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May 2002
ABS MARKET IN JAPAN - REVIEW OF FY2001
A bounce in growth – looking for greater efficiencies
Overview
I. Issuance of ABS (domestic, euro, public offerings, private placements and beneficiary trust rights)
originated by Japanese companies in FY2001(April 2001 to March 2002) was up 50% yoy to about
JPY 3.5 trillion which was above initial forecasts of between JPY 2.5 and 3 trillion.
II. In relation to underlying assets, commercial real estate was almost the same as lease payments
and accounted for about 20% of the underlying assets which were securitised during the year. In the
previous year, consumer loans accounted for a mere 2% of the market with JPY 49 billion of issuance.
In FY2001, this sector grew significantly to about JPY 500 billion, accounting for 14.1% of the total
issuance of ABS.
III. The credit rating of Orico’s OASIS was upgraded. OASIS is a re-securitisation of the subordinated
portion of a securitised auto loan issue. The underlying assets were the subordinated beneficiary trust
rights of the Oscar series which were redeemed and the credit rating upgrade reflected the higher
level of the complementary credit. This confirmed the performance stability of the underlying auto
loans.
IV. In the US, the collapse of LTV caused debate about the definition of “true sale.” The Japanese
securitisation markets are also faced with the challenge of Mycal CMBS. The first “trustees attack” in
Japan is not only a problem for the rehabilitation of Mycal but can be seen as a issue affecting the
recovery of the entire Japanese economy.
V. There was a low level of issuance of domestic CDOs in the first half of the fiscal year but the
market grew dramatically in the second half. This was due to the issuance of Shinsei Bank’s Master
Trust Type CDO, very large synthetic CDOs based on domestic credits and the arrival of UFJ’s
medium-sized business CDO etc.
VI. In FY2002, we expect a continuation of the growth trend. In particular, there is room for
development of the CDO sector with total loan outstandings of JPY 450 trillion (domestic banks) This
has a large potential to boost the market. While the market expanded greatly in FY2001, the taste of
exposure to market weakness suggests there is a need to reconsider the extent of underlying support
for further expansion of the market.
Fixed Income Research Department
This report is intended only for the professional and business clients to whom it is distributed from the Mizuho Securities Co., Ltd. This report has bee n prepared
for information purposes only and is not an offer to buy or sell, nor is it a solicitation of an offer to buy or sell any securities mentioned herein. The information
contained in this publication is derived from what we believe are reliable and accurate sources, but we do not guarantee its accuracy or completeness. The
opinions reflected herein may change without notice. Neither the author, Mizuho Securities Co., Ltd., nor any subsidiary or affiliate of the Mizuho Financial
Group accepts any liability, whatsoever, with respect to the use of this document or its contents. Neither this document nor its contents, nor any copy of it, may
be altered in any way, transmitted to, or distributed to, any other party.
May 2002
CONTENTS
I. ISSUANCE ACTIVITIES IN FY2001.................................................................................................. 3
Overview of ABS issuance market.................................................................................................. 3
Issuance increased by 50% over FY2000 to JPY 3.5 trillion.......................................................... 3
Widening of Spreads ....................................................................................................................... 3
Breakdown of underlying assets .................................................................................................... 4
II. LEASE CREDIT ABS ........................................................................................................................ 5
Rating Upgrade on the Resecuritised subordinated portion – Oasis SPC................................... 5
III. HOUSING LOANS •i RMBS•j ............................................................................................................. 7
Change in the credit rating of Asahi Bank’s securitisation of housing loans .............................. 7
Housing Loan Corp MBS................................................................................................................. 8
Housing Loan Corp MBS – Ratio of early redemptions is higher than expected......................... 9
IV. COMMERCIAL REAL ESTATE SECURITISATON .......................................................................... 10
Mycal CMBS................................................................................................................................... 10
Assessment by Credit Rating Agencies....................................................................................... 10
Limited Impact on the market as a whole ......................................................................................11
Debate about bankruptcy separation in the US – LTV Steel Company....................................... 12
Securitisation of shops following the collapse of Mycal............................................................. 12
Largest CMBS - KDDI..................................................................................................................... 13
(1) Rent levels are high.................................................................................................................. 15
(2) Strong demand from tenants................................................................................................... 15
(3) Profits are stable....................................................................................................................... 15
CMBS originated by Banks ........................................................................................................... 15
V. CBO•^ CLO ..................................................................................................................................... 17
Shinsei Funding............................................................................................................................. 17
Synthetic CDO – Serena Finance .................................................................................................. 18
UFJ Medium sized firm Primary CBO ........................................................................................... 18
Valuation of CDO’s performance – Moody’s................................................................................. 19
CLO has highest performance ...................................................................................................... 20
(1) Impact on trading price ............................................................................................................ 21
(2) Pre-payment.............................................................................................................................. 21
(3) High recovery rate on loans..................................................................................................... 21
Comparison with corporate bonds............................................................................................... 21
VI. REVIEW OF FY2001 / OUTLOOK FOR FY2002............................................................................. 23
Change in Credit Rating................................................................................................................ 23
Period of consolidation for the ABS Market................................................................................. 24
(1) Reduction in domestic public offerings.................................................................................. 24
(2) Underlying increase in issues................................................................................................. 25
Need to reconsider the underlying market................................................................................... 25
2
May 2002
I. ISSUANCE ACTIVITIES IN FY2001
Overview of ABS Chart 1. ABS Issues by Japanese Corporates
issuance market in the Domestic & Euro Markets
JPY’billion
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
0
FY1994 FY1995 FY1996 FY1997 FY1998 FY1999 FY2000 FY2001
Issuance increased During FY2001 there were approximately JPY 3,500 billion of ABS issues
by 50% over FY2000 (including public issues, private issues and beneficiary trust rights in both
to JPY 3.5 trillion the domestic and euro markets but excluding ABCP) originated by
Japanese corporations. This was a 50% increase on the previous year and
above our initial forecasts of JPY 2.5 to 3 trillion1. (Refer Chart 1). One
feature of FY2001 is the issuance of mega transactions such as the retail
targeted Life Funding Company ABS for an amount of JPY 245 billion and
Central Tower Estate, which was a securitisation of KDDI office buildings for
an amount of JPY 135.7 billion.
Widening of Spreads While the issuance volume increased in FY2001, spreads also widened.
