BofA Sees Japan Investors Moving Into More Structured Assets

  • Expects buying of real estate, mortage-backed securities
  • U.S. regulations weighing on CLO issuance, liquidity: BofA

Bank of America Corp. sees Japanese investors fleeing negative rates moving into more structured products overseas, including debt backed by pools of loans.

Japanese institutions are already pushing into riskier assets. Norinchukin Bank acquired more than 2 billion pounds ($2.9 billion) of U.K. mortgage-backed bonds, according to people with knowledge of the matter. Japan Post Holdings Co. will shift more of its $2.6 trillion investment portfolio into riskier products such as overseas real estate investment trusts and infrastructure funds and has begun investing in private equity, company president Masatsugu Nagato said last week.

“Japanese investors are increasingly looking abroad, which is a natural reaction to negative interest rates,” said Alex Batchvarov, the head of international structured finance research at Bank of America Merrill Lynch, in an interview in Tokyo. “We expect the next step to be moving into commercial real estate,” as well as commercial and residential mortgage-backed securities both in the U.S. and Europe, he said.

BOJ Effect

Unprecedented monetary stimulus by the BOJ is driving Japanese investors into overseas products that could be hurt by unfavorable exchange rate moves and are less liquid, carrying the risk of losses if investors seek to exit positions quickly as happened during the 2008 global financial crisis. Still, with domestic benchmark sovereign yields of as long as 10 years below zero, institutions have little choice but to put their money into more complex assets.

Private U.S. mortgage bonds ballooned in popularity during the mid-2000s as lenders made more and more home loans, often to borrowers who lacked the ability to repay. The ensuing defaults triggered the worst economic crisis since the Great Depression. In March, the number of U.S. homes in foreclosure fell to 631,000, the lowest since October 2007, according to Black Knight Financial Services, as the housing market recovers.

Japanese investors are looking at diverse structured products from the more than $5 trillion of U.S. home loans that get bundled into government-backed securities to collateralized loan obligations -- pools of high-yield corporate debt packaged into securities of varying ratings. They should have started looking earlier at CLOs because new regulations in the U.S. are reducing issuance and liquidity, according to Batchvarov.

New CLO sales in the U.S. plunged to $8.2 billion in the first three months of the year, its slowest quarter since 2012, as managers comply with a new rule requiring them to retain 5 percent of deals. CLO sales reached nearly $100 billion in 2015 and a record $124 billion in 2014. Batchvarov said CLO issuance in the U.S. this year could be as low as $45 billion.

Default Rate

A report by Standard & Poor’s in 2014 showed that of more than 6,100 ratings on 1,100 CLO transactions in a 20-year period, only 25 had defaulted and none with ratings of AAA or AA had. Despite low default rates, CLOs gained a bad name during the credit crisis as almost all securitized products got labeled as toxic, according to Batchvarov.

Credit Suisse Group AG said in March that holdings of securitized products including CLOs triggered writedowns of $115 million in the first quarter as of March 11, in addition to $146 million in the fourth quarter.

“This is a not reflection of the credit performance of the bonds, this is a reflection of market volatility” and mark-to-market losses, Batchvarov said. Investors should choose the portfolio and CLO manager carefully and hold to maturity, he said. “Just invest and hold on to them.”

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