Euroweek – Japan capital markets report, October 2011
Japan’s municipalities and prefectures are, in many cases, in considerably better financial shape than the sovereign itself. Sophisticated and communicative borrowers, albeit mainly domestically, they are able to borrow within a few basis points of Japanese government bonds.
Leaving aside JFM (see box), the only one of Japan’s various prefectures and city issuers with a track record in international markets is Tokyo Metropolitan Government, or Met Tokyo, as it is widely known. Met Tokyo could hold its own as a sovereign issuer in its own right: little surprise, considering it represents a population of 13.16 million and a nominal GDP of $917 billion, bigger than many countries. Its general account budget alone is worth Y6.24 trillion and it initially targeted Y750 billion of fundraising for 2011, and potentially more to fund earthquake countermeasures.
The vast majority of that will be domestic, but Y50 billion of it is earmarked for international markets; Met Tokyo first launched a government-backed bond in 1964 and issued five without guarantees between 2004 and 2008 before it stopped being cost-efficient to continue. “In the last three years, cost-wise international funding was not competitive enough,” says Yoshiko Aida, director of the bond section in the Bureau of Finance within Tokyo’s metropolitan government. “But we believe international bond issuance is one way to diversify our investor base, and to reduce the risk of unstable funding. We believe it is very important.”In August, she said that a single dollar five-year deal looked the most likely. At the time of writing, Met Tokyo was about to depart on a non-deal roadshow across Asia, “in order to have international investors understand Met Tokyo’s credit as well as to have better ideas of investor appetite,” according to Reiko Hayashi at Bank of America Merrill Lynch, one of the banks leading the roadshow.
That apart, Met Tokyo and the rest of the prefectures (there are 32 prefectures and 19 cities, making 51 municipal issuers in total) tend to do almost all of their funding domestically, but in the main they do so with sophistication and a commitment to communication. There is a clear second tier of prefecture issuers covering much of Honshu and including, among others, Yokohama, Aichi, Shizuoka, Kanagawa, Osaka, Kobe and Kyoto.
Those in this field tend to make clear well in advance not only how much they will borrow through the course of the coming year, but in what maturities. For example, any investor in Kobe’s paper will know that the prefecture intends to raise Y20 billion apiece of five, 10 and 20-year paper in financial 2011, along with Y10 billion in 30-year, Y30 billion in jointly issued local government bonds, and a further Y10 billion in whatever maturity makes sense at the time. Investors in Kyoto knew to expect five-year bonds of Y10 billion each in July 2011, September 2011, January 2011 and March 2011, and 10-year deals of the same among in August and December 2011. Doing so ensures the market is not surprised. “We announce our plan at the beginning of every fiscal year, on our home page and in other ways too,” says Akihiko Onodera, director at Aichi prefecture’s budget management division. “We think it is quite important to let investors know they have stable funding, and we hope this will help international investors’ understanding of Aichi prefecture bonds.”
There are several patterns evident in Japanese municipal issuance. One is the increasing use of joint muni issuance, through which 35 prefectures and cities have joined forces to issue collectively, sharing proceeds and costs. Kyoto is one of the most prolific users of this approach: it will raise more in 10-year funding this way in financial 2011 than it will in its own name. “The market treats these joint muni bonds as a benchmark, as representing all local governments,” says Yoshitaka Kamitana, director of the budget section at Kyoto municipality. “We think there is some merit to participating in this programme.”
Another pattern is a growing interest in longer-term funding. Shizuoka, for example, has issued 30-year bonds every year since 2007. “There is a receptive audience for 30 year funding, with strong demand,” says Tsukamoto. “Also, investors in this area are different from those in 10 and 20 years.” 30-year bonds attract life insurance companies, 20-year bonds are bought by big funds often representing local regional banks and associations, and 10-year bonds appeal to regional investor bases.