Looking at the trends in launch spreads for lease payment backed ABS,
spreads for tranches of shorter than 1 year to maturity in mid 2000
contracted to Yen LIBOR flat or under. At the beginning of FY2001, spreads
on similar issues were Yen LIBOR plus single digits and in the latter part of
FY2001 spreads had reached Yen LIBOR plus double digits. In the case of
AAA/Aaa rated senior ABS issues backed by real estate the spreads were in
the Yen LIBOR plus 30s at the beginning of the year but late in the year had
widened to Yen LIBOR plus 50 to 60 bp.
1
The figures used by Mizuho Securities are the total of public issues, private placements
and beneficiary trust rights that securitise assets in the domestic market owned by
domestic corporations. Synthetic type transactions only include those tranches sold to
investors. Since there are many private placements that have not been publicly disclosed,
the actual issuance figure may be higher.
3
May 2002
Behind this widening of spreads in the ABS market we can point to demand
and supply factors such as the large volume of issuance in the fourth
quarter. However, the uncertainty in the entire domestic credit market also
had a major impact. Following the collapse of Mycal in September 2001,
Enron collapsed in latter half of FY2001 and there were a number of other
credit events, which shook the domestic credit markets (corporate bonds,
non-government bonds etc.) In the past, when there has been an increase
in credit instability there has been a shift of funds into ABS as part of a
“Flight to Quality”. In the latter part of FY2001, the impact came not only
from simple risk factors but also liquidity and the problem of a decline in risk
taking capacity.
Breakdown of Chart 2 shows a breakdown of the underlying assets which have been
underlying assets securitised. In FY2001, commercial real estate as an asset class was almost
the same in size as lease payments accounting for 20% of the market. In
addition while consumer loans accounted for a mere 2% of the market in
FY2000 with JPY 49 billion of issuance. In FY2001, this sector grew
significantly to about JPY 500 billion, accounting for 14.1% of the total
issuance of ABS.
Chart 2. Breakdown of Underlying Assets by Type
FY2000 (Apr 2000 - Mar 2001) FY2001 (Apr 2001 - Mar 2002) Commercial
Other Real Estate
Other Shopping (incl non-
2.3%
11.0% Lease Credits performing
Payments CBO/CLO 5.6% debts)
CBO/CLO 25.6% 8.2% 21.4%
5.4%
Shopping
Credits Auto Loans
5.8% 8.8%
Auto Loans
14.0%
Lease
Housing Payments
Housing 21.1%
Loans
Loans
Commercial 18.5%
20%
Real Estate
(incl non- Consumer
performing loans (incl
debts) Card Loans)
18% 14.1%
Source: Mizuho Securities
4
May 2002
II. LEASE CREDIT ABS
Rating Upgrade on On 19 February 2002, Moody’s Investors Service upgraded the credit rating
the Resecuritised on Oasis SPC Series 1 by 3 notches from A2 to Aa2. This transaction is a
subordinated portion re-securitisation of the subordinated portion of an auto-loan securitisation
– Oasis SPC originated by Orico. The upgrade came about because of progress in the
redemption of the underlying subordinated beneficiary trust rights of the
Oscar series. The upgrading reflected the increase in the level of credit
enhancement on the outstanding principal of this special purpose bond.
(Note. For similar reasons this issue was upgraded further to Aa1 on April 9,
2002. S&P also announced a 5-notch upgrade of the issue from A to AAA on
April 11, 2002).
In the Oscar series, the preferred beneficiary trust rights have been
completely redeemed and the originator is using a scheme of “clean-up call”
to buy back the underlying debts. Chart 3 shows buy backs that occurred in
relation to Oscar I on 7 January 2002 and Oscar II and III on 1 February
2002. Due to this buy back of underlying debt the underlying asset pool has
been liquidated into cash and the outstanding debt for Oasis has declined.
Consequently, the increase in the subordinated proportion has led to an
upgrade of the credit rating.
Chart 3. Oasis Series 1 – Outstanding debts and ratio of subordinated
portion
400 60%
Total Subordinated Beneficiary Rights
Outstanding underlying bonds at end of month
350 Proportion Subordinated 50%
300
40%
250
200 30%
150
OSCAR I 20%
100 Redemption
OSCAR II, III 10%
50
Redemption
0 0%
Jul'01
Dec'01
Oct'01
Nov'01
Sep'01
May'01
Jan'02
Jun'01
Apr'01
Aug'01
5
May 2002
Table 1. Performance on OSCAR Series (Units: JPY’million)
Series Issue Initial Initial Initial Initial •¨ Accumulated Ratio of
Date outstanding outstanding proportion of Average Bad Debts Accumulated
amount of amount of subordinated life Bad Debts
underlying subordinated beneficiary (years)
debts beneficiary trust rights
trust rights
OSCAR I Mar’98 45,500 6,500 14.28% 1.64 •¨ 1,723 3.78%
OSCAR II Aug’98 47,400 7,400 15.60% 1.67 •¨ 1,590 3.35%
OSCAR III Dec’98 35,600 5,600 15.73% 1.60 •¨ 1,060 2.98%
OSCAR IV May’99 43,500 7,500 17.24% 1.50
OSCAR V Nov‘99 42,900 6,900 16.08% 1.55
OSCAR VI Sep’00 40,000 5,600 14.00% 1.76
However, this upgrading of Oasis suggests the stability of performance of
the underlying auto loans. Table 2 shows the performance on the Oscar
Series, which forms the underlying assets of Oasis. Looking at Oscar I, II
and III series, which have already been redeemed, the final ratio of
accumulated bad debts was about 1/4 to 1/5 of the initial proportion of
subordinated beneficiary trust rights. This clearly demonstrates that the
performance of auto loans is one of the most stable forms of debt out of
those debts targeted at the domestic retail market.
6
May 2002
RMBS•j
III. HOUSING LOANS •i
In the first half of the fiscal year there was only JPY 173.5 billion in new
issuance of RMBS. However, in the second half of the fiscal year, the
combination of 3 private sector MBS and 2 transactions from the
Government Housing Loan Corporation (Series 4 and 5) led to a substantial
rise in issuance to JPY 482.0 billion. Private sector MBS consisted of 2
issues for a total of JPY 202 billion backed by housing loans held by Asahi
Bank and an issue backed by Meiji Life for about JPY 180 billion 2. For the
year as a whole, issuance of MBS was up 40% on the previous year.
