Japan’s leveraged buyout financing market is expanding rapidly as corporate carve-outs and succession-related transactions increase. However, concentrated lending exposures and uneven risk-management capabilities are raising questions about its sustainable growth, market participants pointed out.

Major banks continue to dominate LBO financing, particularly for larger deals, while regional banks and non-bank lenders face challenges in assessing credit risk and managing exposures. The market also needs a secondary market for trading loan exposures, they noted.

The Japanese Bankers Association (JBA) is discussing how to balance market growth with risk management through a study group examining issues affecting domestic LBO financing and decided to compile a risk-management guide by the end of March next year. The initiative is not intended to fully standardise loan documentation, but to provide guidance that supports practical decision-making.

Outstanding domestic LBO loans held by nine major Japanese banks rose to JPY 6.6tn (USD 41.8bn) in September 2023 from JPY 2.6tn in March 2019, while regional banks’ exposure increased to JPY 1.4tn from around JPY 200bn over the same period, according to stats disclosed by FSA.

This follows findings published by the Financial Services Agency (FSA) in July 2024. The regulator identified risk-management shortcomings, including that around 60% of regional banks had no manual covering LBO financing.

The financial collapse of major auto-parts supplier Marelli, which left lenders facing substantial credit costs, has further highlighted the need to develop a market that can attract more participants while distributing risk appropriately.

Now, Japan’s shift to a rising interest-rate environment highlighted that the next focus will be how to establish discipline acceptable to participants with differing interests, including what pricing adequately compensates lenders for risk and how much leverage should be tolerated.

Limited secondary market

Unlike the US, Japan has a very limited secondary market in which loan exposures are traded, leaving banks with few options to reduce explores before maturity. This contributes to the cautious stance that limits broader market participation.

A former banker familiar with the Marelli situation said the banks had been unable to make an early exit because “there was no market through which they could adjust their risk.”

Banks traditionally expect to hold loans until maturity and have little experience of selling exposures, both in terms of internal procedures and banking culture, the former banker said.

An LBO banker at a regional bank echoed this view, saying relationship banking remains deeply embedded in Japan’s banking culture, with lenders expected to continue supporting their borrowers until the end.

In the case of Marelli’s collapse, many of its loan claims ultimately passed to overseas distressed-debt investors. Japanese lenders had previously provided approximately JPY 450bn in financial support, mainly through debt forgiveness, during Marelli’s 2022 restructuring, according to media reports at the time.

However, rising competition for deposits is creating incentives for banks to manage their balance sheets more actively, another regional banker said.

Loan growth at the bank has continued to outpace deposit growth. If a secondary market existed, the bank could transfer portions of existing exposures to external investors and redirect the resulting credit capacity towards new lending, the banker added.

According to Bank of Japan data, the outstanding domestic loans of city banks, including the three megabanks and Resona Bank, rose 7.9% year on year to JPY 280.6561tn as of August. These institutions accounted for 46.8% of domestic lending.

Foreign Lenders

Foreign lenders are also beginning to participate in Japan’s LBO financing market, although their involvement remains limited. BNP Paribas served as the sole lender on the JPY 16.17bn financing package supporting EQT’s 2026 acquisition of Japanese systems integrator Mamezo, while Deutsche Bank has strengthened its leveraged finance business in Japan by recruiting an experienced LBO banker from MUFG Bank.

However, a broader expansion of foreign lenders’ participation is likely to depend on the development of a more transparent secondary loan market that would allow them to trade loan exposures and distribute risk more effectively, according to market participants seeking to expand Japan’s LBO financing market.

Credit assessment 

Limited credit-screening capabilities is another obstacle to expanding regional bankes’ particiapation in LBO financing, a banker at another regional-bank said.

Strong demand for investment can also drive lending spreads below levels that can adequately compensate for risk, the lender said.

Following their experiences during the COVID-19 pandemic, many regional banks tend to avoid industries with high earnings volatility. As a result, restaurants and apparel businesses are among the sectors that sometimes struggle to secure financing.

An employee at a second-tier major bank said the industry urgently needs to recruit and develop specialists capable of handling LBO financing.

Mid-sized banks frequently rely on experienced professionals recruited from foreign banks to assess LBO transactions. These employees often work as specialists focused on individual deals and may move to another employer after four or five years, without passing on sufficient knowledge to junior colleagues.

Pricing

The JBA has identified the disclosure of pricing information to improve transparency as a medium-term objective.

In the US, third-party providers and industry bodies such as S&P Global’s LCD and the Loan Syndications and Trading Association publish interest-rate and spread data for leveraged loans. Japan has no comparable disclosure infrastructure, and individual banks retain pricing information internally.

“No one disagrees with the general direction of improving transparency,” a major-bank lender said.

However, bringing the information together is likely to prove challenging because banks differ considerably in the scale and sophistication of their LBO-financing operations.

For now, the challenge is not simply bringing more capital into Japan’s LBO market, but developing the pricing transparency, credit expertise and risk-transfer mechanisms needed to support a broader lender base.