Posted by on October 22, 2017 10:50 pm
Tags: , , , , , , , , , , , , , , , , , , , , , ,
Categories: Bank of Japan Bond Business Copper Corporate bond default Default Probability Economy European Central Bank Finance Financial markets Greece japan money Moral Hazard New Normal Nikkei Open Market Operations Quantitative Easing ratings Recession Transparency Yen

Last week, the simmering scandal involving Japan’s third largest steel producer exploded, when following reports that Kobe Steel had falsified data about the quality of its steel, aluminum, copper, iron powder and other products it sold to customers across virtually every single industry, Japan’s Nikkei also reported that some Kobe Steel plants in Japan had been falsifying product quality data for decades, well beyond the roughly 10-year time frame given by the lying steelmaker. Worse, not only did the company, having already been caught, lie to shareholders and rule-abiding employees how long this illegal behavior had been going on, but – in a glaring example of corporate idiocy – had effectively enshrined and codified its fraudulent ways, as the cheating procedures eventually became institutionalized in what was a fraud manual, allowing the practice to continue as managers came and went.

As all this was taking place, not only did the stock price of Kobe Steel plunge, but its bonds tumbled sending its default probability sharply higher.


It now turns out that the rout would have been far worse, had it not been a direct intervention by the BOJ itself, which appears to have stepped in and bought Kobe bonds to arrest the plunge.

Posing a rhetorical question, “to buy or not to buy”, the Nikkei reports that “the Bank of Japan appears to have chosen the former in considering whether to include debt issued by scandal-hit Kobe Steel in its bond-buying operations.

Here, it may come as a surprise to some that as part of its ultra-loose monetary easing policy, the Japanese central bank also holds roughly 3.2 trillion yen ($28.4 billion) in corporate debt, similar to the ECB’s CSPP program. The BOJ maintains that balance through purchasing operations held roughly once a month. This past Thursday’s operation was the bank’s first since Kobe Steel’s data tampering came to light earlier in October.

While the BOJ has previously avoided bonds from companies rocked by scandal, according to an official at a Japanese asset management company, this seems to no longer be the case. Whereas such avoidance has occurred even if the security otherwise meets credit ratings and other requirements set by the bank, when it comes to Kobe bonds, Kuroda decided to make an explicit exception.

And like the ECB, which provides only token transparency when it comes to its corporate bond purchases, the BOJ is likewise opaque about its open market operations. Investors who want to sell corporate bonds in a BOJ operation often do so via brokerages. These investors do not know whether the central bank bought the debt until results of the operation surface later that evening. And, as the Nikkei reports, it was learned later Thursday – to the relief of investors – that the bank purchased around 20 billion yen to 30 billion yen worth of corporate bonds, a major insurance provider estimated. About 170 billion yen worth of Kobe Steel bonds are circulating in the market, more than 40 billion yen of which fulfills BOJ requirements.

Since the BOJ does not break down the purchases by issuer, whether the central bank bought Kobe Steel bonds can be inferred by the average interest rate of corporate bonds accepted. A clue that the BOJ had indeed purchased Kobe steel bonds – the metric jumped from the prior operation in September, suggesting the steelmaker’s bonds likely were included in the purchases. Since only one company saw a dramatic spike in its bond yields – and default probability – it can be safely concluded that the BOJ did in fact purchase bonds from the distressed corporation.

Of course, having purchased Kobe Steel bonds means that the central bank has once again greenlighted an unprecedented moral hazard, encouraging bond traders to buy bonds issued by a company which according to some may be facing bankruptcy in the not too distant future. Indeed, even the Nikkei writes that the Bank of Japan finds itself in an awkward position:

“If it did buy Kobe Steel bonds, investors who normally would steer clear of such a company may purchase the asset anyway in anticipation of selling it to the BOJ. But if the bank blacklists Kobe Steel, investors might see the bonds as an even bigger risk.”

An even better question: should Kobe Steel file for bankruptcy, and its debt be equitized in the form of post-reorg equity, just how will the BOJ act when, after buying billions in Kobe bonds, it finds itself a major equity stakeholder in the restructured company? While we don’t know the answer, it will certainly be a closely followed case study in central bank “activism”, because after the next downturn, all eyes will be on the ECB which over the past 16 months has purchased over €110 billion in European corporate bonds with increasingly lower credit ratings. After the next European recession, many of these issuers will be bankrupt, leaving the ECB as one of the major equity stakeholders in an unknown number of upcoming restructuring processes, where it will ultimately end up owning post-reorg equity.

Or perhaps neither the BOJ nor ECB will allow any of the corporate names in its bond portfolio to default, bidding up bonds without relent, and resulting in the most bizarre zombie company world of all: one where bankrupt companies see their bonds trading at (or above) par, unable to file for bankruptcy – just like Greece – as the alternative would be the “new normal” financial equivalent of “crossing the streams.”

Leave a Reply

Your email address will not be published. Required fields are marked *