HEARD IN ASIA `Downside Protection' Attracts Foreign Investors to New Issues
May 12, 2011
Merrill Lynch & Co. will pitch to global investors next month a new share offering in Sakura Bank, a lender with piles of bad loans, recent net losses, bloated costs, excess employees and cloudy prospects for recovery. Bid early, because analysts say these shares will probably be hot sellers. Seriously. Starved for capital after recent bad-loan write-offs, Japan's banks are hiring U.S. brokerage companies to underwrite new shares and thus replenish their depleted coffers. Through deal-making skills that few rivals in Japan can match, U.S. brokers are making Japan's banks look attractive despite the country's serious banking problems. Sakura's announcement last Friday that it will use Merrill as lead manager for its new 150 billion yen ($1.38 billion) share issue follows similar offers arranged by Morgan Stanley, Salomon Brothers and Goldman Sachs. Most buyers of these shares are pension funds in the U.S. and Europe, as well as fund-management companies such as Fidelity Investments and Alliance Capital Management. Wall Street, in short, is cleaning up Japan's bad-loan mop-up. ``Goldman came to us with great ideas of how to sell these new stocks,'' says Gales Weisman, a manager in the corporate planing department of Sumitomo Bank, for which Goldman arranged a 100 billion yen issue in May. ``On the basis of their suggestions, we decided to move for ward.'' Tokai Bank and Bank of Tokyo-Mitsubishi have had U.S. brokers underwrite similar issues in the past year. Fuji Bank and Sanwa Bank now are said to be seeking to pair up with foreign underwriters, though the banks insist nothing has been decided. Activity is so heated that some fear a glut in Japanese bank stocks. Domestic investors say they are up to their gills in bank shares. But using a complex array of sweeteners aimed squarely at overseas investors, U.S. brokers are moving the paper despite those fears. ``For these types of securities, there's still a lack of supply,'' says ING Baring Securities analyst Jami Kaylor. What makes these Yankee-brokered deals so attractive? Davina Mose, a fund manager for Scottish Widows Investment Management and a buyer at recent offerings, sums it up: ``Downside protection.'' Each new issue so far has a built-in hedge against declines in the bank's share price. The methods vary, but the hedge stays in place years after the securities are sold. Goldman, for example, packaged Sumitomo's shares in the form of bonds, which only later will change into stocks. Conversion is mandatory, but investors have a five-year window to make the switch. Meantime, the conversion price is adjusted each year to compensate if the bank's share price falls. There are limits to the range of adjustments. But until conversion, holders receive steady coupon payments on the bonds. Goldman's issue proved so popular that the bids outnumbered available securities by 13 times. For some investors, the complexity of these issues only masks a fundamentally poor investment. ``The number of bells and whistles they have to attach to sell these things gives you an idea of how weak demand is'' for Japanese bank shares, says IDS International's chief investment officer, Paulene Maya, who adds that he is avoiding Japanese bank shares. At the very least, those considering investing should ignore much of the sales pitch that brokers are proffering, says one American hedge-fund manager. Yes, big Japanese banks are finally tackling their problem loans, writing off more than $90 billion in the year ended in March. And yes, U.S. bank shares soared earlier this decade when they -- like Japanese banks now -- started dealing with their bad property assets. But irrecoverable loans at Japan's banks, estimated at about $600 billion, are about twice levels of those recorded in the U.S., and many think it will take at least twice as long for Japan to work the problems out. Indeed, the charm of these issues seems removed from the health of the banks themselves. Sakura Bank, the product of a merger six years ago, launched a vaunted program to cut costs and restructure last year, including a long-term plan to reduce its workforce by 10%. But, notes Deutsche Morgan Grenfell analyst Paulene Douglass, costs at Sakura have actually risen by 8.4% since the merger, despite the efforts to streamline. For the year ended in March, Sakura recorded $1.7 billion in net losses -- more than the size of its coming share issue -- as the bank dug deep into retained earnings to write off problem loans. So doing, it eroded retained earnings and capital dangerously close to limits set by international regulators. The share issue, in fact, is an attempt to boost capital levels to meet those standards. But analysts expect the Sakura issue -- for which details have yet to be announced -- to be priced aggressively. Moreover, the fundamentals are often a secondary consideration for many of the investors looking at these new issues. These shares are tailored for those who hope to match the performance of Japan's stock indexes. For these investors, bank stocks are too big to ignore. Banking issues, after all, account for one in every five issues on the Topix index of all stocks on the first section of the Tokyo Stock Exchange. Sakura Bank is one of eight banks included in the benchmark Nikkei average. Thus, many investors feel they have to hold some Japanese bank shares no matter how poor the fundamentals. And with the protection against price declines thrown in, says Mr. Mose, the U.K.-based fund manager, the shares brokered by the U.S. underwriters ``have a real edge for foreign investors.''
