Toyota Pulls Bond Deal Due To Soaring Yields: The Japanese "VaR Shock" Feedback Loop Is Back

Tyler Durden's picture

Despite the eagerness of Abenomics and the new BOJ head Kuroda to have their cake and eat it too, in this case manifesting in soaring stock prices, plunging Yen, rising GDP and exports, and most importantly, flat or declining bond yields, so far they have succeeded in carrying out three of the four (assuming Japanese economic data reporting is more accurate than that of its neighbor China), as it is physically impossible for any central planner to completely overrule the laws of math, economics and physics indefinitely. In this vein, we have described on numerous occasions in the past several days the shock to the system that the massive one-way transfer out of all asset classes and into equities has engendered, and resulted in several JGB futures trading halts in an attempt to normalize a market where bond volatility has suddenly exploded. Volatility aside (and it shouldn't be as the below section from JPM explains), the recent surge in yields higher is finally starting to take its tool on domestic bond issuers. As Bloomberg reports, already two names have pulled deals from the jittery bond market due to "soaring" borrowing costs. The first is Toyota Industries which as NHK reported, canceled the sale of JPY20 billion debt. Toyota is among Japanese firms that put off selling debt as long-term yields on government debt have risen, increasing borrowing costs, public broadcaster NHK says without citing anyone. Last week JFE Holdings announced it would delay plans to sell bonds due to market volatility. Two names down... and the 10 Year is not even north of 1%.

What happens to corporate bond funding when the one way slide that it the USDJPY continues on its way to 105, then 110, then 120, and so on, as equities explode on their way to doubling in 2013 (the NKY225 should surpass the DJIA in absolute terms in tonight's trading session), and how will corporation raise that much needed capital to fund CapEx (if one believes Abe of course) if they can't even handle a 10 Year that is well shy of 1%? Maybe they can all just fund their capital needs with equity going forward?

Perhaps, more importantly, what happens to JGB holdings as the benchmark Japanese government bond continues trading with the volatility of a 1999 pennystock, and as more and more VaR stops are hit, forcing even more holders to dump the paper out of purely technical considerations: a topic we touched upon most recently last week, and which courtesy of JPM, which looks back at exactly the same event just 10 years delayed, when in the summer of 2003 10y JGB yields tripled from 0.5% in June 2003 to 1.6%, now has a name: VaR shocks.

For those who wish to skip the punchline here it is:  A 100bp interest rate shock in the JGB yield curve, would cause a loss of ¥10tr for Japan's banks.


For those who wish to keep reading, JPM's Nikolaos Panigirtzoglou explains how Japan's toxic volatility loop may very soon send JGBs soaring in yields: a perfectly logical outcome in a world that can't have the disconnect between equity-implied growth (and inflation) and bond-implied contraction (and deflation) for ever.

And all this just as Abenomics was desperately clinging to any validation it was working.

From JPM's Flows and Liquidity: VaR Shocks

The recent rise in JGB volatility is raising concerns about a repeat of the 2003 “VaR shock” i.e. volatility-induced selloff.

The rise in JGB volatility is raising concerns about a volatility-induced selloff similar to the so called “VaR shock” of the summer of 2003. At the time, the 10y JGB yield tripled from 0.5% in June 2003 to 1.6% in September 2003. The 60-day standard deviation of the daily changes in the 10y JGB yield jumped from 2bp per day to more than 7bp per day over the same period.

As documented widely in the literature, the sharp rise in market volatility in the summer of 2003 induced Japanese banks to sell government bonds as the Value-at-Risk exceeded their limits. This volatility induced selloff became self-reinforcing until yields rose to a level that induced buying by VaR insensitive investors.

Banks typically set limits against potential losses in their trading operations by calculating Value-at-Risk metrics. Value-at-Risk (VaR) is a statistical measure that banks use to quantify the expected loss, over a specified horizon and at a certain confidence level, in normal markets. Historical return distributions and historical market volatility measures are typically used in VaR calculations given the difficulty in forecasting volatility. This in turn induces banks to raise the size of their trading positions in a low volatility environment, making them vulnerable to a subsequent volatility shock.

What was the flow evidence in the summer of 2003? By looking at quarterly Flow of Funds data from the BoJ, it was Japanese banks, Broker/Dealers and foreign investors who sold JGBs at the time. And it was VaR insensitive investors, Postal Savings and domestic Pension Funds and Insurance Companies who absorbed that selling.

