Korea Housing Finance Corporation (KHFC) has mandated BNP Paribas, HSBC, ING, SG and Standard Chartered for the Reg S/144A issue, according to an announcement today (Friday), with investor calls starting on Monday.

KHFC’s last euro benchmark was a €1bn five year priced at 18bp over mid-swaps in June, while Kookmin Bank on Wednesday sold a €500m five year debut green covered bond at 14bp over on the back of more than €1bn of demand.

Following a mandate announcement on Tuesday and investor calls, Sumitomo Mitsui Trust Bank (SMTB) leads Goldman Sachs, BNP Paribas, Crédit Agricole, Barclays, UBS and Daiwa yesterday morning went out with initial guidance of the mid-swaps plus 28bp area for a seven year euro benchmark, expected rating Aaa. Demand peaked at close to €1bn and a €750m issue was priced at 25bp, with the final order book some €885m.

“All things considered, it definitely went well,” said a syndicate banker at one of the leads.

The deal is SMTB’s second benchmark covered bond, following a €850m seven year in October 2020, and the banker said that the book compared favourably with the debut’s.

“First off, we saw repeat investors coming in and supporting the trade, showing their ongoing interest in the name,” he said, “and on top of that, we saw new investors coming in.

“Investors are increasingly familiar with Japanese contractual covered bonds – even if, as always, it’s not going to be a name for everyone, because of its structure, geography or what have you.”

Bankers at and away from the leads saw SMTB’s outstanding 2027s at 23bp over mid-swaps and put fair value around that level, which the lead banker said was a fair outcome.

He noted that SMTB still trades at a differential of around 5bp over compatriot Sumitomo Mitsui Banking Corporation (SMBC), which is the first and more established Japanese covered bond issuer, and said he was a little surprised that more investors had not been attracted by the pick-up.

“Considering the marketing work SMTB are doing across Europe, on both a deal and non-deal basis, hopefully the more we see of them in the European space, the narrower the differential between the two issuers will be,” he added. “In terms of credit quality and cover pool, they are next to identical.”

Danish Ship Finance (Danmarks Skibskredit) sold its third euro benchmark yesterday, a €500m (DKK3.72bn) June 2028 issue, while buying back €277.1m of its two previous benchmarks.

Following an announcement of the liability management exercise and new issue on Monday, yesterday morning leads Credit Suisse, Danske, DekaBank and SEB went out with initial guidance of the mid-swaps plus 37bp area for the €500m no-grow June 2028 issue, backed by ship mortgages and expected rating A (S&P). After around two hours, the guidance was revised to 35bp+/-1bp, will price in range, on the back of books above €700m, excluding joint lead manager interest, and the new issue was ultimately priced at 34bp on the back of around €750m of demand, excluding JLM interest.

The issuer had offered to buy back portions of its outstanding €500m September 2022 and March 2025 issues in an offer closing early yesterday afternoon, and ultimately €64.9m and €212.2m, respectively, was bought back.

A banker at one of the leads said the issuer had aimed to offer investors liquidity and the opportunity to switch into the new issue, while managing its liabilities in a manner similar to that in its domestic market.

“It’s a very good step forward for the issuer,” he said.

We will bring you more in-depth coverage of the Danish Ship Finance transactions next week.

After announcing the mandate on Tuesday and holding a virtual roadshow, leads Goldman Sachs, SMBC Nikko, Barclays, Crédit Agricole and UBS this morning went out with guidance of the mid-swaps plus 28bp area for a five year euro benchmark-sized covered bond. The size was ultimately set at €1bn and the deal priced at 24bp on the back of around €1.8bn of demand.

The new issue is SMBC’s fourth euro benchmark since it debuted in 2018, and sixth covered bond overall. Its last deal was a two-tranche trade in October 2019, comprising a $500m three year US dollar benchmark and a €750m 10 year euro.

A syndicate banker away from the leads said the non-legislative issue was a strong result for the issuer as it continues to grow its investor base across both euro and dollar markets.

“I’m really pleased for them,” he said, “and after the dislocated markets of earlier this year, then the rally and the undersupplied market we have now, from a timing perspective, it was spot on.

He praised the deal’s marketing and SMBC’s wider investor relations efforts.

“They’re putting themselves out there and giving the investor base access,” he added, “which is absolutely what they should be doing, and it paid off.”

A syndicate banker at one of the leads said the issue was launched on the back of positive investor feedback after a virtual roadshow that followed the deal’s announcement on Tuesday.

