Wednesday, January 28, 2009

Japan’s CDS spreads wider than west

By Lindsay Whipp in the Financial Times:

Japan’s credit default swaps, which have traditionally experienced tighter spreads than their US and European counterparts, are trading wider and do not look to be narrowing soon.

The iTraxx Japan index usually moves in line with the US’s CDX IG and iTraxx Euro Main but, since late last year, it has been consistently trading wider than the US and Europe.

The iTraxx Japan’s closing price on Tuesday was 322 basis points compared with Monday’s close for the CDX IG of 208.5bp and the iTraxx Euro Main’s 165.5bp, according to UBS figures.

Part of the reason is that Japan’s CDS market is not deep or well developed compared with its counterparts.

Unlike in other more developed markets, Japanese banks rarely use CDS for hedging purposes because the spreads are wider than their net interest margins from loans, making them too costly to purchase, according to Fumihito Gotoh, head of credit research for Japan at UBS.

Japan’s corporate bond market is small compared with the US and Europe as companies have often looked to their banks directly for loans rather than tapping capital markets.

Volumes of CDS outstanding on Japan itself and on Japan Tobacco are much smaller than those for J.Sainsbury and also for Halyk Bank of Kazakhstan, according to DTCC trade data warehouse.

This leaves overseas investors such as hedge funds as the main operators in Japan’s CDS market. As many of these have faced redemptions or are repatriating funds, market volume has thinned further and increased volatility.

“Many overseas investors have suffered from the credit crunch and are viewing Japan from the same perspective that they are viewing their home countries, where there are expectations for a sharp rise in defaults,” said Mr Gotoh.

Bankruptcies in Japan are rising and the level of publicly listed companies filing for court protection in November hit the highest since the end of second world war.

But many of these companies have been relatively new businesses from the real estate sector and do not have CDS in the iTraxx Japan index.

So, while this increase in bankruptcies may have had some impact on the index, “it can’t explain everything”, Mr Gotoh said.

The outlook does not look particularly bright either. “There probably won’t be much significant tightening for the first half of 2009 as we are expecting poor macro indicators,” Mr Gotoh said.

“If the US government contains the problem, institutions are more willing to provide money for the economy that could be a strong driver to lower the spread.”

The dysfunctional nature of Japan’s CDS market does not seem to be reflected in its corporate bond market.

Mr Gotoh estimates that A-rated Japanese companies are raising funds in the domestic corporate bond market at about 100bp above Libor. In the US and Europe, such companies need to spend about 400bp-500bp above Libor.

But Japan’s smaller and lower-rated companies are finding it harder to access funds in the credit turmoil.


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