BOJ leadership change unlikely to alter Japan M&A financing environment

News Analysis 18 April

BOJ leadership change unlikely to alter Japan M&A financing environment

The change of leadership at the Bank of Japan (BOJ) is unlikely to have a major impact on M&A financing in Japan in the short term, as the new governor Kazuo Ueda has maintained a dovish and moderate policy stance thus far, according to experts and deal makers recently interviewed by Mergermarket

Dealmakers, however, are more concerned about adverse macroeconomic factors that could lead to a credit crunch or financial market disruption in Europe and the US, but that possibility now appears to be slim, they said.

There was speculation that the BOJ, under the new leadership, might unwind its ultra-low interest rate policy. Given the weak economic fundamentals in Japan, it seems unlikely that the BOJ will be able to significantly increase long-term interest rates in the near future, they said.

Ueda, a highly recognized academic expert who is nonetheless little known among the public, noted in his first press conference on 10 April that his team intends to continue the current ultra-easy monetary policy and will maintain Yield Curve Control (YCC) and the negative interest rate applied to commercial banks’ reserves at the central bank.

“Monetary easing will continue in one way or another. I don’t think there will be any hindrance to M&A activities, “ said Tetsuya Inoue, senior researcher at Nomura Research Institute and a long-time acquaintance of Ueda. He served as a research assistant for Ueda from 2000 through 2003 when Ueda was a member of the Policy Counsel of BOJ.

Inoue pointed out that Ueda, during recent parliamentary sessions, has endorsed the ultra-easy monetary policy measures introduced by controversial predecessor Haruhiko Kuroda as “what was needed” and he will maintain them at least for the time being.  

Japan’s YCC, which has been in place since 2016, has had serious side effects including the loss of market mechanisms for trading Japanese Government Bonds (JGBs) and a weakening of financial institutions' earning power, according to Inoue. Under the YCC policy, the BOJ is committed to buying an unlimited amount of 10-year JGBs to forcibly suppress the benchmark 10-year yield to around zero with a margin range of plus or minus 0.5%.  

Rather, Ueda may maintain the easy-money policy stance by shifting the YCC peg target to the 5-year JGB yield from the current 10-year JGB as he once argued in a Nikkei article published in April 2021. This would mean easing monetary conditions in Japan will continue, he said.

However, Inoue, echoing many other economists, said that given the relatively weak state of Japan's economic fundamentals, the removal of the YCC policy would not push up the benchmark 10-year-yield to a level comparable with that of the US or Europe in the first place.

BOJ estimated the potential growth rate of Japan at as low as 0.27% for 4Q22 and the central bank also predicted that the consumer price index is likely to fall below the 2% level sometime next year from the current 4%. Potential growth rate is an estimated indicator that reflects the growth capacity of Japan's economy from a longer-term perspective.

Rei Kyogoku, Executive Officer and Head of Corporate Finance with SMBC Nikko Securities, said Ueda’s BOJ may make some decisions on its monetary policy after May, when financial results of major Japanese listed companies are announced.  However, currently there are no reasons for BOJ to further raise the YCC upper limit beyond 0.5% as long as the actual benchmark yield stays below that level as it does now, he said.

Kyogoku also noted that in general, the interest rates on LBO loans are more directly influenced by the credit of each acquisition target and various macroeconomic factors, than the BOJ’s monetary policy on long-term interest rates.

“If the credit condition of a target is good, (an LBO-based deal) won’t be affected much even if interest rates are rising,” Kyogoku said.

A Japanese private equity executive said that his firm is doing various case studies, but the BOJ’s potential policy changes would not affect private equity business largely.

Banks already lending with caution

A senior lender anticipated that the current level of debt capacity and economic conditions that banks offer to private equity sponsors can be preserved for the next one or two years despite the economic turmoil. This is because banks have already tightened their lending stance to a reasonable level on LBO financing, after they incurred a substantial loss at KKR-backed automaker Marelli that went to court-led rehabilitation process in 2022, he said.    

“I imagine that many LBO lenders would be paying more attention to macroeconomic risks, such as a potential credit crunch in the US, however, their lending stance remains neutral. We also don’t put excessive stress when we build a financial model of a target company at this moment”, the first lender noted. 

Another senior lender echoed this view and pointed out that after companies were hit by the COVID-19 pandemic, banks have downsized their debt capacity from previously excessive levels of 7x or more of EBITDA to 4x-5x. 

To ride on low capital cost in Japan, global private equity firms are likely to increase their exposure in Japan furthermore to capitalize on the country's still moderate lending environment, the second lender pointed out.  

Even if interest rates rise gradually, the potential impact on private equity’s internal rate of return (IRR) is quite limited, the second lender noted.  “They are aggressively seeking investment opportunities in Japan more than before with accumulated dry powder”, he added. 

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