“Through elaborate marketing efforts,” he said, “the order book gained strong momentum, and the final order book size reached about €1.8bn, achieving a competitive re-offer spread of 24bps over mid swaps, reflective of strong investor demand.”

The banker away from the leads said the IPTs of the 28bp area could be considered on the generous side given that SMBC’s outstanding June 2026s were at 23.5bp.

“But I think it was fair and sensible,” he added, “and investors will be happy as that’s a decent chunk of change relative to other geographies – granted, it’s non-legislative, but it’s still a triple-A rated product.”

The lead banker said the order book, comprising around 70 accounts, was of very high quality and consisted of a broad investor base of asset managers, central banks and official institutions, insurers, pension funds, and bank treasuries. Germany, Austria and Switzerland were allocated 57%, the UK and Ireland 9%, France and the Benelux 7%, Scandinavia 13%, and others 9%.

The Japanese issuer held a roadshow after having on 28 May announced plans for Reg S intermediate to long euro and/or short to intermediate maturity US dollar benchmarks. Both potential trades were then launched today, with the euro being a five year and the dollar a seven year.

The dollar tranche was sized at $1bn (EUR884m, ¥109bn), larger than typical Reg S dollar trades, on the back of demand above $1bn at the re-offer of 50bp over mid-swaps.

“This was a great trade, the dollar piece in particular,” said a syndicate banker at one of the leads. “To get to $1bn at this level for its inaugural trade is a testament to the value investors see in SMBC’s structure and the quality of the underlying collateral.”

The dollar deal was priced at 50bp over mid-swaps following guidance of the 50bp area, with the syndicate banker noting that a few large orders were limited at 50bp, and the emphasis being on size rather than price.

A banker away from the leads nevertheless said that the spread was a decent outcome, suggesting that a five year Canadian five year dollar benchmark would come in the low 40s.

“This implies they have not been charged too much for the funkiness of the structure, which isn’t for everyone,” he said.

The lead banker put the dollar pricing at equivalent to around 20bp over in euros, saying this made for a healthy curve, with SMBC’s EUR1bn November 2023s quoted at 15bp-16bp and the new seven year euro being priced at 25bp over.

Pricing on the euro benchmark was tightened from the 30bp area on the back of demand that peaked above EUR900m, of which some EUR800m was good at re-offer.

The lead banker said that both tranches were very well placed, but that the dollar in particular was with “very sticky” accounts, predominantly government institutions and asset managers.

He suggested SMBC’s inaugural dollar transaction would incentivise other Japanese banks to enter the covered bond market.

“The other Japanese issuers value dollar funding more,” he said, “so to be able to show to the market that even in Reg S format they can execute a billion is a great takeaway.”

See here for yesterday’s deal coverage.

What kind of a reception did you get from investors regarding your plans, structure and credit story on the roadshow?

Atsushi Ouchiyama, SMBC: The reception we got from investors was overall warm, and we had meetings with around 60 investors in seven days!

During the roadshow, we explained: firstly, SMBC’s solid credit story; secondly, the stable and large housing market of $1.6tn mortgages outstanding, with a delinquency ratio of less than 1%; and thirdly, the attractive structure of the SMBC covered bond programme, with 25% OC with only triple-A self-originated RMBS. And we believe our story was well understood by the investor base.

What we emphasised most is the programme’s uniqueness from an investor point of view, in that they can gain exposure to a triple-A product out of Japan, which is hard to find in the market because even government-guaranteed product is rated single A.

Also, we emphasised that our ultimate goal is to diversify the investor base for SMBC and become a frequent issuer off this programme, which is shown by its size of EUR20bn.

How do you feel the transaction went? How did it compare with your hopes and expectations regarding demand and pricing?

Ouchiyama, SMBC: I feel the transaction went exceptionally well thanks to a well-prepared marketing effort by all those involved in the transaction. The demand and pricing were right in the middle of our expectations.

Our priority was to diversify the investor base, so price was not our first priority for the inaugural transaction.

Are there any other aspects to the transaction that you consider particularly interesting or surprising?

Ouchiyama, SMBC: We saw traditional bank treasuries participated in our book even with uncertainty regarding the LCR treatment of our covered bond programme.

Many central banks and official institutions – some of whom we have never seen in the book for senior unsecured bond offerings – also participated.

How do you the potential for Japanese covered bond issuance in light of this debut SMBC transaction?

