Secret Samurai
Over the last 18 months the primary Samurai market has soared in
volume thanks to historically low interest rates and thin yields on
domestic Japanese bond issues. To date, the great majority of these
bond issues have been for corporate finance purposes. Banking
sources say that no project bonds have been issued in the Samurai
market since 1999 by the private sector, making the ¥2.3 trillion
($20 billion) market one of the great untapped sources of project
funds. However, Daiwa Securities SMBC is quietly working on a
transaction for a project in South Korea which, if successful,
could help open the market to sponsors of projects around the
world.
Kangnam Expressway
The financing is being put together for the Kangnam Circular Expressway linking Yomchang-dong, in western Seoul, and Ilwon-dong, in southern Seoul. The project, chiefly sponsored by Dusan Construction with backing from a number of other Korean construction firms, is due for completion in 2005. Daiwa Securities SMBC is the financial adviser to the consortium and Sumitomo Mitsui is adviser for the off-shore tranche of the project finance loan, with the arrangers yet to be selected. Korean Development Bank and Korean Exim Bank are advisers for the on-shore financing.
Total project cost is about $900 million and while the size of the project bond has yet to be finalized, Hiroyuki Muraoka, a senior vice-president in Sumitomo Mitsui's project finance department, says that the Yen-denominated bond is likely to account for between $100 million to $150 million of the total financing amount.
Not only will the bond be one of the first Samurai issues for a private project, unusually, it will also be used to finance the project at the construction and pre-construction stages. Typically, project bonds come in to play at the post construction phase to replace bank loan facilities once the project in question has started to generate revenues. ?In fact we are hoping to issue the bond after the concession agreement is concluded and as soon as we have reached financial close,? says Muraoka.
The bond issue is subject to an investment grade rating from a ratings agency. Project Finance understands that Standard & Poor's has been approached to rate the potential bond issue and a rating will be finalized before the end of this year. The issue is expected to have a 10 to 15 year tenor and Daiwa is timetabling the first or second quarter of next year as the period in which the financing will be completed.
Bonds have been issued in the Samurai market to finance Korean projects before, but market sources say all the previous Samurai bond backed projects had explicit government backing and the bond issues themselves were supported by Korean government guarantees. Samurai bonds have similarly been considered by other quasi-governmental or governmental issuers for specific project needs.
In contrast, this latest deal does not feature direct government guarantees. Nevertheless, Kangnam Expressway is one of Korea's many private partnership in infrastructure (PPI) projects and for that reason does have strong indirect government assistance. Korea's PPI Act stipulates that a competent authority (in this case the Seoul metropolitan government) can provide a minimum revenue guarantee of up to 90% of the base case income.
Extra support is also available in the event of severe fluctuations in the value of Korean Won. Clearly, a significant depreciation in the Korean currency would make it difficult for the Won generating toll road to pay back its foreign denominated debts. Again this is standard practice in Korean project finance: all other Korean PPI projects with foreign currency loans can access the same exchange risk support.
The first of many?
Banking sources believe that many other project bonds could be launched into the Samurai market following the Kangnam deal. It is not clear, however, what proportion of these issues will be for Korean developments. Korea is a more likely venue for Samurai financings than many other countries in Asia simply because Japanese investors have a long history of investing in the country.
Indeed, in the past Japanese investors have only been willing to buy foreign debt with a rating under single-A if issued by a sovereign issuer (in which case nationality is less important) or familiar Korean corporates. ?The Japanese capital markets are reasonably comfortable with Korean risk which is one reason why Japanese securities houses are targeting projects there,? echoes another Japanese banker.
A second key question is whether the expansion of the Samurai market represents a short-term window of opportunity that will peter out in a year's time or a more lasting phenomenon.
The Samurai primary market grew rapidly in 2000 but appears to be stabilizing in 2001. In 1999 the volume of new issues in the Samurai market was about ¥660 billion, but in 2000 the Yen value of new issues soared to about ¥2.3 trillion. According to Jack Gunn, head of Japan new issues at Merrill Lynch in Tokyo, as of the beginning of August this year, the value of new issues stood at about ¥1.3 trillion, merely trending in line with year 2000 volumes.
Yet most market players think that the explosion of issuance in the Samurai market is only the start of prolonged yen frenzy. Siddharth Prasad, co-head of global primary markets at Nomura, thinks the Yen's share of global primary bond business could grow from its present 7% of the total international market ? it has already grown from three percent last year ? to perhaps 15% to 20%. ?The Yen market will continue to grow because the underlying reasons for the explosion are permanent features in the market,? says Prasad.
