Risk of Algerian default puts builders in CDS bind

by Katsuyo Kuwako and Brian Fowler

Bloomberg

Two of the nation’s biggest construction companies are learning the risks of expanding in developing markets to offset dwindling domestic demand, credit default swap prices show.

The cost of insuring the debt of Taisei Corp., the nation’s third-largest general contractor, and No. 4 Kajima Corp. rose faster than contracts for any other Japanese nonfinancial company over the last month after the daily Asahi reported they might not collect $1.2 billion owed for work in Algeria.

Taisei’s five-year swaps climbed to 203 basis points on Jan. 27 from 117 on Dec. 7, the day the article was published, while Kajima’s jumped to 207 from 146. The Markit iTraxx Japan index added 12 basis points, or $120,000 for $10 million of the face value, to 110 in the period.

“There are widening concerns the companies could sustain losses,” said Mitsuyoshi Takahashi, an analyst at Mizuho Securities.

The dispute, which also involves smaller contractors Nishimatsu Construction Co. and Hazama Corp., underscores the challenges facing Japanese companies pursuing growth abroad as the economy is set to grow at the slowest pace among all Group of Seven nations except Italy. While Japan’s near-zero interest rate has given corporations funding costs that are about 3 points lower than in the U.S., the increase in credit default swaps indicates investors are concerned about the risks that companies need to take to increase earnings.

Kajima is negotiating with the Algerian government over the withheld payment, said a Tokyo-based spokesman who asked not to be identified, citing company policy. A Taisei spokesman in Tokyo declined comment because Kajima is the project’s coordinator.

The nation’s aging and shrinking population, combined with a 60 percent reduction in domestic construction orders from their peak of ¥26.5 trillion in the year ended in March 1992, is driving builders overseas. Economic growth will slow to 1.6 percent this year, compared with 2.5 percent for all advanced nations, the International Monetary Fund said Jan. 25.

In contrast, growth in the Mideast will accelerate to 4.6 percent this year and 4.7 percent next year.

The Japanese companies, with China’s Citic Group and China Railway Construction Corp., won contracts worth $11 billion in 2006 to build 1,200 km of the trans-Algerian east-west highway.

Overseas orders for 43 Japanese contractors last year totaled ¥670 billion, of which ¥244 billion were in the Mideast and Africa. That compares with ¥34 billion for the same two regions 10 years ago.

Taisei’s revenue from the Mideast and Africa accounted for 9.5 percent of sales in the period that ended March 31, up from 1.7 percent four years earlier, while for Kajima sales in the region comprised 4.8 percent of the total, up from 0.5 percent.

Taisei, which is rated A by Japan Credit Rating, sold ¥10 billion in 1.58 percent seven-year bonds on Dec. 9 at a premium of 59 basis points over the swap rate. The yield on that note touched a high of 1.632 percent on Dec. 13 before edging lower. It was 1.476 percent last week.

The last time the company sold a seven-year bond was in May 2007, when it paid a coupon of 1.8 percent.

“Foreigners and institutional investors dominate the CDS market, so it’s sensitive to negative news and unresponsive to positive news,” said Yasuhiro Matsumoto, head of credit research at Shinsei Securities Co. in Tokyo. “The stock market is dominated by local investors and individuals, so the moves are different.”

Corporate bond yields on similarly rated securities declined to a 21-month low of 20 basis points, or 0.2 percentage point, above notes with AA grades, according to Bank of America Merrill Lynch indexes. In the U.S., the same gap is 36 basis points, the data show.

The yen’s 9.2 percent gain against the dollar over the last 12 months has reduced the value of sales earned overseas for Japanese companies. And by Monday, the had yen strengthened to around 82.05 to the dollar in Tokyo from 82.92 on Thursday.

“There’s a lot of risk in overseas construction in the Mideast and North Africa, so Japanese general contractors have stopped taking new orders and are now only fulfilling contracts agreed in the past,” said Takahashi.