whole of a CMBS deal, which was backed by its headquarters building, in February. The deal, which totaled 90 billion ($826 million), with the first loss piece worth 39 billion, is thought to be the first Japanese CMBS in which none of the paper was retained by the issuer.

Similarly, when Dai-Ichi Mutual Life securitized five buildings from its property portfolio in March, in a deal worth 18 billion in total, it managed to place the 7 billion sub piece.

According to securitization pros, selling the subordinated chunks requires greater commitment to providing good quality information to investors in order to allow them to accurately assess the risks. If this is done, finding investors is not hard, as shown by the recent announcement from Tokio Marine & Fire Insurance Co. that it is looking to increase the proportion of subordinated CMBS paper that it holds (ASRI 3/27/2000 p. 2).

Another factor that it is likely to make a difference in the Japanese CMBS market is the introduction of property conduit-backed deals, which should decrease the amount of subordination needed by increasing the diversity of properties backing a securitization.

At the moment, all deals package revenues from a single company's buildings but, according to Drevon, this could be set to change, as sponsors of property conduits begin to look to Japan. He thinks conduit-backed deals will make their debut in 2001, or even possibly by the end of this year.

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