In the 1970s, banks in the U.S. and Europe thought they'd found a great way to make money amid falling interest rates. They lent directly to governments in Latin America, for high fees. The rationale was that if these nations could print money, they'd never default. Turns out they also had the sovereignty to decide not to pay foreign lenders. The outcome was the Brady plan, one of the biggest ever restructurings of bank debt.
Lenders in Japan should review this chapter of financial history. Faced with negative benchmark interest rates, they're venturing into treacherous waters. On Wednesday, engineering-services provider JFE Holdings got a 60-year subordinated loan from seven institutions, including the nation's three megabanks and a trio of life insurers. The facility is being underwritten by the Development Bank of Japan, so the fact it ranks below other debt if JFE goes bankrupt shouldn't matter. Or should it?
If only it were just JFE. The week before, commodity trader Mitsui & Co. announced it was seeking a similar facility, and at least five other companies are doing deals along the same lines.
Why would banks anywhere offer 60-year loans and risk being the last to get paid? You won't find the answer in a textbook, because financial academics wouldn't dare truck with such an outrageous idea. The negative interest rate environment created by the Bank of Japan, however, has thrown up anomalies that would send even the most conservative banker bonkers.
Subordinated loans, even the short-term kind, tend to be a good barometer of financial excess.
And while they aren't new in Japan, 60-year terms only began to be offered more widely in the past few years. Such tenors, in fact, are a Japanese idiosyncrasy. Only the Koreans and a handful of project-finance deals in Europe and the U.S. have attempted such a bold structure.
When banks involved in the Brady plan lent to Brazil, Mexico and Chile, they were certain they'd found a surefire way to increase shareholder returns. That's probably how Japanese lenders feel right now.
It would be healthy for them to take a step back. Being the last in line and saying upfront you're not in a hurry to be paid is no business for commercial banks.
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