Change in the credit Outlines of 2 issues originated by Asahi Bank are provided in the following.
rating of Asahi Bank’s
securitisation of
housing loans Table 2. Outline of issuance details for Abode 2
Class Issue Amount Interest Rate Credit Rating
(JPY’billion) (Moody’s)
A1 100.0 n/a Aaa
A2 20.0 n/a Aaa
A3 20.0 n/a Aaa
B 7.5 n/a A2
C 5.6 n/a Baa13
Total 153.1 - -
Beneficiary trust rights backed by 9,517 housing loans owned by Asahi
Bank. The loans total JPY 157.1 billion. The loan pool consists of 68.3%
housing loans, 22.8% loans for condominiums and 8.9% other loans.
Table 3. Outline of issuance details for Abode Beta
Class Issue Amount Interest Rate Credit Rating
(JPY’billion) (Moody’s)
A1 33.0 1mL+45 Aaa
A2 5.6 1mL+55 Aaa
A3 6.0 1mL+74 Aaa
B 2.5 1mL+98 A2
C 1.8 1mL+145 Baa3
Total 48.9 - -
Unsecured corporate bond backed by 3,030 housing loans owned by Asahi
Bank. The loans total JPY 50.1 billion. The loan pool consists of 70.3%
housing loans, 21.6% loans for condominiums and 8.1% other loans.
2
Extracted from a report in the Nikkei Shimbun on 28 March 2002
3
Subsequently, downgraded to Baa3 in February 2002
7
May 2002
Moody’s, which rated these the Abode series MBS, changed the rating of
tranches of these issues twice in the final 6 months of FY2001.
First, on 5 December 2001, Moody’s upgraded the rating of Abode Series I
Class C (issued in February 2001) from Baa2 to Baa1. When initially issued,
the bond was not considered to have sufficient enhancement level to
address commingling losses and set-off risks. Hence the rating was capped
by Asahi Bank’s senior unsecured debt rating (Baa2 at the time). A review of
the performance of the underlying loans, the potential commingling losses
and set-off risks led Moody’s to the conclusion the issue should be
equivalent to the long-term deposit rating of Asahi Bank (Baa1 at the time).
Hence, the change in rating from Baa2 to Baa1.
Next, on 6 February 2002, this same tranche (Abode Series 1 Class C) and
Abode Series 2 Class C (issued in December 2001) were both downgraded
from Baa1 to Baa3. This was because of a downgrading of the long-term
deposit rating of the seller, Asahi Bank, from Baa1 to Baa3.
Housing Loan Corp The Government Housing Loan Corporation is a leader in the Japanese
MBS MBS market. The issuance plans for FY2002 are 3 times the previous year’s
issuance at JPY 600 billion. The plan is to have annual issuance of JPY 1
trillion by FY2005. The issuance schedule for FY2002 has already been
announced with 5 separate issues (3 in the first half of the fiscal year for
JPY 100 billion each and 2 in the second half for JPY 150 billion each). In
addition, the Government Housing Loan Corporation is to change to a
book-building method to create a smooth absorption of the bonds into the
market.
Table 4. Issuance Schedule for Government Housing Loan Corporation
MBS
Period Series Issue Amount (JPY’ billion)
Jun 2002 6 100
Aug 2002 7 100
Oct 2002 8 100
Dec 2002 9 150
Feb 2003 10 150
While there is some uncertainty about reforms for the structure of the
Government Housing Loan Corporation, S&P and R&I, which both assign
ratings to the MBS issues of the Corporation, continue to rate the MBS
“AAA” while acknowledging the risk of a change in the legal status of the
Corporation.
8
May 2002
Housing Loan Corp More than one year has passed since the Housing Loan Corporation MBS
MBS – Ratio of early first came to the market. The ratio of early redemptions in the first year for
redemptions is higher Series 1 has already been announced. However, comparing the actual
than expected results with our initial forecasts, our forecast of 1.52% was exceeded by
75% with actual early redemptions in the first year accounting for 2.65%. In
addition, in recent years there has been a trend for an increase in the ratio
of early redemptions in the short period (about the first year) from issuance.
This phenomenon can be attributed to (1) the absolute low levels of interest
rates means it is difficult to expect conversion of loans into low long term
fixed rate borrowings; changes in the employment environment are fostering
the application of surplus funds into early repayments; and (2) private
financial institutions are taking strategic measures in relation to housing
loans to utilise short and medium term interest rates. Switching of loans in
such circumstance results in an increase in the early repayment of entire
loans.
9
May 2002
IV. COMMERCIAL REAL ESTATE SECURITISATON
Mycal CMBS The trustee for Mycal, which collapsed in September 2001, has said the
rents on Mycal Shopping Centers, which have been securitised in a CMBS,
are under consideration as being treated as collateral for rehabilitation and
not public debt. The public debt has nothing to do with rehabilitation
procedures and the value of the store use comes from the rents paid in
accordance with the rental agreements. Should this be treated as collateral
for rehabilitation, under the civil rehabilitation law this would cause the rent
to be cut. Below, we highlight the implications this argument will have to this
transaction and for the ABS market.
(1) If deemed to be collateral for rehabilitation and for example should rents
be cut, there would be a decline in the cash flows during the term of the
issue, which equate to interest payments on the CMBS.
(2) If deemed to be collateral for rehabilitation, sale of the real estate will not
be possible.
(3) It will be necessary to reconsider the meaning of a true sale in the case
of a sale and lease back transaction.
At present, the issue is whether or not Mycal’s bankruptcy trustee Hideo
Seto can treat the issues as collateral for rehabilitation (currently under
consideration). There has been no specific justification of such position to
date. Opinions from other legal experts are predominantly that “the
ownership rights have effectively been transferred (i.e. a true sale) and so it
will be impossible to treat the property as collateral for rehabilitation.”
Assessment by Credit On 8 April 2002, Moody’s downgraded the credit ratings on 2 CMBS issues.
Rating Agencies The reason for the downgrade was not based on any legal argument but
due to a revaluation of property values.
