One month ago, when tracing the contagion from the recent surge in Libor rates, we tracked it down in an unexpected location: Japan.
As we reported at the time, “some Japanese lenders have been trying to pre-empt the Libor blow out. Sumitomo Mitsui Financial Group cut its global CP and CD funding by $7 billion in the year to June, while a $28 billion jump in deposits outpaced a $19 billion increase in lending globally, according to Deutsche Bank. As a result, its loan-to-deposit ratio shrank from 149.6 percent in March 2015 to 135.5 percent at end-June. Mitsubishi UFJ also saw its ratio fall to 115.1 percent from 117.8 percent in March 2015 on the back of a rise in deposits.”
The problem, however, is that in the short term, Japanese lenders would unlikely be able to raise enough from deposits to replace the lost access to U.S. money markets. Prime money-market funds slashed their holdings of Japanese securities to $115 billion at the end of July, down 25% from $153 billion two months ago, according to ICI. Previously second to only the U.S. by country of issuer, Japan has now fallen to third behind France.
Being increasingly locked out of money markets means that beyond paying up substantially for U.S. dollars, Japanese banks have few options. Leverage requirements mean global banks are reluctant to provide repos, while foreign-exchange swaps would be a more expensive way to access U.S. dollar funding, said Koichi Sugisaki, a rates strategist at Morgan Stanley MUFG Securities cited by Bloomberg. Three-month CP and CDs now cost roughly 80bp-90bp on an annual basis, but three-month FX forwards have also become more expensive at around 1.5 percent per year, he said.
As we observed at the time, one option for Japanese banks is to access US dollar bond funding, by directly selling short-dated, US-denominated bonds, which could provide Japanese banks with some respite from short-term dollar funding pressure. “Japanese banks could consider issuing short-end bonds from the operating bank level in the future to meet short-term liquidity needs as an alternative to CP/CDs,” said Masanori Kato, head of debt capital markets for J.P. Morgan in Tokyo. “Short-term notes would be a possible alternative avenue, and demand would be there for it as Japanese banks are seen as a safer haven due to Brexit concerns.”
However, even that option may not be feasible. According to Chris Wood, who in his latest Greed and Fear report also observes the ongoing blow out in 3M Libor rates and Libor-OIS spreads, he notes something troubling. To wit: “the new rules require institutional prime money market funds, which are not invested primarily in government debt, to report a floating NAV based on the current value of the assets they hold.”
Then there is this: As a consequence of the pending changes, many prime money market funds have been reclassified to government funds over the past year. Consequently, US prime money market funds’ total assets have declined by US$668bn since the end of October 2015 to US$789bn on 7 September, while government MMFs have risen by US$741bn over the same period to US$1.755tn (see Figure 3).
That, in itself, is not news to our readers. What is, however, is the following:
The above raises an issue for non-government borrowers of US dollars such as Japanese mega banks. For example GREED & fear heard this week in Tokyo that one major Japanese bank is borrowing US$60bn from money market funds.
$60 billion in Libor reliance for just one Japanese bank, whose funding costs on just one tranche increased by hundreds of millions? One wonders just how much pain this and other Japanese banks can sustain as their short-term funding costs soar, while their assets generate less and less income (thanks Kuroda), and more importantly, how long before the “counterparty stigma” trade emerges.
Ironically, and as we pointed out first a month ago, the first casualty to the US Libor blow-out is not be in the US at all, but in Japan, a country whose central bank just managed to unleash the most recent episode of global market turmoil. Something tells us that should the Libor move continue, that risks for Japanese banks will not be “contained.”