Japan Credit Market Update: Increased protection buying send spreads wider

Japanese credit default swap spreads were wider this week, with investors buying protection on the back of new convertible bond issuance, more credit concerns and the possibility that accounting scandals seen in the US may spread to Japanese companies.

Kinki Nippon Railway set the tone for the week on Monday when it issued a profit warning, or rather issued a larger loss forecast, due to the bankruptcy of its affiliate Dai Nippon Construction.

On Monday, Kinki Nippon widened its net loss forecast because of Dai Nippon’s bankruptcy. By Tuesday, Standard & Poor’s had downgraded Kinki Nippon to double-B-plus from triple-B-minus. The rating agency said that Kinki’s restructuring efforts won’t be enough for the company to recover from adverse economic conditions.

As a result, the spread on Kinki Nippon’s credit default swap widened to 115 basis points Friday from 105 earlier this week.

The cost of protection on Japan’s largest leasing company Orix surged this week after a report from Deutsche Securities questioned the company’s financial disclosure practices. The report shook investor confidence and as a result, the company’s shares dropped to a three-year low with credit default swap spreads jumping to 270 basis points Friday from 205bp Monday.

Meanwhile, investors went to the market to buy protection on real estate company Mitsui Fudosan as it priced a ¥80 billion eight-year convertible bond on Wednesday. The cost of five-year protection Mitsui Fudosan rose to 155bp from 105bp earlier this week.

One dealer said that “the market is building the possibility that Orix may spread” to the rest of the market, boosting demand for protection.

Overall, he reckoned that the Japanese credit default swap market will remain within a range, typically with spreads “widening on economic and credit quality concerns and tightening as collateralised debt obligations hedges are being done.”