Gunn agrees that market growth is driven by a number of factors, none of which looks like abating. ?On the one hand, he says, ?demand for fixed income investments is driven by substantial liquidity in Japan, at almost all levels: from large corporates, to regional companies and retail customers.? Retail sector liquidity is a by-product of very high savings levels currently standing at 17% of disposable income.
On the other side of the coin, growth in the Japanese corporate sector has almost come to a halt, domestic companies have been more focused on paying down debt and restructuring than new expansion plans. As a result, Japanese companies have had limited financing needs and says Gunn, ?investors are faced with a very limited supply of domestic bond issues.? Domestic corporate debt issues fell by 40% in 1999, from a record volume of ¥9.6 trillion in 1998. Domestic volumes continue to be well down on 1998 highs. Then, after the recapitalization of the Japanese banking system in April 1999, banks took up their old habits of relationship lending, so that corporates withdrew from the capital markets. Domestic investors are therefore turning to the alternative, namely foreign corporate, issues.
Supply and demand
The supply problem is compounded by the historically low interest rates in Japan. Returns on domestic bond issues, whether government or corporate, are at rock bottom encouraging investors to look for better interest rates on foreign bond issues. One banker at Sanwa says: ?Japanese retail investors have traditionally been a bit risk-averse. But in the circumstances of low interest rates and a short supply of domestic names, investors are increasingly looking for more yield and to build a diversified portfolio.? With yields on Japanese corporates at Yen Libor plus 5bp to 10bp, the yield pick-up for sovereigns issuing at 65bp to 95bp is a considerable draw for Japanese investors. On the other side of the equation, low Japanese interest rates are encouraging many foreign borrowers to issue in Yen.
The biggest source of liquidity in the Japanese bond market in 2000 was around $100 billion in teigaku postal savings deposits, which Japanese retail investors deposited in five- and 10-year savings accounts in 1990 and 1991. These matured between April 2000 and April 2001. Prior to maturing, investment bankers were worried of a major contraction in demand for bonds, whether Samurai or domestic as the capital once tied up in the teigaku system migrated to financial products with higher returns than investment grade bonds could deliver. Gunn says that the impact of maturation has been much more limited than many had feared. ?Demand for bond instruments in Japan continues to be very strong.?
The final factor that could dampen interest in Samurai bonds is a recovery in the equity markets, particularly in Japan. The weak performance of the Tokyo stock market is, after all, one of the main reasons that so much cash has headed to the debt capital markets. The Nikkei index is down about 30% in 12 months and now stands at a 17-year low. However, while market analysts are betting on a recovery in the Nikkei over the next year, dependent on a US economic recovery, Gunn does not any believe that recovery would be dramatic enough to have a significant negative impact on the bond market.
Increasing risk appetite
Evidence of increasing risk appetite on the part of Japanese investors has been particularly striking this year. Twelve months ago investment bankers doubted that there would be significant appetite for non-sovereign credits. Since then, says Gunn, ?deals like Enron's Samurai bond [underwritten by Merrill Lynch] have shown that investors are willing to consider BBB corporate credits.? He adds, ?we are seeing the large financial institutions beginning to take a closer look at single-A and triple-B rated corporates from non-Japan to enhance their returns. This issue should be the start of a trend.?
At the beginning of June, Enron became the first triple-B rated US corporate to launch a deal in the Samurai market with a tenor of over one year. The dual tranche bond issue, which comprised a ¥40 billion two year floating rate note and a ¥10 billion two year fixed rate portion and which was co-managed by Mizuho Securities and Tokyo-Mitsubishi Securities was rated Baa1 and BBB+. According to Gunn the FRN has a coupon of Yen Libor plus 83bp, while the fixed rate issue had a coupon of 0.77%.
The transaction was between 10% and 15% oversubscribed, with about 20 accounts participating. However, what Enron does have, giving it an advantage compared to many potential foreign issuers, is good name recognition in Japan because of its increasing involvement in the Japanese power sector.
A number of other large corporates have launched or are planning to launch Samurai bonds, including Dow Chemical, Baxter International and Telecom Italia. These less well-known names, says one debt capital markets banker, will test the market's depth and provide a better indication of how attractive project bonds will be to Japanese investors.
Many bankers believe that the Kangnam deal and subsequent project bonds can be successfully marketed without significant government backing, as long as the Samurai market continues to be an issuers market. ?Government guarantees probably aren't absolutely necessary, if there is political risk insurance from an entity like Nippon Export and Investment Insurance,? says Naomi Yasuda Fisher, head of infrastructure finance at Fuji Bank in Tokyo. The challenge will be to broaden the market for private project bonds beyond South Korea.
