While Japan's securitization market started off the year with a wave of new asset-backed issues, its development thus far has been slowed by the lack of a domestic investor base for asset-backeds.

But as investors become more familiar with analyzing structured products, that's starting to change. Reflecting the growing demand for ABS, Japan's Sumitomo Life recently set up a 12-strong structured finance department in its Tokyo head office focusing on domestic asset-backed issues, said Nobuki Yasuda, senior staff manager of the department.

Sumitomo Life is especially interested in transactions backed by commercial real estate. "We want to be an active player as an investor in commercial mortgage-backed securities," he said. "This asset is quite new, and the number of public issues so far is not more than 10. But commercial mortgage-backed securities have the biggest spread and therefore the greatest value."

Sumitomo has invested in both public and private CMBS deals, he added.

Increasing the ABS Portfolio

This fiscal year, Sumitomo's asset-backed portfolio is budgeted for 600 billion ($4.9 billion), a six-fold increase over its ABS portfolio of 100 billion at the end of March. Compared with the firm's total asset size of 24.1 trillion, the amount of asset-backed investments is still very small, but the firm's ABS investments will grow over time as the market deepens, Yasuda said.

"Domestic ABS issuance has slowed in recent weeks, but the overall trend is that the market will continue to grow," he added. "Traditionally, Japanese companies have relied on bank funding, but that is changing, and more companies are going to the capital markets."

MBS: Not Right Now

To date, Sumitomo has invested in transactions backed by familiar Japanese assets, such as auto loans, equipment leases, office buildings and shopping loans. The structure and spreads in credit card and auto loan-backed deals have been fairly uniform to date, and do not offer as much value as those backed by real estate, he noted.

The firm has mostly purchased triple-A rated tranches but is not averse to buying lower-rated securities. "The size of the mezzanine pieces is usually very small, but we may invest in them since we are not limited by ratings constraints," he said.

Residential mortgages have been a hot topic in Japan, in the wake of the country's first MBS recently issued by Sanwa Bank. However, as an originator of home loans, Sumitomo is not interested in buying mortgage backed-issues. "Our mortgage portfolio is between 400 billion and 500 billion. Investing in residential MBS would not provide any more diversification in our total portfolio. We would also have to give up a certain spread, compared to our residential loans," Yasuda explained.

But that may change as the market develops and new asset classes appear, he said. "We are always open to considering new assets, including residential mortgages. It depends on the spread, risk and reward of each security," he noted.

Bullet Securities in Favor

Sumitomo favors fixed-rate bullet securities with maturities ranging from three to five years, reflecting domestic investors' preference for short-dated paper. Its back office system has difficulty in booking longer-dated, pass-through securities, but the firm will consider such securities if they come with higher yields.

That was another reason why the firm did not buy the Sanwa MBS issue, he said. "Our main computer system cannot perceive pass-through schemes completely, so we must support them separately by hand. This technical problem creates extra work for back office staff, which is why we need extra spread. We have bought a few issues with controlled amortization, where the prepayment is relatively constant," Yasuda added.

Since the pace of domestic ABS issues has slowed recently, Yasuda could not comment on the merits of recent transactions. High liquidity in the domestic market has led many potential ABS issuers to turn to bank funding instead, Yasuda explained (see related story on p. 2 on Japan's market).

Yet he is confident that there will be plenty more ABS investment opportunities going forward. This fall, Japan passed new securitization laws that simplify the tax treatment for special-purpose corporations and the perfection process for the transfer of assets.

"Real estate securitization is quite new, and the main reason is the new SPC law [which] gave us a chance to find this new market. But since it's new, we are finding good value in this area and very attractive spreads against other fixed-income products," he concluded. - VC

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