Table 5. Details of credit downgrades by Moody’s
Issue Downgrade Extent of fall Change in level of credit
enhancement
LTV (%) DSCR (times)
NSCFA Aa1 •¨ Aa3 2 notches 40.6 •¨ 48.9 2.61 •¨ 2.13
MSC 1 Aaa •¨ Aa1 1 notch 38.0 •¨ 41.2 2.81 •¨ 2.57
MSC 2 Baa2 •¨ Ba2 3 notches 64.0 •¨ 69.3 1.66 •¨ 1.51
10
May 2002
Table 6. Comments from the Credit Rating Agencies concerning the
true sale nature of Mycal CMBS
Credit Rating Agency Details
Moody’s (Rating We are in receipt of a number of legal opinions that state the rental
Downgrade on 8 April payment obligations on this transaction are the same as a finance lease
2002) and hence it would be difficult for them to be treated as collateral to support
the Mycal rehabilitation. That is how we see the matter. In addition, since
Mycal has neither right nor obligation of buy-back, the transfer of real
estate is treated as transfer of collateral. Therefore, it would be difficult to
treat this as collateral for the rehabilitation. (Translated from the Japanese)
Fitch We do not believe the comments from the trustee for the Mycal
reorganization will have an impact on other general sale & lease back
(Press release on 8 March
transactions. Usually, when assigning a credit rating, a review is made to
2002)
ensure the conditions for transfer of the property and the subsequent lease
agreement are appropriate for a true sale. At present, because each
individual transaction has very unique characteristics there are no common
standards for assessing whether all transactions are clearly true sales.
Ultimately a rating from Fitch is based on confirmation from the legal
representatives for each transaction that there is a true sale. This method
of analysis is not likely to have a direct impact on specific transactions in
future. (Translated from the Japanese)
Limited Impact on the On this occasion, a problem has emerged about the characteristics of
market as a whole shopping centres in Japan. Shopping centres in Japan are not built by
developers with enticements to a number of powerful tenants to generate
cash flow on a sales based floating rental system. (Such a system often
involves a switching of tenants when there is poor sales performance.) In
Japan, retailers themselves become the developer to construct the shopping
centres and then take the role of the anchor tenant. While there is said to be
isolation from bankruptcy in both legal and accounting terms, there remains
room to continue taking part in the scheme as the motive force to generate
cash flow. In order to eliminate such risk, there are triggers to remove
tenants etc but there is a large impact on the success or failure when there
is no dispersion of tenants. In Mycal’s case, this type of retail industry
corporate structure was in place but it is an example of how the risks were
realized. Therefore, as pointed out by Fitch Ratings (Refer Table 6), it is not
believed to have a direct impact on other transactions.
Nevertheless, in the current debate about Mycal’s CMBS, the background
material is not limited to just Mycal. When Japan Leasing collapsed in 1998,
the servicer risk of a lease payment backed ABS originated by Japan
Leasing became an issue and there was a period when the market stopped
just like the present situation. Ultimately, it was decided that Japan Leasing,
in its reorganized form, would continue to be the servicer. This provides an
example of a functioning ABS scheme and a turning point for the
subsequent expansion of the market.
11
May 2002
Debate about America’s 2nd largest steel company, LTV Steel Corporation, which filed for
bankruptcy Chapter 11 bankruptcy in December 2000, has securitised its inventories
separation in the US – and credit sales through two special purpose companies4. LTV declared that
LTV Steel Company the transfers to these two SPCs were not true sales and the courts issued a
preliminary finding that the accounts receivables and inventories could be
used as cash collateral and this raised the debate about the nature of a true
sale. Ultimately in March, LTV received Debtor-in-possession (DIP) facilities
from financial institutions and the true sale nature was not denounced.
In criticizing the true sale nature, the trustee of the bankrupt originator made
reference to the history of the major problem caused by the “trustees attack”
of 1976 in the Hamilton Mortgage case. The LTV problem seems quite
strange given the refinement of the legal arguments for bankruptcy isolation,
particularly since it relates to the US, which has a highly developed
securitisation market. Nevertheless, the lessons suggested by this case
study is that there is no clear warning that there are further cases in the US
of similar securitisation risk Rather the focus is on the extent to which the
profit of related parties can be kept by market participants.
When it was shown the LTV problem would spread, 23 groups representing
market participants such as investors and arrangers produced a
memorandum to oppose LTV. Rather than focusing on the specific nature of
the LTV transactions, market participants presented the case that in the long
history of the ABS markets bankruptcy isolation has been approved under
federal bankruptcy laws which has created what is now a US$ 6 trillion ABS
market (the argument also included the importance of the sector to the
region) and stressed the profit that the segment had provided to the US
economy. In cases of corporate bankruptcy to date, ABS schemes have
been well respected. The frontal attack from LTV left the financial markets
with no alternative but to take annihilative counter measures. Therefore,
there was alarm in relation to the decision favouring LTV and this was an
argument that had negative implications for the ABS market. Further, the 23
groups were brought together by law firm Mayer, Brown & Platt (now known
as Mayer, Brown, Rowe & Maw, considered to be the World’s 10th largest
law firm) which for reference operates securitisation.net.
The Japanese ABS market has also faced the challenge of the Mycal
problem. Although the ABS market has only a brief history, the methods of
securitisation already exceed the framework of simply fund raising. It is an
indispensable tool for the revitalisation of the Japanese economy and is
encumbered with high expectations. Concerning the first trustees attack in
Japan this is not only a problem for the rehabilitation of Mycal but an issue
that will impact on the rehabilitation of the entire Japanese economy.
Securitisation of In FY2001, there were two transactions for securitisation of department
shops following the stores. Global Retail from Seibu Department Stores (JPY 31.7 billion) and
collapse of Mycal East Realty from Tobu Department Stores (JPY 83.9 billion). East Realty
h
was put together following the collapse of Mycal and t e focus of those
4
12
May 2002
involved was the extent to which it was possible to separate the relationship
between the property and the originator (i.e. tenant).
As pointed out in the our semi-annual review of the ABS market in October
2001, there are 3 methods of valuing retail shops:
(1) “As is Value”, for the case properties continue to managed by the
Originator
(2) “Dark Value”, for the case properties are managed by an operator other
than the Originator
(3) “Salvage Value”, for the case the properties can no longer be managed
as shops
In each of the three cases the value of each property is calculated and the
overall value is the combined total of the expected price of each value. The
loan to value for the corporate bond is determined based on this figure and
a credit rating assigned. Consequently, the credit rating of the originator and
the existence of the originator can cause fluctuation in the credit rating of the
asset backed security 5 . In this regard, the product under review was
designed with the main aim of “regardless of the rating of the originator or its
survival, in essence the valuation of the properties is based on the strength
of the underlying securitised properties to generate cash flow.”
