By Megumi Fujikawa and Cezary Podkul
This article is being republished as part of our daily
reproduction of WSJ.com articles that also appeared in the U.S.
print edition of The Wall Street Journal (May 28, 2020).
The Japanese bank that was the biggest buyer of debt used to
fund private-equity buyouts suffered a Yen400 billion ($3.7
billion) hit and said it would stop investing in that market.
Norinchukin Bank owns about 10% of the $700 billion market for
corporate debt that was packaged into securities called
collateralized loan obligations. Other big buyers include Wells
Fargo & Co. and JPMorgan Chase & Co., which each owned
about $30 billion worth of CLOs at the end of the first
quarter.
Losses on these investments could hamper the banks at a time
when bad loans are rising. They could also sour investors on CLOs,
which bought roughly 60% of the debt that private-equity companies
used for deals in recent years, according to the International
Monetary Fund.
"We will limit making new investments" in CLOs, Chief Executive
Kazuto Oku said.
Norinchukin's Yen7.7 trillion ($71 billion) portfolio of CLOs
was invested in the triple-A slices of these securities, and the
loss dates back to the end of its fiscal year on March 31. The
bank, which serves Japan's farmers and fishermen, said the
unrealized losses were offset by gains elsewhere in its
portfolio.
The market has rebounded since the end of March, so its losses
on CLOs have likely shrunk since then. Prices for the type of
securities the bank owns were trading at 95 cents on the dollar
March 31 and were nearly 97.5 cents in mid-May, according to data
from Barclays. Neither JPMorgan nor Wells Fargo announced losses on
their CLO holdings.
Until last year, Wall Street veterans had marveled at the
outsize role played by the large but little-known Japanese bank in
the market for CLOs. It was a sign of how Japanese financial
institutions, faced with negative interest rates on their own
government's bonds and limited opportunities to lend, were
searching ever farther afield for high-yielding investments.
Like most investors in the safe parts of CLOs, the banks are
seeking extra yield for the same level of risk. That strategy blew
up in the financial crisis when supposedly safe securities backed
by mortgages caused big losses for banks.
CLOs have performed better, but as the market boomed, lending
standards loosened. When the coronavirus pandemic hit, U.S.
companies were carrying significant amounts of debt. What followed
were bankruptcies of companies like Hertz Global Holdings Inc. and
J.C. Penney Co. Moody's Investors Service in April placed ratings
on 859 securities from 358 U.S. CLOs, worth some $22 billion, on
review for downgrade.
An important risk right now is that the mathematical models that
created the safe securities didn't take into account a scenario
like the coronavirus pandemic, according to Rod Dubitsky, who
headed U.S. asset-backed securities research at Credit Suisse until
2009.
Mr. Dubitsky argued back then that subprime mortgage-backed
securities were due for a wave of downgrades, and he recently
issued the same warning for triple-A rated CLO bonds. He argued in
a recent paper that the securities don't deserve such high ratings
because of the impact of the pandemic on the economy.
"The entire concept of triple-A CLOs goes out the window because
there is not much diversification left when the entire portfolio is
subject to a global economy that is in deep recession," Mr.
Dubitsky said in an interview.
In recent weeks, ratings firms Moody's, S&P Global Inc. and
Fitch Ratings have collectively placed more than 1,600 bonds from
mostly lower rated CLOs on review for possible downgrades.
The rising risks in CLOs threaten to limit the biggest source of
funding for private-equity buyouts and a source of funds for
struggling companies that are owned by PE firms. If too many loans
held by the funds are downgraded to the lowest levels, the funds
may not be able to buy new loans, further tightening the lending
markets.
Mr. Oku, the Norinchukin chief, sounded only slightly chastened
by the losses, saying it was his job to extract return from the
bank's portfolio and pass it on to members.
"It is difficult to disagree with the opinion that we have to
use member banks' money more effectively instead of investing in
overseas CLOs," he said. "But we have to steadily try to make
investments that are profitable."
Mr. Oku didn't say what specifically caused losses in his bank's
portfolio, but he held out hope that his holdings might keep their
value even in a bad situation. The bank was stepping away from new
investments in that market, he said.
"We will have to examine risks in two stages: how many U.S.
companies will go bankrupt or file for chapter 11, and after that,
in how many of these cases we will see AAA-rated CLOs being
affected," he said at a news conference.
For now, Norinchukin isn't reflecting the CLO losses on its
bottom line. Mr. Oku said the bank still had much larger unrealized
gains in other parts of its portfolio and planned to hold the CLOs
to maturity.
Norinchukin acts as a central pool for funds gathered by local
farming and fishing cooperatives throughout Japan, and it holds
about $600 billion in deposits from member cooperatives. It can use
the money to make loans to companies in farming, forestry or
fisheries, or it can simply invest it in global markets like any
money manager, seeking returns to distribute to members.
Its problem for years has been a shortage of loan opportunities,
leaving the money-management side of the business as the dominant
one. The number of people working in agriculture as their main job
has fallen 35% during the last decade, and those who remain are
mostly over 65.
--Paul J. Davies contributed to this article.
Write to Megumi Fujikawa at megumi.fujikawa@wsj.com and Cezary
Podkul at cezary.podkul@wsj.com
(END) Dow Jones Newswires
May 28, 2020 02:47 ET (06:47 GMT)
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