RBS Aviation Sale to Sumitomo Mitsui Is Credit Negative for Japanese Banking Group, Credit Positive for RBS

RBS Aviation Sale to Sumitomo Mitsui Is Credit Negative for Japanese Banking Group, Credit Positive for RBS

Last Tuesday, Sumitomo Mitsui Banking Corporation (SMBC, Aa3 stable; C/A3 stable),5 Sumitomo Mitsui Finance & Leasing Company (SMFL, unrated) and Sumitomo Corporation (A2 stable) announced that they had reached an agreement with Royal Bank of Scotland Group plc (RBS, A3 negative) to acquire the UK bank’s aircraft leasing unit, RBS Aviation Capital. The $7.2 billion acquisition of one of the industry’s largest specialists in leasing and financing aircraft includes assuming the unit’s existing debt, and is credit negative for the Japanese banking group.
The asset sale is credit positive for RBS, which has steadily decreased its non-core third-party assets (excluding derivatives) to £105 billion at the end of September 2011 from £258 billion at the end of December 2008.

Sumitomo Mitsui Financial Group, Inc. (SMFG, unrated), one of Japan’s big three banking groups, owns 100% of SMBC and 60% of SMFL, while Sumitomo Corporation holds the remaining stake of SMFL. The deal will result in SMFG effectively owning about 70% of the acquired aviation unit, with the rest going to Sumitomo Corporation.

The acquisition will have a limited effect on SMFG’s balance sheet. The total acquisition, represented by the unit’s total assets, will be equivalent to 0.4% of SMFG consolidated assets and 9% of its Tier 1 capital. Sumitomo Corporation will also share part of the acquisition cost and financial burden for its equity stake. However, the aircraft leasing business has a higher-risk profile than core banking operations owing to the cyclicality of aircraft demand and volatile secondary market prices of underlying assets in general.

This is an instance of how current attempts by European banks to reduce their non-core assets to comply with more stringent regulatory capital adequacy guidelines are providing Japanese banks and companies an opportunity to grow through acquisitions. Furthermore, this illustrates the geographic shift of financing sources for aircraft lessors from Europe to Asia in recent months. As an example, European banks, especially UK, French and German banks, have historically been major providers for aircraft commercial loan financing, but avoided making new commitments in recent months, while Asian financial institutions have stepped up their loan participations.

The aircraft leasing business has good growth potential because of increasing global demand for airplanes owing to growing demand in emerging markets and planned fleet replacements in the developed markets, as well as expected further growth of leasing as a percentage of total aircraft financing.
SMFG and Sumitomo Corporation already have an aircraft leasing joint venture, SMFL Aircraft Capital Corporation B.V. in the Netherlands (unrated) that they established in December 2008, with 60% owned by SMFL and 40% by Sumitomo Corporation. We view the acquirers as industry practitoners with existing knowledge of the business, which is a strong mitigating factor against the inherent risks of this acquisiton. More importantly, this acquisition will allow the duo to quadruple the size of their existing aircraft leasing operation and provide the needed capacity to expand their share in this growing market.