Ouchiyama, SMBC: Given the size of the mortgage market, $1.6tn equivalent, and the huge benefit to Japanese banks of having a stable and solid foreign currency funding tool, there is no reason not to explore the covered bond market.

Plans for SMBC’s debut were announced on 11 October and the issuer embarked on an extensive roadshow running from 17 to 26 October (Friday). On Friday the leads announced that the five year euro benchmark could be expected early this week.

Leads Goldman Sachs, SMBC Nikko, Barclays, BNP Paribas, Crédit Agricole and UBS went out with guidance of the low to mid-20s over mid-swaps for a benchmark-sized issue this morning, and after little more than half an hour gave an update saying books were above EUR1bn. An hour later the spread was set at 20bp over and the size at EUR1bn (¥128bn) on the back of more than EUR1.4bn of demand.

According to a banker at one of the leads, the final book was just shy of EUR1.5bn, comprising 67 accounts, with no investors dropping out at the re-offer level of 20bp over.

By way of comparison, five year euro paper from Singapore was quoted at around 9bp over, according to figures circulated by the leads, Canadian paper at 4bp-7bp over, and Australian paper at 7bp over. New issue premiums recently have typically been around 5bp-6bp.

The lead syndicate banker said SMBC’s debut had gone even better than expected, noting that the issuer had the top end of the anticipated size range of EUR500m-EUR1bn, and suggesting that even at the larger size the deal could have been priced 1bp-2bp tighter, such was the strength of demand – in spite of prevailing market conditions being less than ideal.

“The investor community ultimately deemed it a job well done and has awarded SMBC appropriately with a really good sized book, good granularity, and ultimately a good price.” he said. “It’s a win-win for everybody, including the issuer – which optically has priced 60% inside their new issuing OpCo level – and from the investor point of view – they picked up a nice premium over the other comparables.

“And the issuer did not squeeze every basis point out of it, but has left a really good taste for the investors, and I would be surprised if we didn’t see this bond perform on the secondary market.”

He said a new five year euro senior OpCo SMBC issue would probably be priced at around 50bp over mid-swaps. The issuer previously told The CBR that a key aim of issuing covered bonds in euros is to help expand its foreign currency funding.

SMBC also cited the stability of the Japanese mortgage market as a key message it would be conveying to investors on its roadshow, and the lead banker said that this was indeed a key factor in the triple-A rated deal’s success.

The contractual nature of the issuance – with the jurisdiction lacking covered bond legislation – had been highlighted as a potentially limiting factor, alongside the use of RMBS as collateral, with the covered bonds not enjoying key regulatory benefits of legislative issuance.

“There was obviously pushback from some quarters to it being a non-legislative covered bond,” said another lead syndicate banker, “but it was by no means an obstacle we could not overcome. After the pan-European roadshow the story was well understood.

“We had a really good book, with participation from central banks and sovereign wealth funds, which it’s always good to see, asset managers, insurance companies and even bank treasuries. And they are all rates investors.”

Bankers away from the leads said the transaction offered a nice diversification opportunity for investors able to invest in the issue, and appeared to offer a successful start for the jurisdiction.

“It is really good to see that after a lot of work it all came together,” said one of the lead bankers. “Ultimately SMBC has done not only a great job for themselves but a great service for what we anticipate to be other issuers from Japan so that we have a strong Japanese covered bond market on our hands.”

What are the advantages for SMBC in being able to issue covered bonds?

Atsushi Ouchiyama, SMBC (pictured): As SMBC has been expanding lending and the scope of its business overseas as major drivers of growth in recent years, we believe that stability of foreign currency funding will be a key to further growth for our overseas business going forward. SMBC has been focusing on securing a stable and lower cost of funding source by diversifying our funding resources and currencies, as well as expanding our investor base.

You can easily understand our strategy by the fact that among Japanese banks, SMBC is the most frequent issuer in US dollars, euros and the Australian dollar market.

There have been discussions about legislation for covered bonds in Japan. Why have you decided to proceed on a contractual basis? Do you expect support from the Japanese financial authorities for this project?

Ouchiyama, SMBC: Yes, there has been discussion about legislation for covered bonds in Japan and SMBC was also involved in the discussion. As indicated in a report published in July 2011 (by Development Bank of Japan, which served as secretariat, with participation by relevant parties including major financial institutions, lawyers, and academics), Japanese banks back then had a surplus of funds due to stagnant domestic lending as well as a funding structure where funds were mainly sourced from domestic deposits. Therefore, there was no need to introduce covered bonds at that time.

