““CEOs go to their vacation homes just after companies report favorable news, and CEOs return to headquarters right before subsequent news is released. More good news is released when CEOs are back at work, and CEOs appear not to leave headquarters at all if a firm has adverse news to disclose. When CEOs are away from the office, stock prices behave quietly with sharply lower volatility. Volatility increases immediately when CEOs return to work.” —David Yermack, a New York University finance professor, whose recently released study shows a correlation between when CEOs take their private jets on vacation and movements in their companies’ stock price ”
Should you finance your aircraft purchase?
Interest rates remain at historic lows, in part due to the Federal Reserve Bank’s continued efforts to keep them there. Doesn’t this mean that you should finance your next business jet purchase?
A good case can be made for doing just that. A jet owner I spoke to recently seemed interested in upgrading to a bigger, more expensive airplane simply to have an excuse to borrow money. Rates won’t stay low forever. If you can finance a jet purchase at an attractive rate for the next seven years, there’s a pretty fair chance that will look like a good deal at the end of the term.
You might expect that a jet buyer who wants to take advantage of low interest rates would choose a fixed-rate loan. But Ford Von Weise at Citi Private Bank said that most of its clients opt for floating LIBOR indexed rates. Ultra-high-net-worth borrowers can finance the purchase of a business jet today at a rate that’s well below 2 percent.
On the other hand, it’s hard to justify borrowing if you have a lot of cash. While low interest rates make loans cheap, they also minimize investment returns. Money markets and certificates of deposit earn almost nothing, and though longer-term debt investments may offer higher returns, they involve substantial risk. Warren Buffett reportedly said recently that long-term government bonds today are “the dumbest investment.” When rates go up, as someday they surely must, the price of those bonds will fall. A lack of good conservative investment options causes some jet buyers to invest their cash in a new aircraft.
This is the reverse of the situation a few years ago. In 2007, before the crash, a growing group of lenders competed ferociously to finance aircraft purchases. Good collateral, blue-chip borrowers and the possibility of other business opportunities proved irresistible to many lenders. All that changed when the market crashed in 2008, and aircraft finance has been slowly rebuilding ever since.
Of course, if you don’t have cash, financing may be the only way to buy the aircraft. Many high-net-worth individuals have their money locked up in illiquid investments, such as securities of privately held companies or restricted shares in public companies. Those securities can often be pledged to secure a loan to acquire an airplane. When a “liquidity event”—the sale of a business, for example—is on the horizon, borrowers often plan to pay off the aircraft loan at that time.
Perhaps the best reason to finance your purchase is that you may have better things to do with your money than tie it up in an airplane. Though many conservative investments are showing low returns, less conservative ones obviously still offer earnings better than 2 to 3 percent per annum. Investors were gun shy for a while, but as one lender told me, more people now want to pursue higher-risk, higher-reward opportunities. Financing your purchase lets the bank tie up its money in a conservative investment while you pursue a more aggressive investment strategy.
But you should avoid being stuck in an unattractive financing. If the plan is to take advantage of ultra-low floating rates in the near term, consider adding an option to switch to a fixed rate if it looks as if rates will be going up. If the long-term strategy is to pay off the debt when interest rates rise to a level that makes the financing unattractive, avoid loans with blackout periods and prepayment penalties. According to Von Weise, Citi often allows its aircraft loans to be paid off at any time without penalty.
In part, a readiness to permit repayment of aircraft loans reflects the fact that the profitability of aircraft finance has been compromised by the capital reserves and liquidity requirements that banks—especially “systemically important” ones like Bank of America, Citi and Wells Fargo—are being required to keep pursuant to the Basel III accords. (See my article on the “Changing Face of Aircraft Lending” in BJT’s February/March 2013 issue.) Given the razor-thin margins of profitability on many aircraft loans, a bank may be delighted to discover that a borrower wants to pay one off.
Another reason to finance an aircraft acquisition cited by lenders is to avoid the risk of taking a loss on the purchase. One aircraft finance veteran told me that he is seeing many companies—Fortune 500 companies, for example—lease aircraft that never would have dreamed of doing so in the past. A lease typically offers a definite payment structure for a definite period of time, with no residual risk. When the lease ends, there’s no finger pointing at the company about why the aircraft turns out to be worth a lot less than expected. If its value has plummeted, that’s the lessor’s problem.
