WNAM REPORT: Investors in Japanese corporate bonds are increasingly seeking protection against possible credit deterioration when an issuer becomes a takeover target.
Change of Control covenants — which give bondholders certain rights to redeem the debt before maturity if the borrower has a significant change in ownership structure — have until now been very rarely seen in the ¥100 trillion ($680 billion) Japanese credit market. Yet many investors argue that needs to change, with the risks highlighted by future ownership uncertainty of frequent issuers such as convenience store giant Seven & I Holdings and Nissan Motor.
“We need a Change of Control covenant on bonds broadly regardless of their credit ratings,” said Hiroyuki Miyata, a credit portfolio manager at Nissay Asset Management. Investing in yen notes without that has become a risk, he said.
Seven & I has seen its yield premiums jump as it grapples with growing pressure to improve corporate value amid a takeover bid, while spreads on bonds of market researcher Macromill and optical equipment maker Topcon have widened to record levels as private equity firms bid for them.
The blowout in spreads has reflected worries that buyout activity can cause changes in ownership, possibly followed by more debt, delistings and rating downgrades.
“I’m getting many inquiries from bond investors about how they should prepare for potential risks,” said Kentaro Harada, chief credit analyst at SMBC Nikko Securities, adding that investors may demand higher premiums on bonds of companies whose shares have low price-to-earnings and price-to-book ratios if adequate protections aren’t introduced.
Change of Control clauses are typically more common in major bond markets other than Japan, especially for junk-rated issuers. That’s because Japanese companies have historically relied on the banking system to raise funds, and there are few speculative-grade borrowers likely to be takeover targets.
The flurry of M&A activity is bringing the spotlight back to investor protection now though. Leveraged buyouts by private equity firms often come as a surprise for bondholders, who may not have priced in such a possibility, especially when investing in high-grade firms.
Industry group Japan Securities Dealers Association (JSDA) led a series of working group meetings last year that agreed on applying Change of Control clauses and reporting covenants on bonds with debt ratings of BBB+ and lower, while keeping conditions flexible.
Katsuyuki Tokushima, head of pension research at NLI Research Institute, said that a Change of Control clause would provide reassurance if investors are planning to hold onto the bonds for a long time. “A decision to put such covenants on bonds should be something that issuers and underwriters should be considering proactively,” said Tokushima, who was part of the JSDA working group.
“It is highly likely that Japanese companies will continue to be targeted for M&As, and the risk would be higher this year than last,” said Hidetoshi Ohashi, chief credit analyst at Mizuho Securities.
Companies need to be able to tap the debt market for larger funding, on top of bank loans, for corporate activities, said Akiko Kimura, of counsel at Anderson Mori & Tomotsune, and also a member of the working group. Should investors’ calls for covenants grow further, bonds may start carrying a Change of Control clause, she said.
