““[Bill Gates] has been historically one of my best supporters…One of my favorite e-mails he ever sent me…I proposed this crazy project. And he sent back this two-line response: ‘This has got to be the craziest thing you’ve ever suggested. Please proceed.’” ”
Financing a business jet
One of the first consequences of the 2008 Wall Street meltdown was the overnight disappearance of capital. At the time, many aircraft lenders still proclaimed that they were "ready to do deals," but often they lacked the financial horsepower to deliver on that promise.
Now that's all changed. But though banks today have plenty of money to lend, there's a general lack of enthusiasm for loaning it to anyone who really needs it to buy an aircraft. True to form, bankers would much prefer to lend to buyers who don't need the financing. This has been variously described to me as a "flight to quality" and a "feeding frenzy for the best credits."
That said, there are signs that things are loosening up. Since the end of 2010, according to Craig Hannon at RBS Business Aviation Finance, the market has seemed to be more competitive, on everything from advances to terms and pricing, than it was early last year.
Meanwhile, borrowers are being as careful as banks. Some companies are reluctant to purchase assets like business jets at a time of so much economic uncertainty. Supposed stimulants for asset purchases based on tax breaks (like bonus depreciation and changes to the Internal Revenue Code's Section 179 expense rules) often have little effect simply because taxpayers aren't generating the income to make the breaks attractive. With interest rates still low (though fixed rates are creeping up), the value of super-accelerated tax depreciation, which is based on the time-value of money, is greatly reduced. Those factors, plus the trailing clouds of anti-business-jet sentiment from the 2008 meltdown, have led many prospective buyers to adopt a wait-and-see attitude about acquiring a new aircraft.
That's too bad, because prices for lots of business jet models remain low and financing remains cheap. Buyers with excellent credit can expect to obtain loans at interest rates in the neighborhood of 225 basis points over the 30-day LIBOR (London InterBank Offered Rate), or even less. Mere mortals with good credit may pay about 300 basis points. Given how low LIBOR is today, though, some banks are introducing a minimum rate for loans floating on LIBOR. Thus, if the floor is 300 basis points, a loan at "LIBOR plus 225 basis points" would actually start at 3 percent.
Fixed financing rates, which are keyed to the rate at which floating rates swap for fixed, will be somewhat higher, with the percentage inching up as the term lengthens. For this reason, fixed-rate borrowers are generally better off with a term that more closely corresponds to how long they will keep the aircraft–five years, say, instead of 10. Similarly, the era of 20- and 25-year loan amortization is over; look today for loans to amortize in 15 years or less.
An advance rate of 100 percent of the airplane's value is still possible. "For the right clients," said Jim Simpson at First Republic Bank, "we will lend 100 percent of an aircraft's value on an interest-only basis." But buyers today tend to accept that lenders want them to invest enough of their own money in the deal to provide some cushion against the possibility of dramatically falling aircraft values, and in the last few years, borrowers have generally come to tolerate a down payment of at least 10 percent.
Though financing costs are low, so are investment returns. As such, many buyers who would ordinarily finance an aircraft purchase are paying cash. Estimates of how many buyers paid cash last year range from 50 to 80 percent. Some pay cash simply because they're buying an older aircraft. The appetite for older jets as collateral is at an all-time low. Leases on aircraft that are more than 10 years old (where the lender holds title) are often hard to find, and even debt financing can be difficult to arrange on such aircraft. This is true even for banks that are died-in-the-wool credit shops; they still want the collateral value to be there "just in case." Many banks have official cutoffs for providing debt financing for aircraft more than 20 or even 15 years old.
As of this writing, 25 percent of Gulfstream IIIs, 14 percent of GIVs, 8 percent of GIV-SPs and 3 percent of GVs are for sale. The message to banks is clear: find the GV buyer. The GV has a second advantage for a lender: its higher purchase price. For the same amount of work (both in making and administering the loan), a financial institution can loan many more dollars. This can be a big plus unless the institution puts a limit on loan amounts that the financing exceeds or already has too much credit exposure with the customer.
Though many aircraft buyers are paying cash, some still have better things to do with their money than tie it up in an airplane and find the low cost of financing attractive. For the same reason, many buyers choose fixed-rate financing over floating. "People want to lock in today's low cost of money," said U.S. Bank's Pete Georgelas. "The majority of our 2010 aircraft financings were fixed-rate transactions." Still, in many ways, floating rates are even more attractive now, so buyers with a short time horizon–and buyers who think they will save more money in the near term than they will lose when rates go up later–may choose rates that float.
