Aircraft Finance - How to Understand the Options

Highlighting some of the aircraft financing

While cash deals still make up most turbine aircraft transactions today, financing remains a viable option for many, notes Conklin & de Decker’s David Wyndham.

The US Federal Reserve Board has indicated that it plans to increase interest rates gradually. Regardless, financing is very inexpensive at this time. Financial institutions tend to base their aircraft rates on the London Interbank Offered Rate (LIBOR).

LIBOR is the interest rate charged by the leading banks in London when they borrow from other banks. LIBOR currently is the highest it has been in eight years, but rates are still below 2% for their 12-month term. If you or your company has investment-grade credit, money is inexpensive to borrow.

If you plan to purchase an aircraft to be used primarily for business, you may want to have the tax depreciation benefits. In general, owning the aircraft (whether purchased with cash or finance) will give that benefit to you. If you don't need the tax benefits, however, leasing may be the best way to go.

For those seeking to finance a purchase, there is a choice to obtain financing through traditional public banks, private banks and other non-bank financial firms. (For the purpose of this article, we'll use ‘Financial Institution’ as a general term, unless the text applies to one specific entity.)

Buyers of business aircraft should be aware that public banks tend to have greater regulatory oversight and thus may be limited in some of the more creative options that other institutions can offer.

Should I Lease or Buy?

Leasing (in the form of an operating lease) offers a specific period of aircraft access with a defined, fixed-cost of ownership at a specific lease rate. The financial institution that owns the aircraft assumes the residual value risk and will have the tax depreciation benefits.

Short-Term Leases:Some financial institutions will offer short term leases of 18-24 months. Such an arrangement is particularly useful to operators waiting for delivery of a new aircraft. This solution may be easy to do if the financial institution is also involved in the new aircraft financing or leasing.

An important question when leasing is who pays for any unscheduled or major aircraft maintenance? If the leased aircraft is due for a major inspection during your lease, are you going to be responsible for 100% of the expense or will the lessor assume responsibility of at least a portion of the cost?

Long-Term Leases:The length of a lease can vary. Since the financial institution carries the risk of the aircraft’s residual value and must retain aircraft ownership at lease-end, it will price its lease terms accordingly to cover that risk. Several experts within the industry have estimated a 10-12% decline in the value of turbine airplanes, annually. Given the volatility in future aircraft values at this time, lease rates today will reflect that uncertainty.

Early Buy-Outs (EBOs) can be offered in a lease, allowing a Lessee the option to exit the lease by purchasing the aircraft. On an eight-year lease, you may have an EBO at years four, five and six (for example). The financial institution will offer the EBO at a fixed-price that covers its estimated residual value risk, and as a result the EBO can be greater than the aircraft’s fair market value at the buy-out time. With many leases you can exit at any time provided you pay off the remaining lease payments.

Leases also have requirements for the aircraft’s condition at the end of the contract.  There will be adjustments for high utilization and its impact on both the maintenance status of major components as well as the aircraft’s residual value. Many lessors (especially in large cabin jets) will require that the engines be on a guaranteed hourly maintenance program to protect the engine values. With Lessors facing uncertain futures regarding residual values, financial institutions all set the lease rate to cover that uncertainty.

Leases ultimately work best for those who:

• Have no need of tax depreciation;
• Have a fixed amount of utilization; and
• Have a fixed period for which they wish to have the aircraft.

Lease buyers should also look to financing to obtain an aircraft.

Financing:There are many different options within financing. The better the credit, the more options become available. Interest-only or large balloon payments at term-end are still available.

Some loans may have Loan-to-Value (LtV) guarantees to secure the financial institution's risk. LtV is a ratio of the loan's principal balance to the fair market value of the aircraft. The LtV guarantee typically states that the fair market value of the aircraft must be greater than the remaining loan balance.

If LtV exceeds 100% it triggers a payoff to the financial institution that brings the LtV back into a safe range for the lessor. Loans may or may not require collateral in addition to the aircraft.

The Twenty-Year Rule

Since the recession, aircraft values have remained low and there is no immediate sign of that changing. There also remains a good supply of pre-owned models from which to choose. That situation is  great if you are the aircraft buyer.

Along with new aircraft, younger used aircraft would be the preferred asset to lend against. While the change in residual value on a new aircraft can be significant, the financial institution will have a high degree of confidence that they can sell the aircraft in the event of a default from the owner.

Many financial institutions, however, are wary of having to sell an older business jet they’ve taken back from a lease or collected in default. Thus we have the ‘Twenty-Year Rule’ that states, “The age of the aircraft plus the length of the transaction will not exceed 20 years.” On that basis, a 15-year old aircraft would get a five-year loan, but not six years.

The Twenty-Year Rule is a soft rule. The more a financial institution knows about you, your intended use of the aircraft, and the technical knowledge they have about the aircraft you are considering, the more flexible the rule becomes. Regardless, a thorough pre-buy by a qualified maintenance facility (not aligned to the seller) will be essential.

Quality Matters, ADS-B Matters

Financial institutions like financing new aircraft. These are in new condition, have the latest avionics, are in warranty and should see no major maintenance expenses during the first years of use. Financing used aircraft requires more work by the financial institution. The quality of the aircraft and its maintenance status ultimately trumps its age.

ADS-B is a part of the due diligence process for a prospective aircraft buyer. ADS-B is required here in the US by January 1, 2020. On that date, a turbine aircraft not equipped for ADS-B Out effectively becomes impractical to fly.

Be warned that there is not enough capacity in all the qualified avionic shops to update the estimated 11,000 turbine aircraft still requiring ADS-B upgrade by 2020 (and that number does not include the thousands of piston-powered aircraft that also will need ADS-B Out). Lending institutions will be reluctant to finance an aircraft that does not have ADS-B Out capability unless it has a scheduled slot for the installation.

Where’s the Best Place to Finance?

Start where you currently bank. You may already have an existing relationship with one or several financial institutions that you can leverage. They know you, your business and your financials. If you have significant financial resources with one institution, it will likely work very hard to keep all your banking business with them.

Larger institutions often have an aviation banking division as part of, or even separate from their equipment finance division.

If the deal is complicated or your financial institution seems reluctant to work with aircraft, you may wish to look for a financial institution that caters to those types of transactions.

The National Aircraft Finance Association (www.nafa.aero) is a great reference for finding an aviation lender.

NAFA has teams that focus exclusively on aircraft finance and leasing, and the Association offers a product and services finder that enables  you to look up specific institutions.

Some lenders have financing specialties such as aircraft loans and leases from $1m-10m.

Another relatively new resource is FlyFunder (www.flyfunder.com), which seeks to match financial institutions with aircraft buyers in search of financing. FlyFunder uses general details of the transaction as provided by the buyer. The financial institution can review and choose to respond as "interested" to the buyer. FlyFunder’s income comes from a fee paid by the financier.

Another source to find financing may be via the aircraft dealer or broker. Many have successfully closed hundreds of deals that were financed. They may well have recommendations based on the type of deal that you need.

To Summarize

Aviation lenders are ready to make deals, but they are looking for the right deals. The money is there. As with any financial transaction, seek qualified aviation legal and tax advice before making a commitment…

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• This article features in AvBuyer's 2018 Yearbook. Read the full edition here.