The specific method of assessment involves an assessment of the value of
the properties with reference to the business income of Tobu Department
Stores. Then using other approaches to take a critical assessment of the
valuation of the underlying properties we consider whether such value could
be maintained if there were an operator other than Tobu Department Stores.
Ratings are determined based on such valuation. Moody’s, S&P and Fitch,
which rated the transactions, have all confirmed that a collapse of the
originator or its departure would not have an impact on the value of the
properties or the credit rating (provided in pre-sale reports).
In addition, this transaction does not involve a master lease with the
non-listed Tobu Department Stores, a wholly-owned subsidiary of Tobu
Railway Co. rather there is a master lease with listed Tobu Railway Co.
(then a sub-lease from Tobu Railway to Tobu Department Stores).
Consequently, in principle, the payment of rents to the SPC will be the
responsibility of Tobu Railway. At the same time, the contract is in the form
of a 20 year lease on the building with a no right to break clause for the first
12 years (and a similar sub-lease contract). This reduces the improbabilities
at the time of refinancing.
Largest CMBS - KDDI 4 buildings owned by KDDI (including its head office building) have been
securitised. The issue amount was JPY 135.7 billion, making it the largest
domestic CMBS to date. (Central Tower Estate Co., Ltd.)
5
If there is a change in the probability of existence of the originator, the value of the
property as calculated above will change.
13
May 2002
The underlying properties were four office buildings located in Otemachi,
Shinjuku, Osaka and Nagoya owned by KDDI. Relative to other real estate
securitisation transactions in the domestic market this is a prime portfolio.
(The property in Shinjuku is the head office building of KDDI). A feature of
this transaction is not simply that it securitises a head office and office
buildings but that the buildings in Shinjuku and Otemachi are considered to
be “Internet Data Centres” (iDC). As buildings owned by a communications
company the underlying properties enjoy the special features of combining a
durable structure with comprehensive facilities and are also assessed as
iDC. There is large potential for an expansion of Internet businesses such
as Internet banking and electronic trading. Demand for iDC buildings in
prime locations and with good facilities is likely to be high for the medium to
long term.
Table 7. Outline of the issuance of Central Tower Estate
Series Amount (JPY’billion) Credit Rating (Mdy/S&P) LTV (%) DSCR (times)
Mdy S&P Mdy S&P
A 72.5 Aaa/AAA 36.8 34.9 2.09 2.21
B 16.0 Aa2/AA 45.0 42.6 1.79 1.89
C 15.7 A2/A 53.0 50.1 1.57 1.66
D 16.7 Baa2/BBB 61.4 58.2 1.39 1.46
E 14.8 Ba1/BB+ 69.0 65.3 1.26 1.33
KDDI Otemachi Building KDDI Shinjuku Building and vicinity
Metropolitan Mitsui Center
Govt. Offices Building Building
Sumitomo
Building Keio Plaza Yasuda
No. 1
Seimei
KDDI
NS Building
No. 2
Shinjuku
Monolith
Washington
Hotel
14
May 2002
(1) Rent levels are iDC rents are at about JPY 50,000 to 80,000 per tsubo (1 tsubo is
high approximately 3.3 square metres) per month. This level is high compared
with general office space that runs at about JPY 30,000 to 40,000 per tsubo
per month. At present, since there are very few buildings that would meet
the basic specifications of an iDC, even lower grade leased specialist
computer buildings when used as iDC buildings can attract higher rents than
general office buildings in the same area.
(2) Strong demand Currently, amongst iDC there are many being used as specialist computer
from tenants buildings. The supply of specialist computer buildings dropped significantly
in the mid 1990s due to the impact of the bursting of the bubble and
reduction in weight and size of OA equipment. There remains a lack of
supply at present. Therefore, buildings that can be used as iDC continue to
have virtually no vacancies.
(3) Profits are stable iDC buildings find it relatively easy to attract long-term tenants and those
tenants that have difficulty in moving out. In the case of general office
buildings, lease agreements are about 2 years whereas for iDC there are
many cases of lease agreements being for longer than 4 years. This can be
attributed to:
(i) Very large initial set-up costs. Since the facilities are expensive this
makes it difficult to move out;
(ii) Once operations commence it is impossible to stop the systems; and
(iii) To change buildings, it is necessary for a similar system to be
constructed and operational in the new building. This causes users to
duplicate their investment.
CMBS originated by Japanese banks have brought out securitisations of real estate
Banks non-recourse loans. These are TMCMBS-I from the Bank of
Tokyo-Mitsubishi and Reinforce Capital Limited from Sumitomo Mitsui Bank.
Until this transaction, real estate ABS originated by banks were only
transactions for securitisation of branch offices. This was the first transaction
involving securitisation of non-recourse loans.
In particular, in the case of Reinforce Capital Limited, the underlying
non-recourse loans are not sold and a special feature is the creation of a
synthetic type structure using guarantees. This was the first example of a
synthetic CMBS in the domestic market.
15
May 2002
Table 8. Outline of TMCMBS – I
Issue Amount Credit Rating Scheduled Final redemption
(JPY’billion) (Moody’s) redemption date date
A 16.5 Aaa Jan 2007 Feb 2009
B 2.7 Aa2 Jan 2007 Feb 2009
C 2.7 A2 Jan 2007 Feb 2009
D 3.3 Baa2 Jan 2007 Feb 2009
E 0.6 Ba1 Jan 2007 Feb 2009
Table 9. Outline of Reinforce Capital Limited
Issue Amount Credit Rating Scheduled Final redemption
(JPY’billion) (Moody’s) redemption date date
A 22.7 Aaa May 2006 Oct 2009
B 5.5 Aa2 May 2006 Oct 2009
C 4.0 A2 May 2006 Oct 2009
D 2.8 Baa2 May 2006 Oct 2009
E 5.0 Ba2 May 2006 Oct 2009
16
May 2002
CLO
V. CBO•^
There was a low level of issuance of domestic CDOs in the first half of the
fiscal year, but the market grew dramatically in the second half. This was
due to the issuance of Shinsei Bank’s Master Trust Type CDO, very large
synthetic CDOs (BNP) based on domestic credits and the arrival of UFJ’s
medium-sized business CDO etc. We look at each of these issues below.
Shinsei Funding In order to generate stable fund raising, Shinsei Bank as started to securitise
almost 1/3 or about JPY 1,400 billion of its finance receivables (i.e. loans).