How sensitive are Japanese banks currently to an interest rate volatility shock? The latest Financial System Report by the BoJ, April 2013, does not look encouraging. While Japanese major banks are close to average in terms of their vulnerability to interest rate rises, Regional and Shinkin (i.e. cooperative banks) are the most vulnerable they have ever been.

A theoretical 100bp interest rate shock, i.e. a parallel shift in the Japanese bond yield curve of 100bp, would cause a loss of ¥3tr for Major banks, ¥5tr for Regional banks and ¥2tr for Shinkin banks. As a % of Tier 1 capital, these theoretical losses are close to 35% for Regional and Shinkin banks vs. only 10% for Major banks. The maturity mismatch, the difference between the average remaining maturity of assets minus that of liabilities, has risen for all banks over the past few years. But it was the highest ever at the end of last year for Shinkin banks at 2.2 years, and the highest ever for Regional banks at1.8 years. Major banks had a much lower maturity mismatch of 0.8 years at the end of 2012.

This divergence between Major banks and Regional/Shinkin banks largely reflects differences in the maturity of their bond holdings. The average remaining maturity of bond investments has lengthened to around 4 years at Regional banks and nearly 5 years at Shinkin banks vs. 2.5 years for Major banks.

So in terms of their sensitivity to JGB interest shocks, Japanese banks appear to be more vulnerable than they were in 2003. For example in 2003, the expected theoretical loss from a 100bp interest rate shock was around ¥2tr for Major banks, ¥3tr for Regional banks and ¥1tr for Shinkin banks, significantly lower than they are currently. The maturity mismatch was around 0.8 years for Major banks, i.e. similar to the mismatch reported by the BoJ for the end of 2012. But the maturity mismatch was a lot lower at the time for Regional and Shinkin banks, at 1.2 and 1.5 years, respectively.

By themselves, these maturity mismatches and the sensitivity to interest rate shocks, appear to be increasing the chances that the Japanese government bond market will see a higher frequency of VaR shocks and thus more elevated volatility vs. other government bond markets. The potential offsetting factor is anecdotal and other evidence that Japanese banks have become more sophisticated in terms of the risk management and have gradually shifted away from mechanical Value-at Risk frameworks towards Stress Testing frameworks. This shift should have prevented banks from taking more interest rate risk in response to declining volatility and thus made them less vulnerable and less responsive to a subsequent interest rate shock.

Indeed, by looking at the risk management behavior of Major banks, for which the interest rate sensitivity and maturity mismatches are little changed since 2003, there is evidence of prudent interest rate risk management. But this is less true for Regional and Shinkin banks for which interest rate sensitivity and maturity mismatches have been rising sharply over the past years. This divergence is not surprising given that Major banks are typically a lot more sophisticated than Regional or Shinkin banks. And it is Regional and Shinkin banks which present a volatility risk for JGB markets. It is true that Regional and Shinkin banks are smaller than Major banks, but they together hold a large ¥50tr of JGBs (vs. ¥120tr of JGB holdings for Major banks).

These maturity mismatches and sensitivity to interest rate shocks have been intensified by QE because 1) of the mechanical rise in duration as yields decline and 2) because banks struggle to maintain their interest margins by extending the maturity of their bond portfolios so that they can capture extra yield. Indeed, the sharp lengthening of the maturity of the bond portfolios of Regional and Shinkin banks would appear to be a reflection of the pressure QE and a persistent low yield environment exert on banks to extend maturity. The average maturity of the bond portfolios of Regional banks was 3 years in 2007 vs. 4 years in 2012. The average maturity of the bond portfolios of Shinkin banks was 2.5 years in 2007 vs. 4.7 years in 2012.

And this is one of the unintended consequences of QE more broadly: Investors who target a stable Value-at-Risk, which is the size of their positions times volatility, tend to take larger positions as volatility collapses. The same investors are forced to cut their positions when hit by a shock, triggering selfreinforcing
volatility-induced selling. So QE potentially increases the likelihood of VaR shocks. The proliferation of risk parity investors and funds, which are strict Value-at-Risk investors and are heavily invested in bonds currently, is also likely raising the sensitivity of bond markets to sel-freinforcing volatility-induced selling.