Not every financial institution is fixated on arranging aircraft loans with ultra-high-net-worth individuals and Fortune 100 companies. Some institutions actually cultivate a niche in below-investment-grade credits. The mission of other lenders is sometimes based on the aircraft. The focus at Cessna Aircraft Finance is on financing the purchase of new or preowned Cessna models and the emphasis at the U.S. Export-Import Bank is on financing the purchase by buyers outside the U.S. of aircraft manufactured in America.
PNC Bank has made a market in asset-based limited and non-recourse business jet financing. Tom Taormina at PNC said the asset-based product has worked well for his firm in the downturn. Assuming you can make at least a 20 percent down payment with limited recourse or 40 percent with no recourse, PNC will require no financial statements or tax returns and will impose no financial covenants. If a default occurs–and depending on which asset-based product is involved–PNC's recourse is either just to the aircraft or to the aircraft and some limited recourse.
According to popular belief, this should result in PNC repossessing more aircraft than credit-based lenders. But "our limited or nonrecourse borrowers," said Taormina, "are less likely to turn in the aircraft keys than some of our credit-based customers." Those big down payments discourage defaults; equity, apparently, builds character. Other lenders sympathetic to an asset-based approach include Prudential Capital Group and Diversified Lenders, Inc.
The alternative to paying cash or borrowing to buy an aircraft is a lease. In an operating lease, the lessor takes title to the airplane and leases it back to the buyer. This has several advantages for the buyer. First, if the buyer isn't making any money, has plenty of loss carry forwards or isn't planning to operate the aircraft in a trade or business, it can't benefit from taking tax depreciation. So the financial institution purchases the airplane instead and leases it back to the "buyer," in theory passing on the benefit of the aircraft tax write-off in its leasing business to the lessee in the form of a lower lease rate. Second, the "buyer" can walk away from the airplane at the end of the lease if aircraft values have fallen dramatically.
Proposed changes in accounting rules, however, would undercut another significant benefit of leasing. Under current rules, an operating lease isn't booked as an asset or liability on the lessee's balance sheet; instead, lease payments show up as expenses on the income statement. The net effect, referred to as "off-balance-sheet treatment," is to make it hard for investors in the lessee company to figure out that it has acquired an aircraft. Such leases are accordingly popular with public companies that aren't eager to advertise that they own a jet.
Under the proposed accounting standards, on the other hand, the lessee would treat the obligation to make lease payments as a liability, with a matching asset corresponding to the right to use the aircraft. This has the potential to be a significant blow to financial institutions like GE Capital and Bank of America that have earned a reputation for expertise in writing aircraft leases.
Back in the days of the feeding frenzy for business jet financings, loans often went from proposal to signed documents in a week. These days, business aviation attorney Stewart Pearl tells his clients who are new to a bank to allow up to eight weeks to get a loan finalized.
One reason is that banks are doing more due diligence, and the credit approval process can drag on longer. Another reason is that banks are taking a harder look at the aircraft. Though almost all financial institutions are making credit-based rather than asset-based aircraft loans, they still want the asset value to be there in case they get stuck with repossessed and off-lease aircraft with painfully depressed values (as happened to many lenders in 2008-09). Similarly, financing is much easier to obtain for newer and large-cabin/long-range aircraft, where values have held up better than they have for older and smaller jets.
The borrowers themselves can stretch out the process. One lender told me that aircraft buyers are fussier today about financing terms and recalled that a customer requested 24 separate proposals from the lender for the same financing. While such diligence is often commendable, devoting too much time to the financing may not only kill the loan deal; it may kill the aircraft deal altogether. A purchase can fall apart if the buyer doesn't have his financing on tap when the aircraft is ready for closing, so Pearl advises clients to plan ahead. "When a client wants financing for an aircraft purchase," he said, "I often suggest that he get in touch with the banks as soon as possible. Even if there is no specific aircraft purchase to evaluate, just providing financial information to the bank can save time."
As many bankers will acknowledge, the changes to business aviation finance in the last few years have been positive. The super-heated atmosphere of 2007 has given way to a more normal and healthier finance market. Financing for your business jet purchase is likely to be available, though it may take a little extra effort to find the best loan for you.
This article is an update of one that appeared in BJT's February/March 2011 issue.