This is a master trust type CDO backed by loans to corporates and regional
public entities that have been originated or acquired by Shinsei Bank. The
following table shows the two series which have been issued consisting of
Shinsei Funding One (JPY 100 billion) in December 2001 followed by
Shinsei Funding Two (JPY 60 billion) in March 2002.
Table 10. Outline of Shinsei Funding
Issuer Series Issue Maturity Credit
Amount Date Rating
(JPY’billion) (S&P)
Shinsei Series 2001-1 Class A 60 Oct 2003 AAA
Funding 1
Series 2001-2 Class A 40 Oct 2006 AAA
SPC
(Dec’01)
Shinsei Series 2002-1 Class A 30 Jan 2005 AAA
Funding 2
Series 2002-2 Class A 30 Jan 2007 AAA
SPC
(Mar’02)
According to S&P’s pre-sale report, the rating assessment has been based
on a mapping of Shinsei Bank’s credit evaluation system and S&P’s rating
scale. In relation to monitoring, there will be ongoing inspections and
updates of internal credit ratings that reflect the most recent credit strengths.
Further, reviews of internal credit ratings will occur at least once a year and
coincide with the following:
(1) Careful scrutiny of the correlation between Shinsei Bank’s internal credit
rating and S&P’s credit score; and
(2) Scoring by Shinsei Bank using the S&P Credit Model.
To date, CLOs originated by Japanese banks were basically driven by the
desire for balance sheet contraction. However, this transaction is being
driven by the desire to raise funds smoothly and at low interest rates and
clearly indicates a different phase. In addition, there is a limit to the number
of issues that can be made as a measure for addressing the balance sheet.
17
May 2002
This transaction is expected to be repeated for a certain amount on an
ongoing basis and hence have a large impact on the market.
Synthetic CDO – A large synthetic CDO (SCDO) was put together using credit default swaps
Serena Finance on domestic corporations. To date, there have been many SCDOs backed
by US credits brought to the domestic market but virtually no large-scale
transactions backed by domestic credits. In FY2001, there were two
transactions (Serena Finance) for a total of JPY 90 billion and JPY 182
billion respectively, arranged by the Tokyo Branch of BNP Paribas. JPY 9
t
billion of each transaction was sold to investors in he market (Tranches
were rated AAA to A+) and the balance was separated into super senior and
subordinated portions. The underlying pool consisted of 90 companies (91
companies for the 2nd issue) covering 24 to 26 industry sectors. The
average credit rating on the overall portfolio was relatively high.
A special feature of this transaction is, by the fact that it was the first large
scale synthetic CDO to be backed by domestic credits, the large number of
companies in the portfolio. Until only a year ago, there were usually no more
than 20 to 30 domestic names quoted in the credit derivatives market. This
number has recently risen to about 100 companies and hence the ability to
launch a domestic synthetic CDO.
UFJ Medium sized A primary CBO was formed through the selection of 384 transactions with
firm Primary CBO medium sized business clients of the national branch network of UFJ. Triple
One Funding Ltd Yen Notes No. 1 (2 year notes) had an issue amount of
JPY 49.2 billion6. The issue is backed by zero coupon domestic private
placements issued by 384 medium sized companies (JPY 0.1 to 0.2 billion
per company, with a total face value of JPY51.2 billion) as part of their fund
raising. The difference between the issue amount on the CBO and the
amount of the underlying asset pool is put into reserves, which is sufficient
to pay the interest payments and expenses during the life of the CBO issue.
For credit enhancement purposes, UFJ provides a subordinated loan of JPY
2 billion and the underlying private placement bonds have been appended
with two covenants. A private placement bond will be redeemed prior to
maturity
(1) If the issuing corporation incurs an ordinary loss; or
(2) If the shareholders’ equity of the issuing corporation falls below 75% in
the financial period immediately prior to an interest payment date.
These covenants are checked once a year by the Bond Trustee, UFJ Bank.
Since UFJ Bank is also providing the subordinated loan it has a high
incentive to monitor the underlying assets.
6
Details of this issue were released by R&I on 13 March 2002
http://www.r-i.co.jp/eng/release/200203/e02-c-137.pdf
18
May 2002
Chart 4. Breakdown of industry types in the underlying asset pool
Transport & Agriculture,
Real Estate
Communications Fishery &
3.1%
2.9% Forestry
0.2%
Construction
4.7%
Retail
9.0%
Manufacturing
41.0%
Service Sector
12.1%
Wholesaling
26.9%
Unlike the large volume of primary CBOs, which were arranged in 1999 to
2000, this issue provides expected benefits of diversification in the
underlying pool of assets. Similar types of CBOs in the past have
concentrated on listed companies and so many had diversification through
10 to 20 companies. Naturally, with such a level of diversification, the
method of evaluation shifts from one of looking at the individual risks of
specific assets to one of a quantitative actuarial type approach7. An issue
therefore arises with the disclosure of the originators credit system. In this
transaction, the credit evaluation is based on the statistical data for ratio of
overdue debt and ratio of bad debts under UFJ Banks internal credit rating
system. In the past, there has not been much active due diligence in
matching the internal credit rating standards by financial institutions with
those of the credit rating agencies. This transaction goes to show that this
barrier for financial institutions is being overcome. The environment is being
created to facilitate participation by non-listed medium and small sized
companies in this type of market type indirect financing programme.
Valuation of CDO’s The performance of CDOs in the period from 1996 to 2002 as compiled by
performance – Moody’s shows that there has been a difference in the rating changes based
Moody’s on type.
The types of assets that have shown good performance as indicated by the
change in credit ratings from Moody’s are (1) Balance Sheet Cash flow
CLO; and (2) Arbitrage Cash Flow CLO. On the other hand, types of assets
7
Unlike the case of cash obligations for lease credit obligations, one does n ot consider
the risk of commingling and so the credit enhancement level is low (subordinated ratio of
3.9%)
19
May 2002
which have shown bad performance are (1) Arbitrage/ Cash Flow CBO; and
(2) US$ Synthetic Balance Sheet CDO.
Table 11. Performance by CDO Category
Good Performance Bad Performance
Balance Sheet Cash Flow CLO Arbitrage Cash Flow CBO
(US$ and non-US$) (Backed by high-yield bonds)
Only one of the 88 For several of the credit rating
US$ denominated Balance Sheet levels, this type of CBO sustained
Cash Flow notes outstanding in the the highest downgrade rates. For 3
beginning of the year was of the 10 investment-grade
downgraded – it went from Ba2 to categories, these deals showed the
B2 during the year. highest downgrade rates.