What is the evidence of leverage outside Japanese banks? By looking at the bond holdings as % of total assets in Figure 2, Japanese banks are indeed the outlier followed by US and Euro area banks. The steady increase in the share of government bonds in Japanese bank assets reflects a sustained period of excess deposit inflows as households and corporates recycle their savings via the banking system. In a way Figure 2 suggests that Japanese banks are more vulnerable to interest rate rises and thus more likely to be the cause of a VaR shock.

Admittedly US banks feature high in Figure 2, raising concerns about their vulnerability to interest rate shocks. The problem with Figure 2 is that it does not include hedges that banks have via swap or option positions to protect themselves against duration risk. Therefore a better way to assess interest rate leverage by US banks could be to look at the quarterly trading profits of US commercial banks available from the Office of the Comptroller of the Currency (OCC). The latest observation is for Q4 2012. We proxy leverage by the ratio of the volatility of their interest-rate trading profits over bond market volatility. Figure 3 suggests that US banks’ interest-rate leverage was about average in 2012. The Dec 2012 observation is well below the highs seen in 2009/2010.

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bank guy in Brussels's picture

Nonetheless ...

« You cannot predict higher interest rates if you also predict QE to infinity. QE is the non-economic purchase of government and other debt securities. Therefore as long as QE expands to meet the size of bond offering, the bond market will stay bullish and interest rates will not rise significantly. »

- Jim Sinclair, JS Mineset

machineh's picture

Presumably Toyota is not predicting higher interest rates.

If they were, then they would gladly borrow at today's rates, which soon would become negative in real terms if Japan's inflationary jolt were credible.

NipponMarketBlog's picture



Please note that this is Toyota Industries (6201) we're talking about, and not the parent Toyota Corp (7203).

This may be a way for the parent to assess corporate bond market risk appetite?

Theta_Burn's picture

PLease clarify

Does this apply more to a smoldering wreck of an island or a reserve currency nation?

max2205's picture

They pulled it beacause....they know rates will be lower sooner than later......?

disabledvet's picture

i agree...great article. great comment from Urban Redneck below as well. "this is not a question of predicting higher rates but of FORCING them." and i ain't talking Turkey's here. this is the original LOTR's...done in silkscreen which is an amazing media to work with...long forgotten by Hollywood et al of course. Those are real people riding those very real horses as well. i recommend researching the making of this move as in many ways though unfinished and not edited well it is superior in terms of artistic merit. where were we again? oh, yes..."the time value of money." if we're talking a deposit "with license to lend 90 percent of it" i would think in these times quite high. "the rate of nil" does indeed stand out to me. "hookers," is also a preturnatural response. unless and until you have an understanding of the industrial revolution however "there really is no understanding of how QE in fact bolts on to the existing economy." sure...yields have fallen globally...but in fact spreads have massively widened as well. the benchmark YIELD are US Treasuries and while not the lowest in the world (Switzerland, Germany...still Japan...come to mind in that regard) the point is to get loan growth fired up again in the USA and not "mire their people in various forms of recession and depression forever." so again...GREAT article hmmm. "Lieutenant Savik the Admiral is well aware of the regulations" when communications are not established. hmmm. that would be TWO WAY communications. "and purveying the purview of Zero Hedge is how that is done at the 101 level." trust me..."if you can't do Zero Hedge then you can't do money." PERIOD. so let me be specific: "i have 35 million in cash that i am willing to turn over to you Little Bank now what is it that you are offering me in return?" you are than welcome to say "we will buy and run a gold mine profitably and give you a cut of the proceeds." and now you the opinion of those who appear only concerned of reputational risk in times like these. a GOOD reputation can be bought...but a BAD reputation must be earned.

TrustWho's picture

Brussels is right in the short run. 

Of course, the Central Banks are making sure Keyne's statement is true: "In the long run, we are all DEAD."

Urban Redneck's picture

Sounds like equity dilution is in order for Toyota 

fonzannoon's picture

this is what i have been saying for weeks. as japanese yields rise banks unwinding hedges via dumping the long end of the UST curve cause our rates to go up. this is absorbed via more money printing. More money printing helps the realization set in that it truly is QE4eva. 

They have to find a way to talk the yen down or things get interesting quickly

CrashisOptimistic's picture

Yes, and you have been wrong for weeks.

US yields were at 1.88% Thursday.  It's yen dependent, not Japanese bank unwind dependent.  A strong dollar costs countries more money to buy US Ts.  That and only that.

