In delivering a course on Advanced Cash Management yesterday, we always have a portion about Notional Pooling as a variation on cash-collateralised lending, and an explanation of Risk-Weighted Assets and credit risk generally. I usually bring on the example that no lender should advance funds to a low-cost airline without security, because low-cost airlines also tend to be low-capital airlines, and with their profitability depending on achieiving a high re-sale value of their aircraft once they are four or five years old.
I was dumbstruck to hear from one of the course participants that banks are lending to low-cost airlines against “security” in the form of an assignment of landing slots that the airline has contracted at various airports.
One has to assume, within the EU at least, that the airline is actually paying the airport for the slot and not the other way round. Some years back there was a test case where Brussels-Charleroi airport was paying the airline to attract traffic to it, the benefit from which was that the passengers spent money at the airport and in the locality.
If the airport is paying the airline for the slot and the airline is raising loans secured on that slot, the security is a liability and not an asset!
Anyway, assuming that it is the airline that is paying, the security is a perfect example of correlation: the security entails the same risk as the borrower. Airlines go down in times when airline passenger numbers decline. If a low-cost airline flying into Eindhoven goes down, what are the chances that the bank can find a replacement airline to take over that slot into Eindhoven and at a reasonable price? One cannot imagine that alternative airlines are queuing even now, in a buoyant market, to take over those slots.
Indeed, what are the chances that the bank can actually “re-possess” the landing slot and re-market it itself? Is a bank permitted to take ownership of a slot and control it, or do they need an IATA registration to do that? Even if the bank or its agent can become the legal owner, does the asset carry with it a “use-it-or-lose-it” clause, whereby the bank would have to start to use the landing slots or give them back? In other words the bank might have to start running flights itself if it wanted to retain its security. Then it had better make sure that it has slots at another airport too, or else its planes will need to remain airborne over Eindhoven for the elapsed time between their take-off and landing slots.
An assignement of landing slots is exactly the kind of security that loses its value when it is foreclosed upon: that is the meaning of correlation.
Unlike an aircraft – which one way or another can be re-marketed globally if it is re-possessed – a landing slot is tied to one airport, and its value stands or falls on the passenger demand to fly in and out of there. Many airports used by low-cost airlines (like Frankfurt-Hahn and Stockholm-Skavsta) were substantially invented by the airlines themselves, and stand or fall on the low-cost airline that has espoused them.
One despairs of a banking system that allows this kind of lending. One hopes that this type of “secured loan” is not eligible for Quantitatve Easing loans at the Bank of England or the European Central Bank, but I would not bet my own money on that.
The Bank of England’s “Funding for Lending” scheme is the main source of liquidity for banks lending into the UK housing market.
The biggest user of “Funding for Lending” – Lloyds Bank – has recently launched a big drive (literally) to expand its portfolio of car loans. Its offer papers specify this is not a lease but a personal loan secured on the car. Lloyds, not experiencing a growth of retail deposits, can be expected to have found a way of creating a car-backed debt instrument that meets the criteria of “Funding for Lending”, just as it can create mortgage-backed debt instruments which the Bank of England will re-finance.
Let’s hope that banks are not able to create landing-slot-backed instruments that can be re-financed under “Funding for Lending”. “Funding for Lending” is a scheme that merits far greater scrutiny from the Treasury Select Committee, since, on the mortgage side, the constellation is familiar: originator institutions like Lloyds create mortgage-backed debt instruments that are charged to the Bank of England, who pay out against them with funds drawn from wholsale sources.
In this constellation the Bank of England is acting towards Lloyds as Granite St Peter Port Guernsey did towards Northern Rock Building Society.