Yuki Nitta and Makiko Yamazaki

TOKYO (Reuters). During the $34B deal Japan’s top banks made for Medline in 2013, one of the most significant leveraged buyouts after the financial crisis, these famously cautious lenders signaled their willingness to take on riskier and higher-rated U.S. debt.

After years of low rates in the home country, Mitsubishi UFJ, Mizuho Financial Group Inc (NYSE::) and Sumitomo Mitsui have intensified their U.S. operations. They are eager to find yield overseas and now target businesses there, lending to low-rated borrowers, and underwriting junk bonds.

Their timing, however – with interest rates rising and high-yield markets slowing down – will mean they face increased risks and diminishing opportunities that could prove to be a challenge to their ability and endurance.

Shinichi Sato, an executive at Mitsubishi UFJ (Japan’s largest lender), stated, “We will need to closely watch the market’s course after the latest contraction.”

He expressed optimism about the outlook, saying that “the market for noninvestment grade financing will likely stay on a growth trend.”

To be a major player in this market, the big Japanese banks have much to do.

Mitsubishi UFJ is a partner in this tie-up Morgan Stanley According to Dealogic (the largest Japanese bank), NYSE: had 1.6% of $18 billion in fees last year for non-investment grade bonds.

The company aims to climb five places in the League Table for Non-Investment Grade Bonds and Loan Syndication over the next two year, up to the 12th position.

LOCAL KNOWLEDGE

Bankers advise that deals should be closely monitored to ensure there are no defaults by non-investment-grade borrowers.

Japanese banks say it has been difficult to develop this knowledge. They need more trust in local staff and a quicker-moving business culture.

Mizuho expanded its American presence after it acquired the North American corporate loans portfolio of Royal Bank of Scotland in 2015. It also hired 150 ex-RBS (LON) bankers.

Yusuke Kasamatsu (a senior Mizuho banker) stated, “U.S. bank and investment banks have cutting-edge business models, governance and they have developed their presence with talented bankers joining Mizuho.”

“We took into account their viewpoint and improved our game.”

Kasamatsu stated that it strengthened ties with clients of investment grade and reached out to borrowers at lower ratings as it grew its knowledge.

According to a top executive from another megabank, Rivals noticed when Mizuho’s U.S. profits exploded in 2020.

The executive stated that the RBS deal had changed the culture of their company. He declined to identify himself due to the sensitive nature of the subject. They accelerated the due diligence and increased risk management. They listened to the advice of former RBS bankers and made changes.

After trebling its earnings a year ago, U.S. Securities more than doubled profits to 60 billion Japanese yen (or $467 million).

According to Dealogic, its share in the high-yield pool fee pool has increased by 1.5% over three years.

Sumitomo Mitsui took last year a 5% share in Jefferies Financial Group Inc to help target high-yield transactions.

Sumitomo Mitsui Chief Executive Jun Ohta explained that “as our U.S. abilities were weak”, we could not fully benefit from the buoyant capital market” that helped boost Mizuho.

NEW RISKS

However, the lenders with big capital will face new risks due to the United States’ expansion and in particular the high-yield market for debt.

Bank of Japan took notice and stated that exposure to high risk assets could cause unexpected losses for lenders.

The central bank recently stated that banks must “assess their portfolios quality and risk” in order to increase fee revenue.

Although Japanese banks are known for selling loans on the secondary market to hedge against default risk, the Japanese have also been victimized by Wall Street.

Last year saw the collapse of Archegos Capital hedge fund. Nomura Holdings (NYSE: ) was hit by a $2.9Billion. Mizuho, which lost $6 billion during the subprime crisis was one of the most affected Japanese banks.

A Financial Services Agency official stated that it is “reasonable” to allow banks to access high-yield markets overseas after they have accumulated investment-grade debt experience.

The official declined to identify himself.

According to Rie Nishihara, JPMorgan Securities in Japan (NYSE:) Securities in Japan, banks must know the level of risk they can withstand during market turmoil.

She said that there was a speed difference between the top-tier and second-tier bank in accessing information in such situations. This is evident in Archegos’ collapse where top-tier investments banks survived relatively unaffected.

($1 = 128.3900 yen)