A third pattern is exceptionally tight pricing, reflecting the superiority of some credits to Japan itself. Shizuoka is not the biggest issuer in Japan by any means, yet launched a 10-year issue in July at just 3.5 basis points over JGBs – a far from unusual rate for a municipality. While this low yield is perhaps off-putting for foreign buyers (and removes any sense in issuing offshore), it does make for remarkably efficient cost of funding for the prefectures themselves. This, in turn, is part of the reason that more and more of them have highly impressive financial standing. Aichi, for example – which was rated at AA until Japan’s sovereign was downgraded, dragging it down with the sovereign ceiling – has undergone about 20 years of administrative and fiscal reforms, carving huge chunks out of overall headcount, retiring outstanding debt, and building the sinking fund, whose reserves stood at Y393.9 billion by 2010. A comparison between the financial position of Met Tokyo and the sovereign is particularly stark: Met Tokyo’s total bonds outstanding are 1.6 times general account tax revenue, compared to 16 times for the national government. Met Tokyo’s dependency on bonds is 7.9%, whereas the national government is close to 50%. And debt in the general account compared to metropolitan Tokyo’s GDP comes to just 7.6%, compared to almost 200% for Japan itself.
Several prefectures have at least local ratings, and some have international ones too: Aichi has three in total, including Standard & Poor’s. Local ratings (from R&I and JCR) tend to be higher, since they do not feel a prefecture has to be capped by a sovereign ceiling; disputes over methodology are one reason that Met Tokyo, for example, no longer has a rating from Moody’s (though it has one from S&P, which has also been dragged down by sovereign downgrades).
There is also growing use of flexible-term bonds: Kyoto introduced these in 2010, for example, and Aichi moved from Y5 billion in this style in 2009 to Y40 billion just a year later. “Flexible-term bonds are in order to respond to investor needs in every maturity,” Onodera at Aichi says. “For example, in June, when we did bonds in 20 years, originally the issue size was expected to be Y10 billion. But because of strong demand from investors, we used our flexible-term bond budget to increase it to Y20 billion.” Flexible tranches can reflect reverse inquiry, or be used to increase a benchmark bond.
Prefectures have generally had to launch additional budgets since the March 11 earthquake, but outside of the affected areas, they have not been badly impacted in financial terms.
Japan Finance Organization for Municipalities was reorganized considerably between 2008 and 2009, moving from a national-funded model to one instead sourced from Japanese local governments, and with a broadened responsibility to provide funding to municipal general accounts across Japan.
This year JFM has launched its first international bonds since that shift took place, but the lack of national backing appears to have made almost no difference from an international investor perspective: they admire the credit just as much as they already did. “In January we issued our first bond in the international markets since the 2009 reorganization,” says Hiroshi Kiyota, referring to a US$1 billion 10-year bond launched on January 13, with a 4% coupon. “The attitude of investors had not changed: our creditworthiness was accepted as the same as before.”
Perhaps this should not be a surprise. JFM’s credit quality is arguably better than the sovereign – it would be higher rated, were it not for the sovereign ceiling – and in any case the markets see it as implicitly state-backed anyway. When it launched 10-year funding domestically in two issues earlier this year, one with a guarantee and one without, there was only a 1.1 basis point difference between the two.
JFM, like Met Tokyo, had been a frequent issuer in international markets (64 issues raising more than Y2 trillion since 1984) but largely pulled out of the market for cost efficiency reasons in 2008. January was therefore a landmark bond, particularly since it was accomplished by the establishment of a new EMTN program. “Our funding requirements are very big, so in order to make our funding stable, we like to diversify our investor base, not only in the domestic market but in the international markets,” says Kiyota. The January bond was bought by a range of European, US and Asian investors, from central banks to asset managers and banks. It priced at 60bps over mid-swaps. Kiyota says the MTN program will help to respond to reverse inquiry.
In domestic funding, JFM looks a lot like many of the munis themselves; its sweet spot is 10 year funding, which will account for Y1.17 trillion of funding in the 2011 financial year. It will also issue in 20, six and five-year maturities, some guaranteed and some not; will issue private placement 10-year bonds; and will use a program called FLIP, or flexible issuance program, a form of domestic MTN introduced in 2009 to allow issuers to be opportunistic, and increasingly popular among prefectures.
JFM is rated by Standard & Poor’s at the sovereign ceiling and makes efforts to attract international investors, even if the yields on its paper are unattractive to many buyers.