Japan’s struggling regional banks are leveraging relationships with private equity managers to help soften the blow of negative interest rates and a dwindling rural client base.
For the country’s 64 first-tier regional banks, private equity is about more than alpha as, in addition to returns, committing to a fund can spawn lending opportunities.
“Regional banks are using private equity to generate more business in their local area in relation to LBO finance and advisory services,” Kazushige Kobayashi, head of Asia primaries at fund of funds manager Capital Dynamics, told Private Equity International. The firm provides advisory and due diligence services in its role as gatekeeper for Japanese regional banks.
“They often prefer committing to mid-market and lower mid-market funds because there are more synergies with their own client base,” Kobayashi added.
GPs can harness these appetites. Buyout shop T Capital Partners, for example, will sometimes ask the lead underwriter of a deal financing to invite its regional bank LPs to syndicate the loan.
“When we make a big deal, the loan will be syndicated and the regional banks that have committed to our fund will be invited to join the syndication,” said Koji Sasaki, T Capital’s president. “The big banks often have more experience in providing LBO financing, so we tend to provide them with a mandate and they’ll ask us which banks they should invite to participate.”
Private equity commitments enable regional banks to promote investment in their vicinity by introducing the fund manager to its business clients, which in turn provides the GP with additional dealflow and the ability to promote awareness of the asset class.
“After we establish a relationship, we sometimes go to each area to hold seminars and meetings with the bank employees about how to promote this kind of business with the family owners, or in some cases visit the customer to make a pitch together,” Sasaki added.
“But it’s not so easy to convince an owner to sell their company, so having a GP relationship enables banks to offer private equity as one of their client solutions. If the joint marketing leads to investment, the bank will be expected to lead the financing matters.”
The push to develop local economies chimes with advice from Japan’s Financial Services Agency commissioner, Toshihide Endo, who urged regional banks in October to take matters into their own hands rather than relying upon the government to improve business conditions, according to The Japan Times.
Regional banks had ¥329 trillion ($3 trillion; €2.7 trillion) of total assets as of March, according to the Chiginkyo, the Regional Banks Association of Japan. A Bank of Japan report showed that alternatives and investment trusts accounted for more than 4 percent of regional bank assets last year, up from around 2.5 percent in 2013.
“For two or three years, lots of Japanese banks – particularly regional banks – have been actively looking for private equity investments,” Sasaki said.
“It’s not a small amount. Each Japanese regional bank is relatively small, but the number of them investing in private equity is surging.”
Net income for Chiginkyo members fell to a seven-year low for the year ending 31 March, as they grappled with plummeting global debt yields and difficult socio-economic conditions at home. Some institutions, such as Fukushima Bank and Shimane Bank, have resorted to tie-ups with financial services group SBI Holdings to counter deteriorating conditions.
According to a survey this year by JPMorgan Asset Management, demand for better returns has already driven the country’s defined benefit corporate pension funds to allocate a record 21.3 percent of their portfolios on average to alternatives in 2019 – thereby exceeding bonds for the first time.
“Up until recently, regional banks have been invested in government bonds, but those now have negative interest rates so they’re looking to diversify their asset allocations,” Kobayashi noted.
“One direction they’re heading is into private equity, which can deliver higher returns.”
Yusuke Abe, a Tokyo-based partner at law firm Clifford Chance, said that Japanese institutions, unlike US banks, are not subject to Volcker-like regulation that limits private equity investment, provided they satisfy Basel III capital adequacy requirements. Banks with larger deposit bases could, in theory, deploy more into the asset class.
None of the six major regional banks PEI asked for comment for this article responded.
Not all firms are comfortable with the idea of a symbiotic relationship. The extent to which a GP humours its regional bank LPs can depend on how reliant it is on domestic capital.
One investor relations professional at a Japanese private equity firm, who spoke to PEI on condition of anonymity, likened the dynamic to banks having purchased a one-off “entrance ticket” that grants access to a GP.
“It’s quite competitive among lenders so fund managers now have more bargaining power and don’t necessarily need to provide any preferential treatment,” the source said.
“Prioritising lenders that have also invested on the equity side could make our global LPs a little taken aback. We do have regular banks we’re in touch with, but we don’t give them a statistical preference.”
The transactional nature of these relationships can have its downsides, with some domestic funds finding it harder to secure return commitments from regional banks once the relationship has been formed. At least two regional banks are understood not to have re-upped to the latest vehicle from Japanese mid-market firm Aspirant Group, which closed its third fund on ¥50 billion in October, according to a source with knowledge of the matter. The institutions had previously committed to Aspirant’s 2016-vintage Fund II.
Many regional banks rely on gatekeepers, such as Capital Dynamics, and thus have less direct interaction with their GPs. Others may need to be educated about the nuances and long-term nature of private equity, said Capital Dynamics’ Kobayashi.
“If banks are asked to re-up three or four years after their first investment, they might not have seen many exits yet and could struggle to convince their management to commit again until they have proven returns.”