For years, it was best known as Japan’s CLO whale - a US$357 billion investing giant with seemingly insatiable appetite for yield in an era of rock-bottom interest rates.

Now Norinchukin Bank has become one of the biggest casualties of an entirely different financial world - where higher-for-longer borrowing costs are exacting a painful toll on the market’s weakest hands.

The agricultural bank surprised the market this week by saying it would sell US$63 billion of low-yielding US and European government bonds that had become unprofitable to hold after the firm’s shorter-term funding costs jumped. The unlisted firm warned that losses this fiscal year may swell to ¥1.5 trillion, triple an estimate made less than a month ago.

While Norinchukin and the Japanese government have expressed confidence in the bank’s ability to weather the losses, the episode is a reminder of the dangers still lurking in the financial system 15 months after the collapse of SVB Financial Group’s Silicon Valley Bank. Signals from the Federal Reserve and other central banks that they are in no rush to cut rates have caught out many investors betting on more aggressive moves.

That’s creating a tricky landscape for institutions like Norinchukin, which piled into US and European sovereign bonds on the expectation that falling rates would spark a debt rally after two years of declines. The bank is now overhauling its portfolio, selling off a third of its sovereign holdings and shifting to other types of assets, including collateralised loan obligations and domestic and overseas bonds.

“It is surprising that they didn’t hedge interest-rate risk,” said Philip McNicholas, Asia sovereign strategist at Robeco Group in Singapore. “It may have been that they had high conviction regarding Fed and ECB cuts and initially thought it was just a temporary delay.”

Norinchukin isn’t the only bank suffering from wrong-way bets on rates. SVB collapsed early last year after its massive portfolio of long-dated bonds lost value as interest rates soared. The losses sparked a run on deposits that eventually spread to other regional lenders including Signature Bank and First Republic Bank.

More recently, the higher-for-longer rates have led to paper losses at many banks and fund managers. The Fed has yet to move this year, even though the market was pricing in 150 basis points of cuts as recently as December. US banks had US$516.5 billion of unrealised losses in their securities portfolios at the end of March, according to regulators.

The flagship fund at Western Asset Management Co, a US$385 billion bond giant in California, has been one of the worst performers in the market after its managers stuck to the view that longer-term bonds will rally as the Fed gets closer to cutting rates. The firm’s Core Plus fund has beaten just 3% of its peers both this year and over the past three, according to data compiled by Bloomberg.

While Norinchukin has a much lower risk of a run on deposits given its stable farming co-operative clients, it’s facing growing questions about how it mismanaged the debt portfolio, and why the projected losses ballooned so quickly. The bank’s spreads widened Wednesday on the news of its deeper losses, while Japan’s top government spokesperson said the bank’s health is secure.

“I was surprised to be honest” by the size of the potential losses, said Makiko Oouchi, head of finance and general affairs at Iwate Prefectural Credit Federation of Agricultural Co-operatives, a regional body that invests deposits for local co-operatives.

Junichi Matsuda, a member of Kyoto’s Forest Owner’s Co-operative Association, said he hadn’t been informed about recent events by Norinchukin. If the bank were to request more funds to match its deeper losses, “that would be a huge shock,” Matsuda said, adding he sees this as an unlikely possibility. Norinchukin said last month it will raise ¥1.2 trillion from the agricultural and other cooperatives that own it.

The century-old bank has rattled markets before. In 2009, it was forced to raise ¥1.9 trillion after racking up Asia’s biggest realised and unrealised losses on investments in asset-backed securities during the global financial crisis. Norinchukin serves as a central financial institution for Japan’s roughly 3,300 agricultural, forestry and fishery cooperatives. The bank takes deposits from cooperatives, rather than directly from farmers, and manages the money through medium- to long-term investments.

An official from the Ministry of Agriculture, Forestry and Fisheries said “we will continue to closely monitor the business conditions” of the bank, with the Financial Services Agency. The bank’s unrealised losses have been reflected in its capital ratio and won’t affect the lender’s soundness, a company spokesperson said in an email Wednesday.

The spokesperson also said the bank will build the most optimal portfolio by diversifying revenue sources among assets in Japan and overseas, depending on market conditions.

Even if Nochu - as the firm is known in Japan - is able to shift into other assets, the issue of expensive dollar funding remains. In place of interest risk, the bank will be taking on credit risk if it adds collateralised loan obligations or corporate bonds. The firm held ¥7.4 trillion in CLOs as of March.

Company bond spreads have widened in June after the Federal Reserve turned out to be more hawkish than many investors expected. Some signs of economic weakness are also keeping repayment risks alive among weaker borrowers. While global corporate bonds have generated an excess return over government peers of 1.31% in 2024, that’s down from a high of 1.74% at the end of May, according to a Bloomberg index.

Still, Norinchukin has said it will gradually sell its US$63 billion in bonds over time - before its fiscal year ends in March - meaning it could reduce losses if government bonds rally further on any rate cuts later this year.

Norinchukin has little room to pile into stocks, which carry greater risk and require more capital than other assets under Basel III banking rules. Only about 2.3% of the bank’s investments were in equities as of March.

The tricky overhaul now falls to chief executive officer Kazuto Oku. The company veteran has already signalled that management will take pay cuts, and isn’t ready to step down anytime soon.

“There are ways to take responsibility,” Oku told reporters last month after first warning of impending losses. “One is to resign and the other is to execute duty to the full. I would like to choose the latter.” 

  - Bloomberg