Hesh Wiener, author and publisher of Computer & Communications Buyer, explains what he warns is the most severe financial crisis in the mainframe business since the Itel bankruptcy in 1979.
As a consequence of a very weak market for used IBM 3380-AA4 and B4 disks, numerous lease-related financial transactions are under water. The problems for lenders who backed the leases is very bad, and they will soon grow worse: IBM is expected to add new, larger disks to its 3380 series, machines that can each store 7.5 gigabytes of data. The new disks will further reduce user interest in the original 3380s, which have only 2.5 gigabytes of storage. Banks and other institutions provide much of the capital used to fund disk leases. As IBM shipped its original 3380s, hundreds of millions of dollars in loans were written as part of leasing transactions. Some of these loans, particularly the ones made within the last two years, are now at risk.
The ones that will give lenders the most trouble are the so-called balloon loans. These loans – made to lessors but usually arranged so that the lenders can look only to the equipment as collateral – consist of monthly payments for several years followed by one big payment to clean up the unpaid balance. The last payment is called a balloon. The amount of the balloons varies, but $20,000 to $25,000 per disk is not unusual. The monthly payments were geared to the original leases, and were made by users whose disk rental cheques were passed to the lenders. The lenders expected that at the end of their original leases, the leasing companies who found users for the 3380s in the first place could arrange new deals. These new agreements were supposed to bring in more than enough money to cover the balance of the debt and thus pay off the balloon. The risks taken by lenders were assessed using forecasts of disk residual values that indicated that the loans were safe. Until recently, they were. Three- and four-year balloon loans repaid in 1985 and early 1986 demonstrated a good margin of safety for the lenders: when leases ended, the disks were worth a lot more than the balloons that were due. Those earlier loans, however, have no bearing on current conditions, as lenders are beginning to discover. The used 3380 market has crashed, and the disks on which balloons are due this year cannot easily be turned into the $20,000 to $25,000 in cash needed to cover balloon payments. Based on conditions in the used equipment market, a typical 3380-AA4 or B4 is worth $14,000 to $15,000, which is $5,000 to $10,000 less than the amount lenders need in order to recover their investments. Off-the-record estimates made by financiers in the leasing business put the number of disks funded with balloons expiring in 1987 or later at something between 10,000 and 20,000 machines. This is a lot of iron, even though it is only a small part of the worldwide installed base of 2.5 gigabyte 3380s, which industry expert Jim Porter estimates at 175,000 to 200,000. As the balloon-funded disks come off lease, lenders could suffer losses of between $50m and $150m, maybe more. The lenders won’t go after users for this money, but anything that starts as a problem for the leasing industry will eventually create difficulties for end users.While the used equipment market’s disdain for 3380s is the immediate cause of some lenders’ problems, it is also an effect of other circumstances. The fall of the 3380 is symptomatic of the unhealthy climate in mainframe computing in general and the large disk market in particular. Users, lessors and lenders were unprepared for the sudden decline of a market that had been robust only a few years ago. Neither, it seems, was IBM, which depends on a healthy used equipment market to help its leading users migrate to newer, larger disks.According to Porter, IBM may have wound up 1986 with 3380 inventories of around 10,000 machines. Porter’s Los Altos, California, company, Disk/Trend Inc, publishes three annual reports on the disk business covering rigid, flexible and optical disks. Porter ex
pects IBM to sell only 3,700 single-capacity (2.5 gigabyte) 3380 units in the US during all of 1987, compared with 11,600 in 1986. Sales in the US of IBM 3380s with 5 gigabytes or more capacity per unit – Porter forecasts some improvements in 3380 capacity – will reach 31,000 this year; last year IBM sold fewer than 22,000 5-gigabyte boxes in the US market.
Exacerbate the losses
Once IBM has run down its inventories, it can announce and ship what will be the last disks in the 3380 line. Porter believes these 7.5 gigabyte disks are ready now, and await only a go-ahead from IBM’s honchos for release into the market. IBM will gain some time on the plug-compatible makers, and maintain its leadership until it is ready to retire the whole 3380 line. New technologies will enable IBM to replace the series with more compact, more reliable, faster and less expensive devices by 1990 at the latest. Along the way, a fast-access disk with capacity of 2 gigabytes or less is likely to be offered to mainframe users with heavily transaction-oriented applications. All of these developments will please users, but exacerbate the losses of investors that had bet on a long life for the 3380. While the losses won’t be as bad as those on suffered a decade ago on 370/168s and 370/158s, the current problem is the most severe since those days when Lloyd’s bet heavily and foolishly against progress in the computer business. Unlike the Lloyd’s affair, the current situation will not allow the losers to pin the blame on outsiders. Lloyds could at least point to Itel, the large lessor that went bankrupt as its losses came to light, and use that company’s demise as an excuse for its own bad judgement. The financial institutions now preparing as best they can for the inevitable losses they face will have to own up to the greed and ignorance of their own executives in this matter.