JAL bankruptcy? Poised on a knife edge as the government plays hardball


As we reported yesterday, the Enterprise Turnaround Initiative Corporation of Japan (ETIC) has now told the Development Bank of Japan and three major banks that they should be prepared for JAL to file for protection from creditors. According to the Nikkei, ETIC would then become a potential "sponsor" of the airline.

This reverses what had previously looked like a near-certain underwriting of JAL by the government, in order to avoid the unpredictability inherent in a collapse. But the position of Mr. Seiji Maehara, Japan's Transport Minister, has weakened significantly in the face of strong opposition to using taxpayers' money for a bailout. He was the leading voice supporting the underwrite.

The strongest opposition now comes from the Ministry of Finance and from Deputy Prime Minister Naoto Kan, who has his eye on a general election next year. Mr Kan believes that taxpayers' memories will stretch that far - and, importantly, that the electorate would not look favourably on a costly intervention on behalf of the airline (and its staff) when all others are suffering from the downturn. Both Mr Fujii and Mr Kan were members of the five minister team who in Nov-2009 had agreed on a JAL bailout, but they have now changed direction, refusing to guarantee the airline's loans.

Putting together a budget for next year has proven gruelling; 77 year old Finance Minister, Hirohisa Fujii, was admitted to hospital on Monday, suffering from exhaustion after completing the draft budget, which was approved on 25-Dec-2009. The change of heart over a JAL bailout has apparently emerged as the final touches were put to the USD1 trillion budget.

Preparing for bankruptcy in early Jan-2010?

According to sources in the Ministry of Land, Infrastructure, Transport and Tourism (MLITT), the government is considering a bankruptcy option which would keep the airline operating, in a Japanese form of US style Chapter Eleven creditor protection. They don't want to see JAL stop flying, but a protected bankruptcy operation would necessarily involve a considerable downsizing, in order to satisfy future lenders and investors.

Tokyo's tabloid newspapers have been predicting all this week that JAL will fold early in the New Year, but, while it cannot be counted out, this may still be a premature judgment. Nonetheless, JAL's shares have slumped to their lowest level this year, ending yesterday down 8.3% at JPY88, as investors feared a devaluation of their holdings under a bankruptcy scenario. At one stage the shares fell as low as JPY85.

Japan Airline share price: 01-Jan-09 to 29-Dec-09

The scramble to sell may yet be reversed, especially if the airline' pensioners act quickly to agree to cuts in their entitlements (see below), as a more orderly out of court restructuring is still a real option.

But the renewed uncertainty creates ever-widening ripples. The new bankruptcy concerns appear certain to force a downgrading of the carrier's credit rating, and already the premium it must pay to insure its loans has increased significantly; credit default swap margin spreads have reportedly widened by as much as 40 basis points. There is no immediate threat of default on loans, after JAL announced last week that it had raised new loans to cover imminent bond redemptions.

The impact of increased loan costs will however weigh heavily on the airline's future, given its extremely high debt burden. Additionally, the major banks which have been persuaded to support JAL in recent months are reportedly less than pleased by the news that there is now to be no government guarantee for their loans.

No resolution of the one world/SkyTeam battle yet

In the event of bankruptcy and any sharp reduction in airline size, the government would be anxious not to allow a scramble for any airport slots consequently released at Tokyo's capacity constrained airports. Likewise, as both ANA's and (prospectively) JAL's anti-trust immunity applications for inter-airline cooperation on Pacific routes are heard in the US, authorities there will be anxious to ensure that any reallocation is performed transparently. That for example was not the case when the 10,000 new Narita slots for use from Mar-2010 were recently simply reallocated en bloc to ANA.

Equally, as American and its oneworld partners on the one side and Delta and SkyTeam on the other, jostle for position as JAL's future partners, the slot issue will also be vital.

But there will be plenty of other issues if bankruptcy is the course followed. This status can make things messy for the contenders. Lobbying, always a key part of the Japanese system, will be keenly pursued by all concerned, and the fact that "Chapter Eleven-Japanese style" is not a frequent process would make that activity all the more alluring. For the future of JAL it will be important to maintain integrity of process however. Notably, if major foreign airlines are to invest heavily in the carrier, due process and reasonable certainty of outcome will be essential.

Pensioners ready for the worst

One key demand of the government, which has remained consistent throughout, has been the need to reduce the airline's pension commitments. Many JAL retirees now feel that acceptance of the company's demand to cut pensions is inevitable. Already groups of retirees are lobbying others, urging acceptance. They are making phone calls, sending e-mails and faxes in a frenzy of activity. One of the factors behind their urgency is that same recently changed tone of the government's attitude to JAL's restructuring.

A group of some 30 former JAL Vice Presidents, now retired, yesterday emailed around their retired colleagues, urging acceptance of management's proposed pension reduction. The deadline for the final vote is 12-Jan-2010 and by that date it is hoped that the necessary majority to support the cuts will have been reached. If this were quickly resolved, it might help influence the outcome - for example, avoiding a bankruptcy filing - but, as things unravel, it may be too late to save the day.

Even if the retirees do reach the necessary agreement, JAL remains precariously perched on a knife-edge, a position that becomes more dangerous - and complicated - with each day.

It seems that, whatever happens now, the government is going to find itself unpopular on all sides, as it seeks to navigate a course between undermining a national icon, offending major bank creditors and alienating popular opinion by using taxpayer funds to extricate itself from this complex, multi-dimensional problem.

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