The non-US$ Balance Sheet Cash The severity of the downgrades
Flow deals fared even better. None also appears to be the most
of the 43 notes were downgraded pronounced for this category. For
while 7 were upgraded as a result example, of the 71 Ba ratings
of improved portfolio performance. outstanding on 1 January 2001, 7
were downgraded to Caa to C
during the course of the year, Of
the 35 B ratings, 18 were
downgraded – 10 of these
downgrades were to Caa3 and
lower ratings.
Arbitrage Cash Flow CLO US$ Synthetic Balance Sheet CDO
Only 10 of the 266 ratings in this 2 of the 20 US$ denominated
category were downgraded during Synthetic Balance Sheet CDO with
2001. Furthermore, the severity of Aaa ratings outstanding at the
the rating actions was not beginning of 2001 were
significant. The most severe downgraded during the year – the
downgrade in the investment-grade highest downgrade rate for Aaa
scale was 1 three-notch change. ratings amongst CDO categories.
The other 4 investment-grade
rating actions were single or double
notch changes.
Source: “Credit Migration of CDO Notes, 1996-2001”, Moody’s (27 Feb 2002). Note. The
report only refers to issues outstanding at the beginning of 2001
CLO has highest The study of movement in credit ratings undertaken by Moody’s evaluates
performance all types of categories. Of particular note is the difference in performance
between CLO and CBOs. There is a stronger trend for a downgrading of
CBOs than there was for CLOs when considering the full year of 2001. As
seen in the following table, the difference was 2 to 3 times in the investment
grade class.
20
May 2002
Table 12. Comparison of the risk of a rating downgrade on CBO versus
CLOS (annual average for 1996 to 2001)
Credit Rating Ratio of downgrades Greatest level of downgrade
ACF-CBO ACF-CLO ACF-CBO ACF-CLO
Aaa 0.7% 0% Aa2 Aaa
Aa2 10.25% 3.33% Baa2 Aa3
Baa2 6.63% 3.13% B1 Ba2
Baa3 15.7% 4.65% Caa1 Ba3
Ba3 6.48% 7.68% Ca/C Ca/C
Source: “Credit Migration of CDO Notes, 1996-2001”, Moody’s (27 Feb 2002). Note.
ACF means Arbitrage Cash Flow Type
We consider 3 reasons why the performance of CLO is relatively good as
follows:
(1) Impact on trading Recent credit downgrades of CBOs are predominantly in relation to
price transactions that were formulated in 1997 and 1998. Currently, there is also
pressure on those transactions issued in 1999. At the time, the US high yield
markets had historically tight spread levels and there was a sense of the
market being overvalued. Therefore, the cost of putting together CBOs at
the time was high and the excess spread can be considered as being tight.
On the other hand, CLOs are not tight when considered under such
standards and the cushion has played a role when the market environment
has deteriorated.
(2) Pre-payment Generally, a leverage loan has a faster prepayment than a high yield bond. It
is beneficial to reinvest the cash generated from prepayment when there is
a widening of spreads or redeem the CLO.
(3) High recovery rate A difference in the underlying loans and bonds is the rate of recovery.
on loans According to a survey by Fitch, while the recovery rate on loans is 73% on
unsecured bonds it is 35% (the period of the survey was 1997 to 2000 and
the recovery ratio was based on secondary market prices). The recovery
rate is clearly high for loans. This can be attributed to the Absolute Priority
Rule and the existence or otherwise of covenants. The difference in
recovery rates has a direct bearing on the trading price in a distressed
market following default and hence the difference in the recovery rate of the
pool and the loss ratio.
Comparison with Next, we undertake a comparison of CDO with Corporate Bonds. The
corporate bonds following table shows a comparison of the ratio of rating downgrades
between a number of CDO types and corporate bonds over the year of 2001.
The table shows the most stability in the ACF-CLO. Conversely, we can see
21
May 2002
that there was a large rating downgrade for ACF-CBO and synthetic
BS-CDO. In particular, the latter two show inferior performance to that of
corporate bonds with the same credit rating. In general, CDOs have a
diversified portfolio of underlying assets and there is stability in credit
changes. The reason this survey shows a different result is because of the
small number of transactions and the large impact from the change in rating
on 1 transaction. The average movement in credit ratings over the 5 years
from 1996 to 2000 was announced last year. This shows a comparison of all
CDOs and corporate bonds and demonstrates the stability of corporate
bonds. Since the statistics differ it is not possible to make general
comparisons but we believe the turmoil of the high yield market in 2001 had
a significant impact on the timing of a large number of credit downgrades.
Table 13. Comparison of the risk of a ratings downgrade on CDO
versus Corporate Bonds (Ratio of downgrades in 2001)
Credit ACF-CBO ACF-CLO S-BS S-BS Corporate
Rating (Non-US$) Bonds
(US$)
Aaa 1.7% 0.0% 10.0% 0.0% 1.01%
Aa2 25.6% 8.0% 0.0% 7.7% 16.3%
Baa2 12.7% 2.8% 33.3% 11.1% 14.8%
Baa3 34.8% 7.7% NM NM 10.8%
Ba2 12.1% 15.4% 50% 30.0% 23.4%
Ba3 14.7% 9.1% NM NM 18.2%
Source: “Credit Migration of CDO Notes, 1996-2001”, Moody’s (27 Feb 2002). Note.
ACF means Arbitrage Cash Flow Type; S-BS means Synthetic Balance Sheet
Table 14. Comparison of the risk of a ratings downgrade on CDO
versus Corporate Bonds (Actual probability from 1996 to 2000)
Credit Rating Corporate Bonds CDO
Aaa 92.1% 100.0%
Aa2 84.0% 93.3%
A2 81.7% 95.7%
Baa2 75.1% 98.8%
Ba2 63.8% 85.5%
Source: “Credit Migration of CDO Notes, 1996-2000”, Moody’s (27 Apr 2001).
22
May 2002
VI. REVIEW OF FY2001 / OUTLOOK FOR FY2002
Change in Credit In the domestic ABS market during FY2001 there were many ABS issues
Rating that incurred changes to their credit ratings because of changes in the
quality of their underlying assets. The following table lists those issues that
incurred credit rating changes during the year.
