Japanese synthetic CDO market to see continued growth

Japan’s synthetic collateralised debt obligation (CDO) market is likely to continue to boom in 2003, according to a report published this week by credit rating agency Moody’s Investors Service.

The 28 CDO transactions Moody’s rated in Japan in 2002, including cash and synthetic transactions, were worth ¥3.14 trillion ($26 billion). The volume in 2002 was more than eight times the volume in 2001. Moody’s added that including unrated subordinated tranches and super-senior classes, the total reached about ¥4.1 trillion.

The volume of synthetic transactions rose to 82% of total volume, said Moody’s analyst Yusuke Seki. And synthetic transactions will remain dominant in 2003.

Of the 28 rated deals, 19 were synthetic CDOs, including 10 balance sheet and nine arbitrage deals. All nine cash deals were balance sheet transactions.

As Japan tries to clean up its banking sector, balance sheet securitisation transactions – which would help banks transfer some risk off their balance sheet and ultimately free up capital – are likely to continue to be an active sector of the market in 2003.

Mizuho Holdings this week became the latest Japanese financial institution to announce larger-than-expected provisions against bad loans. The bank expects losses to reach ¥1.95 trillion in the fiscal year ending March 31.

In November, UFJ Holdings said provisions for bad loans would be likely to reach ¥480 billion this year, and Mitsubishi Tokyo Financial, which owns Bank of Tokyo Mitsubishi, forecasted provisions of ¥460 billion.

The moves follow the appointment of Heizo Takenaka in October as head of the the Financial Services Agency (FSA), Japan’s financial regulator. Takenaka has been pushing for structural reforms of the banking sector and more drastic measures against non-performing loans that have been plaguing Japanese banks.

As they announce the provisions, the banks are also seeking funding from domestic and foreign investors. Already, Goldman Sachs is expected to invest ¥150.3 billion in Sumitomo Mitsui Financial Group, which owns Sumitomo Mitsui Banking Corporation (SMBC), and Merrill Lynch is expected to invest ¥100 billion in UFJ Holdings.

In addition to direct investments, the banks are also likely to structure balance sheet collateralised loan obligations to raise funds. SMBC and Mizuho already sold ¥500 billion and ¥1.26 trillion of synthetic CLOs respectively last year.