What banking arrangements will best serve an airport operator’s international expansion plans? IBOS Banking Association’s Bob Lyddon provides some tips.
A recent raft of banking regulatory changes has altered the banking landscape for companies operating internationally, and for companies with big projects to fund, such as new airports, who might reasonably have expected to be able to tap into international banks.
That will be a concern to airport operators with new infrastructure to fund. In the past several financial centres housed their own marketplace of wholesale banks willing to take participations in large syndicated loans, and the home country of the bank would not be determinant of its appetite for the size and location of the borrower.
The globalisation of banking in this form is going into reverse gear. This operates on two levels.
Firstly, as regards day-to-day services, international companies need to find alternatives to either a bank that can do something everywhere or everything just somewhere.
Collaboration amongst different banks will be a key determinant of ability to offer service to international clients. Banks’ international business models are coming under simultaneous attack from different angles. There will be fewer individual banks capable of supporting the day-to-day side in any but a small number of “home markets”.
Secondly, as regards lending criteria, banks are having their ‘target markets’ more narrowly defined in all the dimensions of geography, industry, credit quality and facility type. The London syndicated loan market has historically contained hundreds of banks whose main role was to build an asset book in which to house surplus liquidity. Centres like Luxembourg and Paris would have their own specialities but were still part of a large and liquid global market.
There may have been compartments of the market specialising in aircraft, shipping, energy, telecoms and so on, but these were facilitators to cope with the volume: they were not niches.
Importantly the interest basis was always London Interbank Offered Rate (LIBOR), because funding was readily available on that basis and because these banks had no retail deposit base. The funding side, for example the 3-monh LIBOR market, was highly liquid, with banks prepared to take large exposures on one another as well as on end-borrowers.
But now the banking model of an overseas branch funded on LIBOR-based liabilities is under attack from several angles.
Firstly there are the concerns that banks have around one another’s credit risk. The LIBOR market has become far less liquid in terms of amounts, and the tenors are now 1-month and below. This means that banks will be having trouble funding the current loan book without central bank support, and they will be experiencing a mismatch between the 3-month LIBOR that the loans are pegged to and the 1-month LIBOR of their funding.
For new airports this can only mean fewer potential bank lenders, smaller amounts and a more frequent interest re-set.
As if this was not enough, regulators are designing and implementing new ways of ensuring stability, with parlous consequences for international lending.
The UK Banking Commission is not the only regulator-based initiative to consider an enforced separation of ‘risky’ and ‘non-risky’ activities, either completely or so as to isolate the one from the failure of the other.
Banks’ overseas offices have housed diverse activities such as venture capital and proprietary trading under one roof with day-to-day banking and syndicated lending. Any divorcing of the two both puts up costs and these will be passed on to borrowers in the form of higher interest margins.
These overseas offices are also under threat from recently introduced increased capital adequacy requirements under the heading Basel III. On one level these rules simply increase the cost of lending by imputing higher capital to each piece of risk-attracting business, pushing up loan margins and inducing banks to try to pay less for deposits. That affects all banks.
But there is a new element, which will be hitting international banks the hardest. These are the rules around ‘unstable deposits’ which compel banks to set aside a percentage of deposits in low-interest bonds, as a defence against a run on deposits.
Overseas branches of banks tend to be bought-money banks, meaning their liabilities are unstable, bought in from other banks, corporate or institutional investors at a price relative to LIBOR, and for a fixed term of one to three months.
The market is yield-driven. The bank has no branch network in the country and so has no retail deposit base. All its funding would count as ‘unstable’.
These regulatory attacks have to be considered against banks’ rationale for establishing international presence to begin with.
Banks have generally been interested in airport finance because it is a type of asset not available in the home market, so it offers risk diversification, yield enhancement or simply an ability to house surplus deposits in big size, in a project with public backing.
Airport finance is a typical activity housed in a wholesale banking division which, if it is outside the home country, is a branch that that is a bought-money operation, probably with very low capital but also historically quite low costs: the bank was able to spin quite a big wheel on a small capital and cost base, with no worries about funding.
Now all the drivers for that have gone into reverse:
• Banks are short of capital generally;
• The market, especially the interbank market, is short of liquidity;
• Both the asset and liability sides of the balance sheet are having extra costs imposed;
• The operating structure of an international bank may have more cost imposed on it e.g. by the UK Banking Commission;
At the same time governments are putting pressure on banks to deploy what capital they have at home and not overseas: an erosion is taking place.
International banks will be narrowing their client lists, reducing the target market definition, and not allocating credit lines behind types of lending that do not follow the new model.
The upshot is a thinner market of bank lenders available to fund the new airports that will be needed to support projected traffic growth.
A further complication would be where lenders did not have a subsidiary or branch in a suitable location for the borrower: the borrower might find itself compelled to gross up its interest payments to lenders because of the withholding tax rates defined in the Double Tax Treaty between their own country and that of the lender (worse still if there is no Double Tax Treaty).
When it was a borrower’s market, a lender without a suitable office might establish one – for instance, an in-country branch – in order to alleviate withholding tax. Now that it is a lender’s market, the message might be ‘borrow from me on my terms or get your money somewhere else if you can’.
This is not a promising picture and airport sponsors would be well advised to consider the future unreliability of the international syndicated loans market. The alternative sources could include:
• The large indigenous banks in the airport’s country, who at least have a retail deposit base and who are under pressure to concentrate their lending in the “home market”. The price may not be as welcome as in the past, but the liquidity should be there;
• Non-bank sources – direct issuance of bonds to investors, secured with public guarantees or with hypothecation of cashflows;
• Development banks: for example in the EU the European Investment Bank is planning to introduce a new instrument called a Project Bond which is issued direct to investors, but under an EIB guarantee. In other words the public guarantees and hypothecation of cashflows are made in the EIB’s favour, and the EIB’s ‘AAA’ S&P credit rating is assigned to the bonds. EIB bonds are highly liquid and rank as central bank money, so the amount of money available via this conduit should be substantial. And of course a new airport within the EU falls exactly into the category of infrastructure project that it is the EIB’s objective to support;
• Islamic funding, possibly for the moveable assets required by the airport; Islamic funding is a niche market and only available for certain types of transaction, but a new airport is a large enough undertaking to permit specific portions to be dealt with in this manner;
There are big changes afoot in the structure of the international banking market, and this has a direct impact on the available sources of funding for new airports.
Borrowers will increasingly need to look to sources other than commercial banks to access funds, without forgetting the large indigenous banks who are under an edict to direct their attention towards their ‘home market’.
About the author
Bob Lyddon is managing director of the IBOS Banking Association, He can be contacted at firstname.lastname@example.org 07939 132 341 http://www.ibosassociation.com