Table 15. List of ABS that had credit rating changes in FY2001
Date of Issue Type Series Rating Change Agency Reason
Change
21 Sep 01 J-CMBS-1 CMBS C Upgrade A •¨ A+ Fitch Improved cash
Limited D BBB•¨BBB+ flow
28 Sep 01 Ensemble CBO Senior Downgrade AAA•¨ AA+ R&I Default of
IV Senior M A •¨ BBB Mycal bonds
Mezzanine BBB •¨ BB
Junior M BBB- •¨ BB-
28 Sep 01 Symphonie CBO A Maintained AAA •¨ AAA R&I Default of
Limited B Downgrade AAA •¨ AA+ Mycal bonds
C A •¨ BBB-
27 Nov 01 EDAM Real Downgrade AA+ •¨ AA Fitch Downgrade of
Securities Estate, rating on JGBs
Three JGB
Limited Collateral
Series
99-01
5 Dec 01 Abode RMBS C Upgrade Baa2•¨Baa1 Moody’s Performance of
underlying
assets, level of
commingling
risk
6 Feb 02 Abode RMBS C Downgrade Baa1•¨Baa3 Moody’s Downgrading of
Abode 2 RMBS C Baa1•¨Baa3 Asahi Bank’s
long term
deposit rating
19 Feb 02 Oasis SPC ABS Upgrade A2 •¨ Aa2 Moody’s Progress in
redemption of
underlying
subordinated
beneficiary
rights
25 Mar 02 All Aboard CBO Senior Maintained AAA •¨ AAA R&I Deterioration in
Funding II Senior M Downgrade A •¨ BBB the credit
Junior M BBB •¨ BB strength of the
underlying
asset pool
23
May 2002
Period of The domestic securitisation market in grew rapidly in FY2001. However, it
consolidation for the was a year when concerns emerged about the low level of liquidity and
ABS Market market capacity. With this in mind, the pursuit of volumes was
overshadowed by the insufficiencies in the market infrastructure. Many
market participants are concerned about the implications from an impending
crisis which could arise should the market continue to expand at its current
pace. Such concerns come from various perspectives: Will market
efficiencies take over? Will originators be able to continue to come to the
market on a steady basis? Will the market accrue such status as would give
investors confidence to invest?
Considering the market infrastructure of the securitisation market,
benchmarking of each type of underlying asset and disclosure of
performance data has continued since the mid 1990s. There is also the
fulfillment of research and market making functions. The depth of the US
ABS Market is said to be its liquidity rather than its size. Behind this high
level of liquidity are an assumed disclosure and the fact that the lead
manager of the issue always takes a position and is an active market maker.
Securities companies also contribute through the provision of objective
research papers. However, now we need to consider the situation in Japan.
There were phenomena in FY2001 that appeared to go against the trend for
improved liquidity.
(1) Reduction in Firstly, there are concerns about a reduction in the issuance of public offered
domestic public bonds. The proportion of public offered bonds (combined total of domestic
offerings and euro) accounted for about 30% of the market, as was the case in the
previous year. The chart shows that while public offered domestic bonds
accounted for about JPY 600 billion of the domestic issuance in 1999 it was
reduced by half in FY2001. We can see the declining trend in the volume of
ABS for which details are disclosed and, by implication, the volume that
meets the JSDA over-the-counter standards. This is counter to the
expansion of the market as a whole.
Chart 5. Movement in the issuance amount of public offered ABS*
JPY'billion JPY'billion
Domestic Euro
(equivalent)
700 800
600 700
600
500
500
400
400
300
300
200
200
100 100
0 0
1994 1995 1996 1997 1998 1999 2000 2001 1994 1995 1996 1997 1998 1999 2000 2001
24
Fixed income Research
May 2002
(2) Underlying In addition, this does not just mean an increase in private placement issues.
increase in issues This indicates there is an increase in issues that have confidential pre-sale
reports and credit rating releases. While there are certainly reasons, should
there be no disclosure despite the assignment of a credit rating it raises
questions on whether one should participate in the market. There is no lack
of complaints from those who are concerned about the Japanese ABS
market becoming a concealed market.
Need to reconsider Securitisation is not an “exit strategy” as part of a corporate’s financial
the underlying market strategy but an avenue to open up to market participants. If we disregard
frequent issuers, for those originators looking to securitisation as a way of
restructuring, funds will be raised at the time of closing. However, the real
market valuation will start from that point in time. With disclosure to only a
limited number of investors, the Japanese ABS market will never be able to
break out of a limited market. By making announcement to the wider market,
market participants will share in the access to the information and this will
gradually result in the emergence of investors and investor opportunities.
This will in turn result in expansion and improved efficiencies in the market.
In FY2002, we expect a continuation of the growth trend. In particular, there
is room for development of the CDO sector with total loan outstandings of
JPY 450 trillion (domestic banks) This has a large potential to boost the
market. While the market expanded greatly in FY2001, the taste of exposure
to market weakness suggests there is a need to reconsider the extent of
underlying support for further expansion of the market
Based on a special report in Japanese prepared by
Yasunobu KATSUKI, Senior Credit Analyst, Fixed Income Research Dept.
Kenji TOUKAKU, Senior Credit Analyst, Fixed Income Research Dept
Mizuho Securities Co., Ltd.
Tel. (81-3) 5208 2324 Fax. (81-3) 3516 7242
yasunobu.katsuki@mizuho-sc.com
kenji.toukaku@mizuho-sc.com
Mizuho Securities Co., Ltd.
Fixed Income Research Department
Otemachi First Square 1-5-1, Otemachi, Chiyoda -ku Tokyo 100-0004
Tel. (81-3) 5208-3649 Fax. (81-3) 3516-7242
This report is intended only for the professional and business clients to whom it is distributed from the Mizuho Securities Co., Ltd. This report has been prepared for information purposes only
and is not an offer to buy or sell, nor is it a solicitation of an offer to buy or sell any securities mentioned herein. The information contained in this publication is derived from what we believe are
reliable and accurate sources, but we do not guarantee its accuracy or completeness. The opinions reflected herein may change without notice. Neither the author, Mizuho Securities Co., Ltd., nor
any subsidiary or affiliate of the Mizuho Financial Group accepts any liability, whatsoever, with respect to the use of this document or its contents. Neither this document nor its contents, nor any
copy of it, may be altered in any way, transmitted to, or distributed to, any other party.
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