Norinchukin Bank, the Japanese agricultural lender that has become the world’s largest holder of collateralised-loan obligations, has called time on its buying spree, raising questions over the outlook for this hot class of assets.
Norinchukin, which for nearly 100 years has managed the savings of farmers and fisherman from Hokkaido to Okinawa, reported a drop in its holdings of CLOs for the first time in over a year on Thursday.
The bank, commonly known as Nochu, has piled into these investment vehicles, which package risky corporate loans into safer bonds, more than doubling its holdings in little over a year to Y8tn ($74bn) in June 2019.
This total dropped slightly to Y7.9tn in September, however, and Nochu’s president and chief executive Kazuto Oku said on Thursday that the bank’s CLO holdings had “almost peaked”. Mr Oku cited the thinner income now on offer from these securitised debt vehicles, due to falling interest rates and increased demand from investors.
The bank is one of many across Japan to have piled in to such debt, repelled by years of low and even negative yields on domestic assets such as Japanese government bonds. Such moves have prompted some concern among regulators, even though Nochu and other major Japanese CLO buyers such as Japan Post Bank have invested only in the safest of these securities, which carry coveted triple-A credit ratings.
The Bank of Japan warned last month that the country’s financial system is becoming more susceptible to the effects of stresses abroad, citing data that show domestic lenders now hold about 15 per cent of the global market for CLOs. In a semi-annual report, the bank also argued that even triple-A rated tranches “could fall substantially” in value during a recession.
The US CLO market has seen more than $100bn of new supply in 2019, slightly less than in previous years. In contrast, Europe has seen record annual issuance, with volumes likely to hit €30bn before the end of the year.
Chris Acito, chief executive of Gapstow Capital Partners, said that while Nochu pulling back from the market “wouldn’t be helpful”, other major investors would probably fill the void.
“As important as they are I don’t think they make or break the market,” he said. “The market is not as beholden to one mega buyer as some may think.”
Nochu has been burnt on structured credit investments in the past.
The bank had to raise emergency funds at the peak of the financial crisis, tapping its agricultural, fishery and forestry co-operative members for the equivalent of tens of billions of dollars, after placing big bets on asset-backed securities based on US subprime mortgages.
In a bid to avoid a repeat, Nochu has imposed strict conditions on its CLO investments.
The bank will only invest in CLOs from large institutions that have a long record of managing such vehicles. As a result, fund managers on this so-called “approved list” can often raise funds at lower cost than less experienced peers.
Nochu used to insist that a certain amount of a CLO portfolio had to be invested in loans with covenants, once standard investor protections that have all but disappeared from the leveraged loan market. The Japanese bank has since abandoned this stipulation, according to CLO investors.
Nochu’s desire for loans with covenants meant that bankers struggling to sell a new loan due to poor credit quality would often add in one of these terms. Some investors dubbed these more dubious deals “Nochu-eligible collateral”.