The premium paid by Japanese banks to obtain funds on overseas inter-bank markets only affects their costs on non-yen loans, but obviously has a direct impact on aircraft finance. Aside from the up-front yen deposit on a Japanese leveraged lease, 'there are very few yen-denominated deals in aircraft finance,' says Bertrand Grabowski, head of the aerospace group for Banque Indosuez in Tokyo.
Mark Schultz, aircraft finance lawyer at Seattle-based Perkins Coie, notes that the yen's long-term appreciation has discouraged Japanese lenders from making yen-based aircraft loans. He recalls a yen-denominated loan to Varig where the yen's appreciation raised the amount of yen debt relative to the value of the dollar-denominated aircraft despite Varig's regular payments. 'The end result,' says Schultz, 'was that the Japanese trading company found itself severely under-secured.' Thus, observes Grabowski, 'in 99 per cent of the cases, aircraft are financed in US dollars.'
Japanese banks started paying a premium on interbank dollar loans last July after Japan's ministry of finance released preliminary estimates of the country's bad bank debts. The reform measures announced by the ministry were uniformly dismissed as inadequate.
Japan's bank crisis deepened last August with the first failure of a commercial bank since the depression and the closure of two of Japan's largest credit unions. Inadequate supervision by Japanese regulators was seen as a common cause to both problems, though the scandal over Daiwa Bank's US trading losses was not linked to abuses of the bubble economy. The resulting international banking community's loss of faith in Japan drove the inter-bank premium charged to Japanese banks up to 50-60 basis points over Libor during October. This premium, according to Grabowski, reflected 'the market's perception of the creditworthiness of Japanese banks.'
In an effort to avoid this premium, Japan's banks tried to switch from borrowing dollars to trading yen for dollars. They could borrow yen at a discount rate of 0.5 per cent from Japan's central bank, which lowered its rate to that level in September in the hopes of helping them through a rough period with nearly interest-free capital. But foreign exchange markets were soon flooded with yen, and the swap rate for Japanese banks quickly matched the inter-bank borrowing rate, thus ending what one financier called this 'backdoor attempt to avoid the premium.'
By December the premium had dropped to 25 basis points, then 10, as Japan's finance ministry started to unveil draft rescue plans and tighter controls to prevent a repeat crisis. But the premium soared again to 23 points at year's end after rating agencies released unfavourable verdicts on some of Japan's strongest banks and public criticism mounted within Japan over a key rescue proposal for Japan's beleaguered housing loan companies.
Then came the surprise resignation of Prime Minister Murayama, his replacement by Ryutaro Hashimoto, the appointment of a new finance minister without a significant financial background, and the debate over whether to call new Japanese elections. Amid this turbulence, the six-month dollar rate for Japan's soundest banks hovered around Libor plus 18. Where it will go next is the subject of much conjecture.
There is also plenty of speculation about the effect of this premium on aircraft finance. Japanese banks are notoriously secretive about their business and no regulatory authority has canvassed them or compiled statistics on their aircraft funding. Those few Japanese bankers who were willing to speak with Airline Business on the subject did so on condition of anonymity, generally downplayed the premium's effect on aircraft finance, and cited other reasons for any retreat from this sector.
Yet the premium appears to have affected Japan's role in aircraft finance in three ways: it has reduced the overall level of that finance, it has shifted Japanese funding to second-tier credits, and it has forced banks to compete on thinner margins.
Tying Japan's retreat from aircraft finance to any specific reason raises imponderables about cause and effect. The premium has affected the various banks differently and non-Japanese banks have developed more appetite for aircraft finance for reasons that are unrelated to Japan's handicap. Meanwhile Japan's banks have found various ways to dodge the premium's impact.
'If I had to give a figure,' says Bertrand Grabowski, 'I would say that since last summer between 20 and 30 per cent of the normal expected share we have previously seen for Japanese banks has just vanished.' Yet, he quickly adds that 'there have been various effects of various causes.'
Even if Japan's retreat is partly for other reasons, such as the downward pressure on margins, there is no dispute that Japan has shifted to poorer credit airlines. 'When you're bidding BA deals at Libor plus 30 and your funding costs are Libor plus 25, you're out of the business,' says one financier who relies on Japanese funding. However some, including Klaus Heinemann, joint general manager at the London branch of The Long Term Credit Bank of Japan, give other reasons for the shift to poorer credits. 'It is due to margin deterioration for the prime names in the market, the same thing that happened in the late '80s. As margins come down banks try to improve their overall revenue by looking at credits that they would normally not focus on,' Heinemann says.
With roughly a third as many aircraft deliveries as three years ago and banks generally more attracted to aviation, 'you have much more supply and much less demand.' As a result, Heinemann notes that margins on loans to such carriers as Lufthansa, SAS, or Swissair, now at Libor plus 30 or 40 points, 'have roughly halved from three years ago.'
