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Opps to hedge international exposures locally.
=DJ Asia Debt:Pricing In Tokyo Credit Derivs Mkt A Bit Askew Dow Jones International News Service via Dow Jones By Brian Fowler A Dow Jones Newswires Column TOKYO (Dow Jones)--Pricing levels in Tokyo's credit derivatives market show it's cheaper to buy protection on some top-rated Japanese issuers these days than on U.S. names with similar ratings, a clear sign that record-high bankruptcies and bad debts in the banking system aren't shaking the market's faith in this nation's top companies. Take, for example, Ford Motor Co. (F) and Honda Motor Co. (HMC or 7267). Both have solid A2 credit ratings from Moody's Investors Service. And yet, as of last week, the cost of credit default protection on five-year Honda U.S. dollar-denominated debt stood around 30 basis points, while protection on five-year debt issued by Ford Motor Credit, Ford's financing arm, was around 70 basis points. Bankers and institutional investors use the credit derivatives market either to shed risk on loans and bonds or to take on risk as an investment. In a credit default swap, the most commonly-used credit derivative, one party pays a fee measured in basis points on a notional value. The recipient of the fee - the risk-taker - is considered the investor. In the case of Honda Motor, Japanese banks looking to reduce the exposure in their portfolios to that company's debt would benefit from the relatively low cost of doing so. But hedge funds, non-life insurers and other investors seeking exposure to Honda as a way of picking up revenue would get stuck with lower returns. "One of Honda's main markets is the U.S. market, so if an investor wants exposure to the U.S. auto market, Ford offers better spreads," said Joseph Slankas, assistant vice president in the Global Credit Derivatives division at Merrill Lynch in Tokyo. The pricing distortions in Tokyo's credit derivatives market can be linked to two main factors: the low interest rate environment here and skewed supply-demand dynamics. "In the last two years, markets have swung from a focus on hedging to being totally dominated by investors," said Malcolm Perry, managing director at J.P. Morgan Securities Asia Pet. Limited in Tokyo. Not surprisingly, heavy demand to sell protection reduces the premium on that service. More than anything else, however, the narrow spreads in Japan's credit derivatives market underscore the relatively underdeveloped state of the nation's corporate bond market and the effect this has on liquidity. For decades, Japanese companies have tended to rely heavily on bank financing rather than directly tapping capital markets. As a result, while Japan's government bond market is as big or bigger than the Treasurys market, the corporate bond market here remains relatively small. The value of outstanding Japanese corporate bonds was around Y50 trillion at the end of February, according to the Japan Securities Dealers Association. That's less than one-eighth the size of the U.S. market, where the value of outstanding issues stood at $3.372 trillion at the end of December, according to the U.S. Bond Market Association. A small market means a dearth of liquidity, which inhibits trading in secondary markets. On top of that, the lack of an indigenous Japanese high-yield market - all of Japan's high-yield issuers are so-called fallen angels - leaves investors with few opportunities to diversify their portfolios. As a result, the bulk of trading in Tokyo's credit derivatives market involves names rated A or higher. To be sure, there are also historical factors that tilt the supply-demand balance. Despite the bad-loan crisis here, many Japanese bankers feel that domestic top-rated companies are still a relatively safe bet in the international marketplace. "Even if ratings are the same, we tend to feel that the real distance a corporation has to fall to default is larger here," said Takashi Miyauchi, manager of the Derivative Products Division at Fuji Bank Ltd. It's not hard to see why. The U.S. corporate landscape has been scorched recently by the likes of companies such as Xerox Corp. (XRX) and Lucent Technologies (LU), both of which have struggled over the past year with heavy debt loads and credit rating downgrades after having been considered solid credits going into the year 2000. Moody's cut its domestic currency rating for Xerox to Baa2 in September 2000, three notches below where the rating had been at the end of 1999. Lucent's fall was even steeper - to Baa3 in February, four notches below where it was in October 2000. In contrast, credit derivatives players in Tokyo say they can't recall a major credit event on a traded Japanese name since late 1998, when Long-Term Credit Bank and Nippon Credit Bank collapsed in quick succession. The sense of relative safety regarding top-rated Japanese names is a key factor in the dearth of tiering - or spread - between different grades of double A credits, according to Kazuyasu Makabe, vice president, credit trading at J.P. Morgan Securities Asia. "Toyota Corp., with tremendous fundamentals, is rated AA1 and trades with a credit default swap rate around 15 basis points in yen. Sony, another great company, is two notches lower at AA3 and yet only trades about two basis points over Toyota," Makabe said. In the U.S. you might expect the lower-rated credit to trade at a spread of 10 basis points or more over the higher-rated company, Makabe said. The upshot of this is that low spreads can squeeze some investors out of the market for Japanese names. "We are focusing on U.S. and euro names because spreads on Japanese names are so tight," said Koji Ogawa, assistant manager of the Investment and Structured Finance Group at the Tokio Marine and Fire Insurance Co. Pricing is an increasing concern for casualty insurers like Tokio Marine and Fire because the effects of deregulation have hit profitability in core operations while sluggish stock prices and rock-bottom interest rates have weighed on investment returns. "The core businesses for non-life companies are becoming less profitable, so it's important for them to diversify earnings sources," said Ayako Nakajima, non-life insurer analyst at Standard & Poor's in Tokyo. -By Brian Fowler, Dow Jones Newswires; 813-5255-9206; brian.fowler@dowjones.com -Nick Shindo contributed to this story. (END) Dow Jones Newswires 22-05-01 Joseph P. Hirl Enron Japan Corp. 81 3 5219 4500 81 3 5219 4510 (Fax) www.enron.co.jp
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