However, Japanese banks have expanded overseas business and securing stability of foreign currency funding has become more important.

Currently, there is no dedicated covered bond legislation in Japan, nor have Japanese authorities mentioned the possibility of drafting and introducing such legislation in public.

However, we have already explained to the authorities about the intent and structure of this issuance in detail. We would like to encourage the authorities toward the establishment of a covered bond legislation in Japan after this product is welcomed by European investors.

What are the key messages you will be telling investors on the roadshow about:

- The Japanese mortgage market?

Ouchiyama, SMBC: We will be highlighting its stability, its magnitude, and its high quality.

If you were to pick one word to describe the Japanese mortgage market, it would be “stable”. The outstanding residential loan balance of Japan is almost the same amount as it was in 2005. The Japanese outstanding residential loan balance has been stable compared to other developed countries that experienced a doubling in size compared to 2005.

The aggregated market balance is around ¥191.9 trillion (US$1.7tn equivalent) as of March 2018, making Japan one of the largest residential loan markets around the globe.

SMBC’s mortgage portfolio shows high quality performance, with a delinquency rate of less than 0.1%, which is supported by the strong job market and stringent underwriting practices.

- Your covered bond structure, including the use of RMBS?

Ouchiyama, SMBC: The reasons why we use RMBS for the cover pool are as follows:

1. In the Japanese market, having RMBS as the cover pool better serves the interest of bondholders because the secondary market for Japanese RMBS is more liquid, compared to that of Japanese residential loans.

2. As we will conduct mark-to-market valuation of the cover pool through close-out netting, RMBS is better than residential mortgages in terms of having better liquidity in the secondary market, can be marked to market more easily, and having a large secondary buyer base.

3. When residential loans need to be sold and transferred, it is required that the mortgage borrower has to be notified, which is not necessary in the case of RMBS.

Why are you targeting a euro-denominated issue?

Ouchiyama, SMBC: The reason we are targeting a euro denominated issue is because the number of covered bond investors are the largest in euros.

Do you expect a significant Japanese covered bond market to develop after your first issue?

Ouchiyama, SMBC: It depends on how successfully we can demonstrate the concept to market participants. The residential mortgage market in Japan is one of the biggest around the globe. I believe our success will lead to a significant Japanese covered bond market.

Read our earlier coverage of the Japanese bank’s plans here:
SMBC to issue first ever Japanese covered bond

A variety of Japanese covered bond initiatives have come and gone for more than 10 years, including a government-sponsored working group early this decade. Shinsei Bank came close to issuing a contractual covered bond in 2008 but pulled out of two attempts, while SMBC itself was said to have explored covered bond options as far back as that same year.

It was announced today (Thursday) that the megabank will from next Wednesday roadshow a EUR20bn (¥2.56tr) covered bond programme, of which Goldman Sachs and SMBC Nikko are lead arrangers. Subject to market conditions, a five year euro-denominated Reg S benchmark transaction will follow via Goldman Sachs, SMBC Nikko, Barclays, BNP Paribas, Crédit Agricole and UBS.

“Historically, Japanese banks have not been active in the secured market due to [the] absence of dedicated covered bond legislation,” says an SMBC roadshow presentation. “Our contractual framework will satisfy key covered bond requirements for the investors and will grant SMBC access to broader capital markets to further diversify [its] investor base.”

The issuer of the covered bond will be SMBC and the collateral backing the dual recourse instrument will be self-originated triple-A rated Japanese residential mortgage-backed securities (RMBS).

Asset segregation is achieved by collateral being held in a trust account by SMBC according to Japan’s Trust Act, which is therefore not available to general creditors of SMBC. The collateral is included in the cover pool by virtue of a total return swap (TRS) between SMBC acting as trustee and SMBC acting in its proprietary capacity.

This method of asset segregation is understood to build on a quasi-covered bond structure, SumitG, involving Goldman Sachs and Japan’s Sumitomo Mitsui in October 2016.

“The challenge of segregating assets for the benefit of covered bond-holders was one of the main reasons why we haven’t seen covered bonds from Japan before,” a banker told The CBR, “because the concept of the true sale as we know it does not exist legally in Japan. The best way of ultimately making sure that covered bond investors have access to the cover pool in the case of event of default of issuer or guarantor needed to be figured out, and the SumitG trade was the prelude to this.”

