Citigroup Selling Fund for Japan’s Local Banks to Hedge JGB Risk

Citigroup Inc. started selling a fund for Japanese regional banks to hedge against the risk of a decline in the value of their government bond holdings as the world’s biggest public debt swells.

The U.S. bank is targeting Japan’s 106 local lenders and plans to raise as much as 200 billion yen ($2.5 billion), Manabu Miyamae, the head of regional sales at Citigroup Global Markets Japan Inc., said in an interview in Tokyo. The fund is the first of its kind to hedge such risk through yen interest-rate swaps, according to Citigroup, the only distributor of the product.

Regional banks, which held 41.6 trillion yen of Japan’s bonds as of February, are concerned that yields will climb from a nine-year low as the government considers how to contain debt that’s more than twice the size of the economy. Fitch Ratings cut Japan’s credit rating on May 22, citing Prime Minister Yoshihiko Noda’s “leisurely” plan for restoring fiscal health.

“Demand for hedging against an increase in interest rates is growing among Japanese regional financial institutions, and now they’re looking for solutions,” Miyamae said. Citigroup is also targeting credit associations and trust banks as investors for the private fund, he said.

The fund, administered by Tokyo-based Simplex Asset Management Co., will invest in swaps of fixed rates for shorter-term Japanese government bonds and floating rates for longer-term notes in an effort to profit when yields rise. Citigroup, which began offering the products to the lenders today, declined to say how much it expects to earn in fees.

Falling Yields

Japan’s benchmark bond yields are the world’s second lowest behind Switzerland’s as the central bank eases monetary policy and investors buy the notes as a haven amid concern Greece may exit the euro. Ten-year yields touched 0.81 percent in Tokyo today, the lowest since July 2003. Japanese government debt returned 3 percent in the past year, Bank of America Merrill Lynch indexes show.

Banks have been buying the securities as deposits grow faster than loans. Local lenders increased their holdings by about 9 percent in February from a year earlier, according to data compiled by the Regional Banks Association of Japan and Second Association of Regional Banks.

“It will be difficult for regional banks to reduce their dependence on Japanese government bonds for their profits as deposits are increasing while lending isn’t growing,” Katsunori Nakanishi, head of the Regional Banks Association, said at a news conference on May 16. “They need to conduct stress tests and manage the risk,” said Nakanishi, who is also chief executive officer of regional lender Shizuoka Bank Ltd.

‘Uncharted Territory’

The Organization for Economic Cooperation and Development says the nation’s debt will head into “uncharted territory” next year at 223 percent of gross domestic product. Prime Minister Noda must carry out his plans to double the sales tax to 10 percent by 2014, the Paris-based OECD said on May 22.

Ashikaga Bank Ltd., based in Tochigi Prefecture north of Tokyo, is reluctant to add to its 363.3 billion yen of Japanese government bonds in the current market environment, said Hiroyuki Ishikawa, a Tokyo-based deputy manager of the lender’s treasury and securities division.

“We’re closely watching the extent to which interest rates will rise,” Ishikawa said in an interview. “We’re collecting information on hedge products with enthusiasm.”

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