Moreover, the pending changes to lease accounting rules are unlikely to take effect until 2016 or 2017, according to aviation CPA Glenn Hediger, so in the meantime, leases still provide off-balance-sheet treatment for companies that don’t want to highlight possessing an aircraft. If you can’t use the tax-depreciation benefits of an aircraft purchase, a lease also has the potential of passing those benefits to you in the form of lower financing costs.
If you plan to lease, a factor that may make financing easier is the availability of bonus depreciation for factory-new aircraft delivered this year. This lets you write off the whole purchase price, assuming you’re eligible for bonus depreciation and can satisfy the special tests in 2013 for the 100 percent version. If you fail those tests but are otherwise eligible, you can still qualify for 50 percent bonus depreciation for factory-new aircraft delivered in 2013 and 2014. This allows you to write off a total of 60 percent this year in most cases, since you’re entitled to an additional 10 percent based on the normal MACRS depreciation schedule for the remaining 50 percent of the cost. If your financial institution buys the aircraft and leases it back to you, however, that institution gets the benefit of the bonus depreciation.
Bankers Like Some Airplanes More than Others
Lenders pay close attention to the cost, age and model of the aircraft. Suppose you’re buying a 1983 Challenger 601 for $1.5 million. It may be a perfectly good aircraft at the right price, but it won’t be attractive to a lender. First, it is well beyond the age tolerance of most lenders, who are looking for airplanes that won’t be more than 20 or 25 years old when the financing ends. Second, it is in a buyer’s market: almost 23 percent of Challenger 601s are reportedly available for sale or lease at present. No lender wants to have to resell an aircraft like that when the lease ends or the airplane is foreclosed on. Finally, the bank will put at least as much work into this $1.5 million financing as it would into financing a $50 million Global 6000.
As a result, one bank whose rep I spoke to has three tiers of aircraft: most desirable, somewhat desirable and undesirable. Factory-new or relatively new large-cabin and long-range models like the Global 6000, Gulfstream 550 and Falcon 7X inhabit the first category. For qualified buyers, the bank will work hard to win that business. Buyers of aircraft in the “undesirable” category will mostly likely have to go elsewhere for financing.
Will they find it? Maybe, but they’ll have to know where to look. Financing for a problem aircraft, a problem buyer or a problem structure probably fits in best at certain non-bank companies willing to take higher risks for a greater return. But with rates as low as they are, even these financings may prove more attractive than you expect. It doesn’t hurt to look.
Private and Commercial Banks and Affiliates
Banc of America Leasing
Global Corporate Aircraft Finance
Michael T. Amalfitano
CBI Leasing, Inc.
Commerce Bank N.A.
Lake Forest, Illinois
Sean K. Patrick
Chase Equipment Finance, Inc.
Chad E. Colby
CIT Aerospace Business Aircraft
Michael J. Kahmann
Citi Private Bank
Global Aircraft Finance
Ford von Weise
City National Bank
Aircraft Finance Group
Deutsche Bank Private
Private Aviation Finance
David W. Rodin
Fifth Third Bank Leasing
First Republic Bank
James F. Simpson
First Source Bank
Key Equipment Finance
Corporate Aviation Finance
Patti Ann Sullivan
PNC Aviation Finance
RBS Asset Finance
Manchester, New Hampshire
Donald A. Synborski
SunTrust Equipment Finance & Leasing Corp.
Corporate Aircraft Finance
John J. Amato
U.S. Bank Equipment Finance
Capital Equipment Group
Pete J. Georgelas
Wells Fargo Equipment Finance, Inc.
Corporate Aircraft Division
Robert C. Lebano
Other Financial Institutions
Cessna Finance Corp.
Export-Import Bank of the United States
Robert F.X. Roy, Jr.
GE Capital Corp.
Corporate Aircraft Finance
Brent P. Godfred
Guggenheim Partners, LLC
Business Aircraft Investments
Prudential Capital Group