The main lenders to Japan Airlines plan to accept a restructuring package that would require the carrier to file for bankruptcy, sources said, increasing the likelihood of a state bailout this month.

A state-backed turnaround fund plans to establish a credit line of more than 600 billion yen ($6.5 billion) along with a state-owned bank to ensure JAL can keep flying once a bankruptcy is announced, a source with the knowledge of the matter said.

Reflecting growing concerns over the potential fallout from a bankruptcy, the Yomiuri newspaper said the government plans to tap diplomatic channels to reassure the 35 or so countries to which JAL flies that it would support the carrier.

JAL, weighed down by $16 billion in debt and mired in losses, applied in late October to the Enterprise Turnaround Initiative Corp of Japan, a body of restructuring specialists that can tap state-backed funding to bail out ailing companies.

The ETIC has proposed putting about 300 billion yen in fresh capital into JAL, provided it file for bankruptcy and creditors agree to waive around 350 billion yen in debts, sources told Reuters earlier this week.

JAL's main creditors, which include Mitsubishi UFJ Financial Group <8306.T>, Mizuho Financial Group <8411.T>, and Sumitomo Mitsui Financial Group <8316.T>, countered with a proposal that would avoid bankruptcy, eager to limit their own losses.

But with the ETIC holding firm that bankruptcy is the most transparent way to deal with JAL's problems, the banks will almost certainly agree to the ETIC's plan, three people with knowledge of talks between the banks, government and ETIC said.

JAL needs 300 billion yen and the ETIC is the only one that can provide it. If the ETIC is pushing for a court-led restructuring, then we have to accept it. Otherwise JAL will collapse, said one of the sources, adding that banks had been given a deadline of January 15 to agree to the plan.

A bankruptcy could complicate talks with Delta Air Lines and American Airlines , which are courting JAL with rival offers of financial aid, eyeing a stronger foothold in Japan and close ties on overseas routes.

Both American, which partners with JAL in the Oneworld alliance, and Delta, which is trying to get it to defect to the SkyTeam group, have said they would invest in JAL whether it goes through bankruptcy proceedings or not.

JAL spokeswoman Sze Hunn Yap and the ETIC declined to comment. No one at the state-owned Development Bank of Japan or the three private lenders could be reached for comment.

TIMING

The ETIC is eyeing some time between January 19 and 22 for JAL to file for bankruptcy and for the ETIC to officially announce its plan to support the carrier, sources have said.

The ETIC is keen to have its restructuring plan in place at that time so as to minimize potential disruptions to air travel during the college entrance exam season, which runs from the second half of January through March.

The timing also coincides with the start of the next parliament session on January 18.

Dealing with JAL is one of a long list of problems facing the Democratic Party of Japan, which took power in September after beating the long-ruling conservative rival on a platform that promised to focus on the interests of consumers and workers.

Prime Minister Yukio Hatoyama declined to comment on Friday about when the government would make a decision on JAL, but stressed that it would work to prevent disruption to flights. JAL accounts for the bulk of air traffic in Japan.

We need to think about customers, Hatoyama told reporters. We have worked so far to avoid disruptions to flights as much as possible and we will continue to try to do so.

Underscoring the depth of JAL's problems, the ETIC has estimated JAL could post a net loss of 1.23 trillion yen this financial year due to restructuring, leaving it with a negative net worth of some 840 billion yen, a source said.

During the three-year timeframe set for rebuilding the carrier, the ETIC has proposed cutting about 13,000 jobs and slashing more domestic and overseas routes, a source said.

The ETIC is planning to have JAL file for protection under the Corporate Rehabilitation Law, a process similar to Chapter 11 in the United States. Normally this would lead to a complete reduction in capital, rendering JAL shares worthless.

But the ETIC is considering a plan to keep JAL's shares listed on the Tokyo Stock Exchange, a source said, news that has helped support JAL's stock. The carrier still has a market value of around $2 billion.

(Additional reporting by Taro Fuse, Yoshifumi Takemoto and Yoko Kubota in TOKYO and Archana Shankar in BANGALORE; Editing by Nick Macfie)

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