The covered bonds are expected to be rated Aaa by Moody’s. SMBC itself is rated A1/A by Moody’s and S&P.

Credit enhancement includes minimum overcollateralisation (OC) of 25%, which is higher than in most traditional covered bond jurisdictions with legislation, while the triple-A rated RMBS have their own layer of credit enhancement. The weighted average loan to value (LTV) ratio is 90.1%, with high LTV mortgages being typical in Japan, but LTVs are capped at 80% for the purposes of the asset coverage test (ACT) calculation.

“You have quite a lot of credit enhancement here,” said the banker. “Obviously they are trying to go to an investor universe that is not familiar with Japan’s mortgage market – which is actually one of the strongest in the world, with an exceptionally low delinquency rate, for example – and also they understand that a lot of investors are used to legislative frameworks, and they want to mitigate that with this additional protection.”

A debut covered bond from SMBC would break what has at times appeared to be a regulatory impasse in Japan.

“Similar to what we have seen in the UK and Canada, the banks – with the blessing of the authorities – are now going to be issuing contractual covered bonds and once you see the volumes going up, one would imagine that the regulator would put legislation around it,” suggested a market participant.

“I believe SMBC will be followed by the other megabanks,” he added, “and this has the potential to become one of the biggest covered bond markets out there.”

Outstanding residential mortgage loans in Japan total over $1.6tr (EUR1.4tr, ¥180tr) as of December 2016, according to the roadshow presentation, putting it almost on a par with the UK and ahead of Australia, Canada, France and Germany in terms of mortgage market size. SMBC has a 5% share of outstanding residential mortgages, on a par with Mizuho and SMTB, with MUFG having a 7% share.

Asian covered bond issuance thus far comprises Singaporean and South Korean supply. Most recently Korea Housing Finance Corporation roadshowed a social covered bond that could be the first Korean issuance in euros, a currency in which Asian supply has been confined to Singaporean banks.

Germany’s Pfandbrief Act restricts to 10% the proportion of cover that can be included from non-EEA countries where the preferential claim of Pfandbrief-holders is not certain.

Moody’s said today that it has completed an analysis of a trust structure for Japanese assets in German law-based covered bonds – proposed by the Association of German Pfandbrief Banks (vdp) in co-operation with a covered bond issuer – and that the structure gives covered bondholders a priority right over the Japanese mortgage assets included in the trust.

The rating agency added that where no structure is in place to protect the priority right of covered bondholders, there is a risk that Japanese assets in cover pools are available to other creditors in local insolvency proceedings, and that in such cases it gives limited value to Japanese assets in German covered bond transactions.

As of the end of the second quarter, no vdp members had any Japanese mortgages in their cover pools, according to Section 28 reporting data. However, Aareal Bank reported Eu108m of “building land” among its commercial cover assets for the first two quarters of 2015.

In June 2012 Moody’s gave similar opinions with respect to Swiss and US collateral in Pfandbrief cover pools.

Samurai bonds are publically issued yen-denominated securities sold by foreign issuers mainly to Japanese investors under Japanese law. Previously, yen-denominated covered bond issuance has been restricted to international formats such as Euroyen.

Sandrine Guérin, deputy CEO of CFF, revealed the French issuer’s plans at a conference in Tokyo today (Monday).

According to Marko Nikolic, head of covered bond origination at Nomura – which has been arranging CFF’s planned issuance – work on the project has been underway for around a year, involving long discussions with the Japanese regulators about the treatment of the asset class, and he paid tribute to CFF’s work in paving the way for covered bonds in Japan.

“They are one of the most innovative issuers in the markets,” he said, “as they definitely realise the potential of opening new markets. They are probably one of the top three issuers in the world, so it makes sense for them to employ the resources and spend the time on breaking new ground even though it can be as tough as this.”

Nikolic said that CFF should benefit from a much broader audience in Japan by using the Samurai format.

“The investor base for yen issuance off an EMTN programme would be, let’s say, 50-odd investors, whereas the investor base for the Samurai products would be more like 300,” he said. “All of a sudden you are expanding into all these smaller regional banks that wouldn’t be able to look at a covered bond unless it has the Samurai docs in place.”

He suggested that the product should be positioned relative to the sovereign, supranational and agency market rather than credit products.

No firm timing has been set for any deal, which will be partly dependent upon the yen/euro basis swap.

Japan does not have covered bond legislation, although there has been work on a legal framework and Japanese financial institutions have explored issuing covered bonds using contractual structures and legislation in other countries.