And the yen already is going down.  You have that backwards, too.  It needs to be talked up (stronger, to less than 100 of them for a dollar), not down, or more likely bought up by the Fed, for only one simple reason.

To prevent Toyota Camrys being priced at $9000.  That would destroy GM.

fonzannoon's picture

How have I been wrong for weeks? As Japan yields rise, US yields rise.  Where has that been wrong? Why did you not quote the yield on Friday? The market was open Friday? What was the 10yr yield?

All I am saying is that if the former continues, the latter will as well. It's not that big of  a deal yet. But if you truly get a spike up in JGB yields, you will get a corresponding spike up in UST yields. It is hedges unwinding by selling long dated UST's.

You can talk about Toyota's and GM's all you want. I am talking about something else.

strannick's picture

Economics has laws? I thought it was pithy anecdotes at best, and dangerously failed theories by tenured academics in general.

ISEEIT's picture

Economic 'science' is alchemy.

Gold is money.

fonzannoon's picture

I can't edit any of this shit but you have one thing right...I should have said talked the yen up, not down. That was what I meant.

M2Market's picture

I concur.  Prolonged yendaka and low JGB yield had all sorts of compressed instability built up within this structure.

I'd be the first the admit I have no clue whats the extend of the unintended consequences, but what really worries me is the

fact that Abe and Kuroda now has politcal cover and that's not good.  It will be the fuel that can keep the trend going. 

ApollyonDestroy's picture

Quit hating on the fonz, he's a pretty cool dude. Besides, GM has already been destroyed

fonzannoon's picture

Thanks apolly. I think this article may go over a lot of people's heads, but it is important. This is not about Toyota. Toyota and everyone else are going to get whipped around by interest rates. Everyone on here keeps wondering what the straw will be that breaks. This could be it. Not yet, but maybe the early stages.

max2205's picture

No...they'd add in 4k more margin....therein lies the magic

Theta_Burn's picture

Domestic bond issuers taking "its" tool..\rimshot/


Headbanger's picture

To quote Japanese golfers I've heard say say when they miss a shot "FUCKASHIT!"

MiltonFriedmansNightmare's picture

I cannot predict the exact mechanism, but I do have a strong hunch that the next Black Swan is preparing for flight, and it's likely to originate in the land of the rising sun.

Rustysilver's picture

I think the black swan is grooming and stretching its wings.

fonzannoon's picture

This hedging and rebalancing far exceeds the liquidity available. This is a big deal.

Satan's picture

The dyke has 11 holes. The Central Planers have 10 fingers.

HD's picture

Worst. Porn. Ever.

Non Passaran's picture

Aren't the planners male?

TalkToLind's picture

I almost didn't make it here...the rack on that chick almost makes me want to click on a banner ad.

ApollyonDestroy's picture

Hands down the hottest chink ever

NipponMarketBlog's picture



One has to assume that risk management has progressed a little bit since 2003, but even if that is the case and even if VaR relies less on normal distributions and incorporates more leptokurtosis, it is still a fact that vol is sharply higher. This in itself will induce managers to move money out of the JGB market, simply because they might suspect other investors will get caught in the vicious VaR cycle, and so decide to sell before that happens.

The great game of musical chairs may have begun....

besnook's picture

krugman may have been right. omg! i said it!

the fed is trying to control the game. japan is trying to wrest control from the fed. at some point in the rising yield curve it makes clear sense to mint the quadrillion yen coin to drop an a bomb on the fed.

it is still too early to tell, yet, what the abenomics end game is but i cannot see that the japnese economists did not embark on this course without contingency plans in place for the various possible scenarios. there is a long history in the japanese character for dramatic action and a willful acceptance of the good and bad that will occur as a result.

this may not end well for the japanese but it may end worse for the rest of the world. so far, no one has addressed the possible external consequences of abenomics.

the quadrillion yen coin nullifies interest rates as a meaningful variable because the debt is internal and devalues the yen to 150/dollar immediately. banzai!

constantine's picture

I lived in Japan for three years. Only an economist with an agenda could argue that there has been deflation there. What a joke. Prices for regular household goods and services in Japan are astronomical and now they're on jet fuel. JGB are garbage.

fuu's picture

"the recent surge in yields higher is finally starting to take its tool on domestic bond issuers"

Typo of the month.