Pass-Throughs Gain Ground in Japan


Until now, Japanese investors' preference for bullet securities is a quirk that has limited development of the domestic asset-backed market.

But with the recent emergence of pass-through securities and other non-bullet issues, Japan's buyside is slowly growing more accepting of a wider range of securities, in line with more developed markets.

According to securitization pros, in most markets, asset-backeds are typically structured as pass-through securities, in order to match cashflows on the assets with cashflows on the bonds.

But in Japan, nearly all ABS issues are chopped into tranches of fixed-rate securities that pay out all the principal at maturity. This is because the back office systems of most investors are not equipped to book pass-throughs. As a result, arrangers have to tailor ABS deals to the domestic market by structuring them as bullets, though doing so is often less efficient for issuers.

Yet with the successful launch of the first monthly floating-rate, pass-through issue last month a 20 billion ($185 million), auto loan-backed deal from Nissan Credit Corp. investors have shown that they are willing to buy other types of securities besides bullets.

"Most investors in Japan are not accustomed to pass-through securities," admitted Anthony Dixon, director and head of securitization at arranger Nikko Salomon Smith Barney in Tokyo. "But for an amortizing asset, pass-throughs are more efficient for the issuer, and we felt it was important to continue to educate and push the envelope for Japanese investors to insure long-term viability of the domestic ABS market."

Pass-throughs are more efficient for issuers since all cashflow is passed through to investors, which eliminates the problem of negative carry, or the difficulty of re-investing monthly payments at a rate sufficient to cover the interest payments due to investors. They also require investors to take on some prepayment risk, which most are still loath to do.

But getting Japan's buyside accustomed to pass-throughs is necessary to further develop the market, as it creates more opportunities for ABS investors and issuers alike, said sources. "For the market to really grow, you need to progress beyond bullet securities. It is pretty unusual to have a developed ABS market like Japan which has only fixed-rate bullets," noted another banker.

And widespread acceptance of amortizing structures will only happen when more pass-through issues start coming to market. "Once they reach a certain critical mass, this form of securities will gain wider acceptance and investors will adapt, as we're already beginning to see," said Dixon.