Kangnam Expressway
The financing is being put together for the Kangnam Circular Expressway linking Yomchang-dong, in western Seoul, and Ilwon-dong, in southern Seoul. The project, chiefly sponsored by Dusan Construction with backing from a number of other Korean construction firms, is due for completion in 2005. Daiwa Securities SMBC is the financial adviser to the consortium and Sumitomo Mitsui is adviser for the off-shore tranche of the project finance loan, with the arrangers yet to be selected. Korean Development Bank and Korean Exim Bank are advisers for the on-shore financing.
Total project cost is about $900 million and while the size of the project bond has yet to be finalized, Hiroyuki Muraoka, a senior vice-president in Sumitomo Mitsui's project finance department, says that the Yen-denominated bond is likely to account for between $100 million to $150 million of the total financing amount.
Not only will the bond be one of the first Samurai issues for a private project, unusually, it will also be used to finance the project at the construction and pre-construction stages. Typically, project bonds come in to play at the post construction phase to replace bank loan facilities once the project in question has started to generate revenues. ?In fact we are hoping to issue the bond after the concession agreement is concluded and as soon as we have reached financial close,? says Muraoka.
The bond issue is subject to an investment grade rating from a ratings agency. Project Finance understands that Standard & Poor's has been approached to rate the potential bond issue and a rating will be finalized before the end of this year. The issue is expected to have a 10 to 15 year tenor and Daiwa is timetabling the first or second quarter of next year as the period in which the financing will be completed.
Bonds have been issued in the Samurai market to finance Korean projects before, but market sources say all the previous Samurai bond backed projects had explicit government backing and the bond issues themselves were supported by Korean government guarantees. Samurai bonds have similarly been considered by other quasi-governmental or governmental issuers for specific project needs.
In contrast, this latest deal does not feature direct government guarantees. Nevertheless, Kangnam Expressway is one of Korea's many private partnership in infrastructure (PPI) projects and for that reason does have strong indirect government assistance. Korea's PPI Act stipulates that a competent authority (in this case the Seoul metropolitan government) can provide a minimum revenue guarantee of up to 90% of the base case income.
Extra support is also available in the event of severe fluctuations in the value of Korean Won. Clearly, a significant depreciation in the Korean currency would make it difficult for the Won generating toll road to pay back its foreign denominated debts. Again this is standard practice in Korean project finance: all other Korean PPI projects with foreign currency loans can access the same exchange risk support.
The first of many?
Banking sources believe that many other project bonds could be launched into the Samurai market following the Kangnam deal. It is not clear, however, what proportion of these issues will be for Korean developments. Korea is a more likely venue for Samurai financings than many other countries in Asia simply because Japanese investors have a long history of investing in the country.
Indeed, in the past Japanese investors have only been willing to buy foreign debt with a rating under single-A if issued by a sovereign issuer (in which case nationality is less important) or familiar Korean corporates. ?The Japanese capital markets are reasonably comfortable with Korean risk which is one reason why Japanese securities houses are targeting projects there,? echoes another Japanese banker.
A second key question is whether the expansion of the Samurai market represents a short-term window of opportunity that will peter out in a year's time or a more lasting phenomenon.
The Samurai primary market grew rapidly in 2000 but appears to be stabilizing in 2001. In 1999 the volume of new issues in the Samurai market was about ¥660 billion, but in 2000 the Yen value of new issues soared to about ¥2.3 trillion. According to Jack Gunn, head of Japan new issues at Merrill Lynch in Tokyo, as of the beginning of August this year, the value of new issues stood at about ¥1.3 trillion, merely trending in line with year 2000 volumes.
Yet most market players think that the explosion of issuance in the Samurai market is only the start of prolonged yen frenzy. Siddharth Prasad, co-head of global primary markets at Nomura, thinks the Yen's share of global primary bond business could grow from its present 7% of the total international market ? it has already grown from three percent last year ? to perhaps 15% to 20%. ?The Yen market will continue to grow because the underlying reasons for the explosion are permanent features in the market,? says Prasad.
Gunn agrees that market growth is driven by a number of factors, none of which looks like abating. ?On the one hand, he says, ?demand for fixed income investments is driven by substantial liquidity in Japan, at almost all levels: from large corporates, to regional companies and retail customers.? Retail sector liquidity is a by-product of very high savings levels currently standing at 17% of disposable income.
