Japan’s leveraged buyout finance market, which has largely been dominated by top-tier banks, is exploring ways to expand the pool of investors to cope with an influx of multi-billion dollar deals.
The country is on course to establish a record for overall LBO loan financing this year, with the ¥1.4trn (US$9.8bn) loan backing the buyout of Toshiba by domestic private equity fund Japan Industrial Partners exceeding on its own the previous annual LBO loan volume of US$6.925bn in 2017, according to LPC data. Other deals in the pipeline, such as a ¥400bn loan for government-backed fund Japan Investment Corp's planned purchase of semiconductor material maker JSR, would add to the tally.
The size of the financings has raised concerns over the syndication prospects of such loans, given Japan's relatively shallow institutional investor base and inactive secondary loan market. As a result, the Japanese Bankers Association established a study group in August to address the prospects of more frequent, larger LBO financings.
“It's not that there are any problems with financing now, but if the LBO market continues to grow or the number of large deals increases, we don’t think the current lending structure will be viable,” said Jiro Kiyota, joint general manager of JBA’s chairperson office. “JBA launched a study group, acting as secretariat, to discuss what should be done to attract more institutional lenders other than arrangers.”
The ¥430bn leveraged financing backing the buyout of automotive parts supplier Marelli Holdings by KKR in 2017 illustrates why lenders should avoid concentration risk. The company logged four consecutive annual losses starting in 2018, leading to a court-led restructuring last year that forced 26 domestic and international banks to take a haircut of ¥450bn on roughly ¥1.1trn of debt.
Room to grow
If JIP's and JIC’s transactions come to fruition, this will jump-start Japan’s LBO financing market, which has seen only two deals totalling US$137m so far this year.
Bankers say the market has more room to grow, driven by carve-out deals involving the sale of conglomerates’ non-core assets and succession-related buyouts.
JBA’s study group – which comprises the three Japanese mega-banks Mizuho Bank, MUFG and Sumitomo Mitsui Banking Corp, four private equity funds and other loan investors such as insurers – aims to publish a report and recommendations by the end of March.
“Japan's LBO market should be a market that offers appropriate and balanced risk and return in the first place,” said Jin Nishikawa, head of the M&A finance department No 1 at MUFG. “That is also our responsibility as arrangers. The most important thing is that we continually develop professional LBO bankers who can agree with PE funds on LBO financing with correct risk-return profiles.”
While financing terms have improved since the coronavirus pandemic and the failure of the Marelli deal, risk-return profiles in Japan are not attractive enough compared with offshore markets, bankers said.
“There are points that we can improve on in the future. We can think of solutions such as increasing liquidity of loans, making primary pricing transparent to the public, and obtaining ratings for large deals to make it easier for investors to participate,” JBA’s Kiyota said.
Five domestic banks – Aozora Bank, Mizuho, MUFG, SMBC and Sumitomo Mitsui Trust Bank – have underwritten the Toshiba loan with syndication expected to take place by the end of March, while Mizuho has been mandated on JSR’s borrowing, with the bank group to be expanded by the end of December.
Debut LBO fund
Recognising the need for a wider investor base, MUFG established a ¥15.9bn LBO loan fund in April with domestic financial institutions, the first such fund in Japan.
“As the market expands significantly, we have always wanted to increase the number of investors as there is a risk of excessive credit concentration, and we have been working on this theme for some time now,” MUFG’s Nishikawa said.
“As more regional banks and insurance companies have started to participate in LBO loans, we decided to take on the challenge of developing a debt fund because we thought we would need different type of investors to expand further.”
The fund, managed by Mitsubishi UFJ Trust Bank, has a life of 9.25 years and participates in MUFG-arranged domestic LBO senior loans, mostly large ones.
Shinkin banks, cooperative regional financial institutions serving small and medium enterprises and local residents, regional banks and insurers are among the fund’s investors.
PE funds have welcomed the move as they would benefit from a larger liquidity pool, but investor reactions have been varied, according to Nishikawa.
“There are some people who look at it with a sense of cautiousness as there is uncertainty due to lack of track records. However, there are some investors who are paying close attention to it because it offers attractive yields among various products for financial investments in Japanese yen.”
Finding investors is still challenging but other top-tier arranging banks are also planning to set up similar loan funds to ease concentration risks, bankers said.
MUFG aims to raise the second and third funds next year with larger institutional investors such as pension funds among the target participants.
“We are flexible with fund concepts. Through dialogue with investors, we would like to discover and expand ways to launch funds with different formats and concepts,” MUFG’s Nishikawa said.