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Zombie Banks 1998 edition

About 10 years ago I was living in Singapore, and working in the aerospace sector. At that time getting good deals were difficult, these were the days when Thai Airways finance a bunch of Boeing B747 with loans priced at 12.5 bps (e.g. 0.12%) over LIBOR (the best rate banks lend to each other), it marked a low point in loan prices, it made my life a misery trying to find interesting deals.

One evening while in Tokyo with friends I met the head of one of Japan's premier aerospace banks, these guys were one of the biggest players in the business, they were drowning their sorrows because they could no longer bid on new business, they had effectively been shut down to new business until the new financial year (1998). They bemoaned their poor luck (no new business meant very small bonus), as their bosses even asked them (desperately) to reduce balance sheet usage -- get rid of loans at least until the turn of the year!

Intrigued I called them up the next day (Japanese despite mind numbing drunkenness are always in the office early the next morning) and see if there was anything we could do to help (e.g. make money). In a nutshell they were looking to unload between $1 billion and $2 billion in aerospace loans ASAP. I told them that to sell such a big number would be very complex unless we could figure out a way to make it low risk for the buyer (me in this case).

This was a two step process, the first was a review of the documentation which took a few days (lots of fun was had in Hong Kong for 5 days of loan review). These were fiendishly complex structures, triple dip tax leases (Japan, Hong Kong and other jurisdictions) but they were also boiler plate so once we verified the termination values (which was done via bespoke models) we were ready to deal. What we did was amazing in its simplicity and it still amazes me that these banks didn't think of doing the deal themselves.

We bought the entire loan book and securitized the obligations; today this would be considered a very safe deal, because we matched our obligations exactly and provided full backstop to the investors. What we had created was an exploding note, the Japanese bank would be the paying agent and the counterparty in those days were were allowed to have exploding margins, so we sold a note for six months at a margin of 50 bps over the US Treasury rate and received 150 bps from the Japanese bank, we also took the refinancing risk -- which was large, but at the end of six months we had a margin of 300 bps should the paper not be redeemed by the issuer, we in turn had an exploding margin with the Japanese banks of 500 bps, we had sold on this risk to an insurance company (for 20 bps), so in a nutshell we paid 70 bps (plus structuring costs) and received 150 bps on $1.8 billion for six months with no refinancing risk, since we had sold this refinancing risk to a third party AAA rated entity we generated $15 million dollars in profit for 8 weeks of work, and because the transaction was securitized there was virtually no capital cost, we calculated at the time that our return on capital was 30,000%.

This may seem insane today, in fact it could not work anymore, because with this type of structure with exploding rate would be illegal for corporation (amazingly Alt-A mortgages, which are with exploding rates, are still legal today -- although not much demand)

Why the Zombie banks, because we are seeing the same insane solutions today with the big US banks; Last week Citibank sent a letter to 2 million credit card holders and increased their interest rate from 7.6% to 29.9%, this to people who do not carry balance on their credit cards! People who payoff their credit cards will usually all have the same reaction, can their cards, the impact on the money supply is not negligible here, because credit cards are a form of cash, and this reduction in the availability of credit is certain to have an impact.

P.S. Yes simplified the meat of the deal, the credit agencies were involved (private rating) but since this was sold as a private placement it didn't make the headlines, we were also very lucky in that there was so much money around that we could "pay" everybody in the bank to get the deal done.

P.P.S The $15 million represented 1.1 year of profits for the Japanese Bank in the book (average loan costs was 45 bps), total cost of the transaction was nearly 2.5 years of bank profits on this portfolio.





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