- 23 Apr 2020
- Rohit Jaggi
- Finance - BizAv
Find out more about the available sources for financing private aircraft acquisitions. Rene' Armas Maes explores the five main sources, and how they may be impacted by the COVID-19 pandemic.
Typically, business jets can be financed through a number of traditional and non-traditional mechanisms. Five common ways to finance aircraft are:
For many years, market liquidity and multiple sources of financing have been readily available for Business Aviation clients and prospects. Furthermore, the financing market has shown a tendency to be highly competitive with many players able to lend money using tailor-made structures to meet their client’s needs.
As a result, loan covenant requirements have been reduced, with competitive interest rates offered to access a larger segment of potentially-qualified borrowers.
Financing Aircraft with Cash: Cash payment in full has traditionally been the preferred mechanism of payment for any party that sells goods. With cash, hefty discounts and additional value-added options can be negotiated, particularly for buyers working directly with OEMs.
In addition, cash purchases can bring important tax benefits since no interest payment deductions need to be made. Overall, this method of purchase simplifies the closing of a transaction.
However, when a business jet is not paid in full (using cash), but more than 40% of the asset’s value is placed as a down payment, a lower interest rate can be negotiated and secured.
Financing Aircraft with Debt: When considering a credit-based deal, the difference between bank-issued debt vs. capital market debt is primarily interest rate.
The former needs to issue debt (i.e. bonds) and as a result will expect a higher margin, so higher interest rates can be expected. For capital market debt, however, a large bank should be able to customize a lower interest rate since it is likely to use readily-available funds.
Financing Aircraft via Lessors/Finance Companies: A number of leasing products including operating leases, finance leases, tax-oriented leases, synthetic leases, and sale/leaseback transactions are common – depending on a client’s needs and profile.
Non-bank finance companies’ interest rates can be higher than those of commercial banks, since they are primarily backed by private sources which require higher transaction margins.
However, lessors/finance companies can typically show greater creativity, risk appetite and flexibility in structuring deals to meet a prospect’s financing objectives (i.e. cash flow management and more).
Financing Aircraft via ECAs: Export Credit Agencies (ECAs) such as US Export-Import Bank (Ex-Im), Export Development Canada (EDC) and the European agency covering 36 countries offer loans or financial leases.
ECAs offer key government-backed guarantees, and in many cases are needed to close deals for second- and third-tier credits, as well as for new aircraft leasing companies.
Buying Aircraft with OEM Financing: As a fifth option, you can be sure OEM financing arms will be competing with all the other financing options discussed.
It Comes Down to the Borrower’s Needs…
It is important to note that the strategy of using cash or other funding sources available depends largely on an individual’s, or corporation’s liquidity requirements, cash flow and wealth-management needs.
Prospects should factor in market conditions and conduct analysis of which financial instrument brings stronger returns.
How is COVID-19 Impacting the Financing Sources?
Today, with many economists expecting the larger global economies to go through a depression, global ‘earnings-per-share’ cuts occurring, and corporate profits expected to deteriorate over the next 12 months owing to COVID-19, sources for business jet financing are predicted to dry up somewhat.
COVID-19 Impact on Cash Purchases
As investor cash levels at banks continue to grow, cash continues to be king. Today, a common cash-backed loan instrument can be found in the ‘back-to-back’ (B2B) transaction, a two-party arrangement by which a bank advances a loan to a corporate or private banking account, based on the client’s top-tier deposit and liquid assets with the bank.
As an example, imagine an individual’s cash and liquid funds at the bank are $100m, and the jet it intends to buy costs $30m. The bank loans up to 99.9% of the business jet value to the customer. Since that amount is already in the bank, either through cash deposits and/or liquid assets, there is no major risk of the client defaulting.
Consequently, the bank can lend the money to the client at a very attractive floating rate (perhaps just 1%). This type of deal works well in two ways:
In the case where a client requests a fixed rate, a B2B swap would be the best instrument for negotiating when a bank is unable to offer a fixed rate tailor-made solution.
Depending on the severity of the COVID-19 impact, and assuming low interest rates and economic downturn will be the ‘new norm’ (at least for 2020), B2B cash guarantee transactions could accelerate significantly.
Over the next 12-18 months as many as 50% of aircraft purchases could be represented by this financial instrument.
COVID-19 Impact on Export Credit Agencies (ECA)
Exports Credit Agencies will continue to offer business jet financing despite any fall-out from COVID-19. The average business jet deal has been extended to ten years as lenders try to minimize monthly payments to avoid loan defaults. (Previously, seven years was the norm.)
Moreover, ECAs may well engage in monthly payment and deferral negotiations with clients, and are expected to show flexibility in this regard, like the banks have started to.
Finally, ECAs should continue to provide an important support to the industry since it fills the gap when global economies are faced with market peaks and troughs, including liquidity crunch during uncertain times like these.
During the next 3-6 months a lower number of potential deals are likely to be structured as financial instability impacts both buyers and agencies, and in particular causes asset depreciation.
COVID-19 Impact on Debt (Banks and Capital Markets)
In these COVID-19 ravaged times, the leading global banks are anticipating a large number of bad loans as clients take a financial hit from the pandemic, and they are planning to set aside billions of dollars in reserves for potential loan defaults.
Deteriorating aircraft values and price softening are also concerns to the banks. Aircraft values are hard enough to predict in ‘normal’ market conditions.
The impact of COVID-19 is bringing a new set of challenges since there are too many uncontrollable variables and unknowns, including GDP contraction, future market corrections, currency devaluations, inflation, interest rates, bankruptcies, jobs losses, and more.
As business jet residual values and price softening are expected to continue, most banks will seek to minimize their exposure, becoming less willing to lend money due to the uncertainty not only of asset value itself, but the financial health of the client, too.
For existing loans, the banks are starting to execute some creative payment deferral plans to avoid defaults.
They’ll become more flexible to renegotiate debt terms and offer payment options for distressed clients, as opposed to having assets on their books in a flooded pre-owned business jet market.
Other strategies to avoid default could include cutting fees, extending loan timelines (reducing monthly payments) and allowing borrowers to skip a few months’ payments altogether.
We may see fewer deals ahead in the financing segment. Similarly, commercial loan standards are expected to be tighter with less favourable terms. For the present, most banks are unlikely to seek to increase their aviation portfolio risk until more is known about the impact on aircraft depreciation in the post-COVID-19 world.
An example of pre-COVID-19 bank and ECA financing, and the possible impact of the coronavirus on the respective financing structures is represented here:
Impact on Lessors/Finance Companies
It is expected lessors/finance companies will maintain the same position as banks and be less willing to lend money in order to protect themselves from loan defaults. It’s possible that a few dedicated aviation lenders will be opened for new deals as falling prices, loan defaults and repossession risks increase.
The acquisition of a business jet is never a decision to be taken without first researching your options thoroughly. Today, economic instability, asset deflation, residual value uncertainty, and pricing volatility all bring additional challenges when considering the financing sources available.
Now, more than ever, prospective borrowers should seek expert advice and do their due diligence when entering the aircraft financing market.
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