But Grabowski believes the shift to poorer credits is largely driven by Japan's higher cost of funds. 'Japanese banks could not have access to the prime European carriers that are financing below 35 basis points,' Grabowski says, 'So they turned their attention to other market segments such as China, which is reasonably comfortable paying around 100 points to the lender.'
As a result such airlines are actually benefiting. 'In the case of China, the number of basis points paid by Chinese airlines, guaranteed of course by Chinese banks, is going down to 90 or even lower,' Grabowski says. 'The competition is not so much from European or US banks, but mainly from Japanese banks,' he adds.
Others have gained too. Korean Airlines, for instance, was paying up to Libor plus 95 at the beginning of last year. 'Because of this side effect of the Japanese premium, KAL is now successful enough to pay something like 65 basis points,' according to Grabowski.
But he stresses that other factors, such as KAL's good year, also make a difference. 'So you cannot say that a certain number of basis points are a result of the Japanese premium and that another amount is a result of the airline's improving balance sheet.'
Only Japan's strongest banks are maintaining some presence among the top tier carriers. 'We're talking about three or four Japanese banks and only a few European airlines, such as British Airways, Lufthansa, and the like,' Grabowski says. 'The Japanese banks will maintain a certain share in syndication even if the pricing is down to 25 points. In some cases I suspect they are not even making money.'
Thinner margins have become a fact of life for Japan's banks. Whatever the premium, it pinches them by that much. Despite falling margins worldwide, they also face more rivals. 'The French, German, and Dutch banks continue to be among the most aggressive,' notes David Smith, aircraft finance solicitor at London's Wilde Sapte. German banks especially are winding up commitments to Germany's reunification and have more lending capacity. Players like Chemical Bank, Hong Kong Bank, and Credit Suisse are all interested in funding aircraft due to either shrinking local demand or individual strategies. Are such banks capitalising on Japan's malaise? Many forces affect the market, and the Japanese premium is clearly one of them.
The premium also lengthens the recovery period for Japan's banks. The Wall Street Journal estimated last November that if the premium stayed at 31 basis points through March, it would cost Japan's six largest banks between $50 million and $88 million. Currently the premium is lower, but it still erodes their profits.
The question of when the premium will disappear can be restated as how long it will take to change world perceptions on the soundness of Japan's banks. 'I wish I knew,' says LTCB's Heinemann. 'The problems surrounding Japan's banks will be very visible around the end of the financial year in March 31 when they start publishing results.'
No one is sure about the size of Japan's bad debts. Some estimate they could be as high as $800 billion. A consensus places the figure closer to $600 billion or 10 per cent of all bank loans. During the US savings and loan crisis, according to Financial World, bad debts were only 5.5 per cent of total loans.
A Morgan Stanley analysis of Japan's banking industry predicts it will take years to solve the problem. Japanese bankers agree. 'It will take some time,' says one, 'but the big problems are starting to be solved.'
That is a matter of some debate. The Japanese public opposes using tax revenue to bail out banks. A plan to liquidate seven housing companies has drawn fire because it would require $6.8 billion in public funds, even though the main beneficiaries would be agricultural cooperatives, not banks.
The likelihood of the changeover in Japan's government bringing new economic strategies is apparently slim. 'I'm not sure how influential a Japanese prime minister is on economic policy,' says one Tokyo banker. 'The more important point now is the stability of politics.' Japan's new administration seems unlikely to find the political courage to buck public opinion and solve the banking crisis. 'There is not the political leadership required to decide such a significant use of public funds to solve the problem,' warns Morgan Stanley.
Without that support, Japan's banks will mostly resort to 'the piecemeal method' of slowly writing off bad debts from annual profits and Morgan Stanley predicts a long road to recovery. With Japan's economy still in the doldrums, real estate prices are still falling and debts are actually growing instead of shrinking. Japan's banks lack the financial resources or experience to deal with such a big problem. Deposit insurance funds are inadequate and the government has largely left banks to fix the mess themselves. The Wall Street Journal estimates that some of the strongest banks could write off their bad loans in six months; for others it could take 17 years.
Klaus Heinemann thinks the premium may fade away much sooner. 'The market has already started to understand that really you're not talking about an individual bank's risk, but about the Japanese financial system. From a government perspective it will not be allowed to deteriorate further.' The challenge now is to assess how much of that is wishful thinking.
Klaus Heinemann thinks the premium may fade away much sooner. 'The market has already started to understand that really you're not talking about an individual bank's risk, but about the Japanese financial system. From a government perspective it will not be allowed to deteriorate further.' The challenge now is to assess how much of that is wishful thinking.
Source: Airline Business
