7. Bank Debentures Bonds

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Baldwin Jackson
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1 7. Bank Debentures Bonds 7

2 7.1. Security Type Coupon IBJ Bank Debenture ( Ri-ki in Japanese), Coupon Shochu Bank Debenture ( Ri- Sho ), Coupon Nochu Bank Debenture ( Ritsu-No ), Coupon LTCB Bank Debenture ( Ri- Cho ), Coupon NCB Bank Debenture ( Ri-Shin ), Coupon Zenshinren Bank Debenture ( Ritsu-Ren ), Coupon BoTM Bank Debenture 7.2. Maturity Type 5-year issue 3-year issue 2-year issue Coupon Bank Debentures 1-year issue Discount Bank Debenture 7.3. Tiering Until mid-1992, any issuers names used to be traded as a single category Bank Debentures ( Rikin-sai ). At that time, only its coupon determined a bond yield, not by its issuer s name. In mid-1992, the NCB Bank Debenture was sold off relative to other names. In the following 1 or 2 years, different issues have come to trade with different spreads. At first, the most important factor was the market liquidity, and it sometimes pushed up Ri-ki (IBJ) to richer levels than Ri-Sho (Shochu) or Ritsu-No (Nochu) which have higher ratings than IBJ. However, Yamaichi Shock in 1997 and Russian Crisis in 1998 increased investors awareness of credit risk, and now credit-quality is the most important determinant as can be seen below: Until 1992 After 1992 After 1995 No yield difference IBJ Shochu, BoTM Shochu, Nochu Nochu Zenshinren, BoTM LTCB NCB Zenshinren IBJ LTCB NCB (Sorted by yield in ascending order) 71

3 7.4. History IBJ / JGB Spread History 12 1 IBJ 3y IBJ 5y Shochu / JGB Spread History 8 6 Sho 3y Sho 5y

4 LTCB, NCB / JGB Spread History IBJ 5y NCB 5y LTCB 5y The Bank Debenture market is the second largest domestic bond market next to JGBs. Market-making of Bank Debentures started by New Japan Sec. in Since then, the market volume grew rapidly and the secondary market replaced Medium-term JGBs as a core of medium-term zone or intermediate sector. Until 1988, similar to the current Corporate Bond markets, the Bank Debenture market were not very liquid compared to GGBs and Municipal Bonds. As described before, market participants were indifferent to the issuers name and maturity, purely focusing on the coupon. For example, 4.8% coupon Bank Debenture used to be issued by various issuers for as long as 1 year but traded on a same simple-yield basis. In 199 s, a yield difference began to be seen based on by remaining life, and the difference by issuers name became evident in late 1992 when Ri-shin (NCB) was sold off. By the end of 1993, all names had a different spread, and pricing them became a very complicated task. NCB Shock followed then (as detailed below). Basically, a yield level is differentiated in the order of credit rating. However, its spread pricing is still ambiguous. New issues have significant distortion in terms of pricing. The above graph shows JGB spread histories of Ri-ki (IBJ), Ri-Sho (Shochu), Ri-cho (LTCB) and Ri-Shin (NCB) since 1994 to date. Similar to GGBs, Bank Debentures that were not listed used to be bought for window dressing towards fiscal year-end. Since 5-year Bank Debenture has quite a different coupon compared to its JGB counterpart, it made the negative spread of Bank Debenture versus JGB bigger than that of GGBs. The Bank Debenture s spread used to stay around JGB 1 ~ 15 b.p. towards the end of fiscal year, and once tightened to the narrowest level of JGB 45 b.p. in July ~ August Excluding the fiscal year-end period, the current zone remained stable at JGB + ~ 5 b.p. and noncurrent zone at JGB + 25 ~ 35 b.p. 73

5 [The Impact of the NCB Shock ] Because the Japanese Bond market has long been closed to outsiders, it traded at totally unreasonable prices for a long time until fairly recently. As described before, it can be attributed to expensive pricing in highly competitive underwriting business, investors with poor experience, relationships unique to Japanese businesses, and excessive confidence on rapid economic growth etc. etc. However, the market was struck by a big event in In November 1996, the NCB scandal induced a large sell-off of NCB Bank Debentures, and it sold off to L + 1 b.p. level in the following 5 months with no buying seen. The implications of this event were as follows: (i) this is the first experience for Japanese bond market to be sold off to cheaper level than its overseas counterparts with similar same ratings (ii) domestic investors tendency to follow others blindly created a one-way market without any buyer. This event is called NCB Shock. This event had a significant impact on domestic investors, who started to replace the bonds with poor credit quality of those with higher credit quality. They finally began aware of credit risk. Since then, credit risk as well as other factors, trading more in an economically realistic manner have driven the market. What happened to NCB after then? NCB Bank Debenture that was sold-off to L + 1 b.p. with domestic investors still sidelined, the bonds were eventually bought back by overseas investors. It recovered to L + 3 ~ 4 level, but, in the meantime, domestic investors could not buy until NCB was nationalized, and spreads tightened considerable. 74

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