On the other side of the coin, growth in the Japanese corporate sector has almost come to a halt, domestic companies have been more focused on paying down debt and restructuring than new expansion plans. As a result, Japanese companies have had limited financing needs and says Gunn, ?investors are faced with a very limited supply of domestic bond issues.? Domestic corporate debt issues fell by 40% in 1999, from a record volume of ¥9.6 trillion in 1998. Domestic volumes continue to be well down on 1998 highs. Then, after the recapitalization of the Japanese banking system in April 1999, banks took up their old habits of relationship lending, so that corporates withdrew from the capital markets. Domestic investors are therefore turning to the alternative, namely foreign corporate, issues.
Supply and demand
The supply problem is compounded by the historically low interest rates in Japan. Returns on domestic bond issues, whether government or corporate, are at rock bottom encouraging investors to look for better interest rates on foreign bond issues. One banker at Sanwa says: ?Japanese retail investors have traditionally been a bit risk-averse. But in the circumstances of low interest rates and a short supply of domestic names, investors are increasingly looking for more yield and to build a diversified portfolio.? With yields on Japanese corporates at Yen Libor plus 5bp to 10bp, the yield pick-up for sovereigns issuing at 65bp to 95bp is a considerable draw for Japanese investors. On the other side of the equation, low Japanese interest rates are encouraging many foreign borrowers to issue in Yen.
The biggest source of liquidity in the Japanese bond market in 2000 was around $100 billion in teigaku postal savings deposits, which Japanese retail investors deposited in five- and 10-year savings accounts in 1990 and 1991. These matured between April 2000 and April 2001. Prior to maturing, investment bankers were worried of a major contraction in demand for bonds, whether Samurai or domestic as the capital once tied up in the teigaku system migrated to financial products with higher returns than investment grade bonds could deliver. Gunn says that the impact of maturation has been much more limited than many had feared. ?Demand for bond instruments in Japan continues to be very strong.?
The final factor that could dampen interest in Samurai bonds is a recovery in the equity markets, particularly in Japan. The weak performance of the Tokyo stock market is, after all, one of the main reasons that so much cash has headed to the debt capital markets. The Nikkei index is down about 30% in 12 months and now stands at a 17-year low. However, while market analysts are betting on a recovery in the Nikkei over the next year, dependent on a US economic recovery, Gunn does not any believe that recovery would be dramatic enough to have a significant negative impact on the bond market.
Increasing risk appetite
Evidence of increasing risk appetite on the part of Japanese investors has been particularly striking this year. Twelve months ago investment bankers doubted that there would be significant appetite for non-sovereign credits. Since then, says Gunn, ?deals like Enron's Samurai bond [underwritten by Merrill Lynch] have shown that investors are willing to consider BBB corporate credits.? He adds, ?we are seeing the large financial institutions beginning to take a closer look at single-A and triple-B rated corporates from non-Japan to enhance their returns. This issue should be the start of a trend.?
At the beginning of June, Enron became the first triple-B rated US corporate to launch a deal in the Samurai market with a tenor of over one year. The dual tranche bond issue, which comprised a ¥40 billion two year floating rate note and a ¥10 billion two year fixed rate portion and which was co-managed by Mizuho Securities and Tokyo-Mitsubishi Securities was rated Baa1 and BBB+. According to Gunn the FRN has a coupon of Yen Libor plus 83bp, while the fixed rate issue had a coupon of 0.77%.
The transaction was between 10% and 15% oversubscribed, with about 20 accounts participating. However, what Enron does have, giving it an advantage compared to many potential foreign issuers, is good name recognition in Japan because of its increasing involvement in the Japanese power sector.
A number of other large corporates have launched or are planning to launch Samurai bonds, including Dow Chemical, Baxter International and Telecom Italia. These less well-known names, says one debt capital markets banker, will test the market's depth and provide a better indication of how attractive project bonds will be to Japanese investors.
Many bankers believe that the Kangnam deal and subsequent project bonds can be successfully marketed without significant government backing, as long as the Samurai market continues to be an issuers market. ?Government guarantees probably aren't absolutely necessary, if there is political risk insurance from an entity like Nippon Export and Investment Insurance,? says Naomi Yasuda Fisher, head of infrastructure finance at Fuji Bank in Tokyo. The challenge will be to broaden the market for private project bonds beyond South Korea.
Request a Demo
Interested in IJGlobal? Request a demo to discuss a trial with a member of our team. Talk to the team to explore the value of our asset and transaction databases, our market-leading news, league tables and much more.