Alternative Investment

Bond Rout Forces Japan Regional Bank Into Alternative Assets

(Bloomberg) — The spike in interest rates globally is rocking the investment portfolio of a century-old regional bank in Japan and forcing it to overhaul its strategy. 

Yamaguchi Financial Group Inc., with a $7.3 billion portfolio that far eclipses its market capitalization, has slashed its bond holdings after getting stung by the pace of market moves. Now, it’s looking to invest in less liquid but higher-yielding assets like private REITs and corporate bonds issued by Japanese and foreign companies. The lender is also on the hunt for private equity opportunities and stocks that pay high dividends. 

“Investment in alternative assets is necessary” to diversify and enjoy stable profits that are less affected by market moves, Chief Executive Officer Keisuke Mukunashi said in an interview.  “In the past, we were mainly taking interest-rate risks and equity risks.” 

Mukunashi’s challenges underscore the dilemma facing Japan’s roughly 100 regional banks in their search for yield. With securities holdings totaling more than $600 billion, local lenders had amassed US Treasuries as a safe source of income amid ultra-low interest rates at home, only to see the value of their holdings plummet as the US and other major economies hiked rates to combat inflation.

Losses

While relatively large lenders like Yamaguchi have been able to absorb losses, there is growing concern about the smaller ones. Yamaguchi, that’s located in the western tip of Japan’s main island, posted 14.1 billion yen ($96.2 million) of losses from its foreign bond holdings in the quarter ended in March, the most updated public disclosure available. 

To rid its securities holdings of the poorly performing bonds, Yamaguchi cut its portfolio to a little over 1 trillion yen at the end of March, from 1.5 trillion yen it had held on average for the entire fiscal year. The value of its total holdings has continued to drop since April, according to Mukunashi. 

In a note to clients on Oct. 19, SMBC Nikko Securities analyst Masahiko Sato said the biggest issue for regional bank earnings this year is their foreign bond holdings. With the continuing rise in US Treasury 10-year yield, “we think unrealized losses on foreign bonds have worsened and there has been a sharp rise in bonds with negative spreads due to higher foreign currency funding costs,” he said.

Yamaguchi, with 30 employees in its market operations, is now looking to hire five people from investment banks for its revised strategy, said Mukunashi, who’s been in the role for a little over a year. With a market capitalization of about 207 billion yen, Yamaguchi services government agencies, individuals, and small and mid-sized businesses through more than 200 branches and offices across the country. 

With its revised strategy, the lender hopes to nearly double its assets under management over three years. “Market conditions are against portfolio management,” according to Mukunashi. “But I think it’s also an opportunity for investment in the long-term.” 

©2022 Bloomberg L.P.

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