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NAFA member Adam Meredith, President of AOPA Aviation Finance Company, shares what's important when financing your aircraft.
Thanks to recent, historically low interest rates, AOPA Aviation Finance (“AAF”) has been approached more and more frequently with similar versions of the same story. It goes like this: Somebody they know got a fantastic offer with a phenomenal rate--like 2.9%--on their latest airplane acquisition. Then they want to know if they can get the same deal. When we tell them the reality of that happening is extremely slim, disappointment is always the resulting sentiment.
Here’s why deals like that just don’t happen. A bank must make money on the loans it services, otherwise it fails. It costs banks money to acquire the money they loan to customers. The rate they pay for that money is called the “cost of funds.” For example, they might buy a five-year note from the Treasury at 1.66%. That is their cost of funds. The difference between the lending rate charged to their customers and a bank’s cost of funds is the “net interest margin.”
That net interest margin is a bank’s primary income stream. All expenses, from salaries to rent to utilities, etc. are debited from that net interest margin. Those healthy reserves banks must maintain to cover losses from bad loans also come out of that same source. Even though the cost of funds for each bank is unique to their circumstances, that figure is typically based upon a universally-recognized benchmark like the overall yield curve of the US Treasuries.
For illustrative purposes, let’s say the bank bought five-year Treasury notes @ 1.66%. Their cost of business is 166 basis points. Typically, banks tend to start lending at 200 basis points above their cost of business. Let’s face it, that starting point is for a bank’s best customers—folks with cash collateral, amazing credit, are well-known to the bank, etc. Doing the math, 200 basis points above a 1.66% cost of business equals 366, or 3.66%, so….
For a bank to offer a client a 2.9% interest rate, or 290 basis points, on an aircraft loan, given the above example would mean the bank would have to be willing to reduce its net interest margin from 200 basis points to only 124. What would possess a bank structure such a “skinny deal?” After all, as one of my graduate school finance professors used to repeat incessantly, “There’s no free lunch.”
A deep-pocketed client who is very familiar to the lending bank and whose investments are already being fee-managed by that bank could be one reason a bank might make an exception to the rule. AOPA Aviation Finance recently brokered a super mid cabin, new aircraft deal valued at over 20 million dollars. The borrower had an existing relationship with a bank where AAF had an existing relationship with its aircraft group. The bank wasn't aware that our client was looking to purchase an aircraft, and the client wasn’t aware his bank had an aircraft financing group.
Because we had relationships with both, we were able to articulate the reasons for keeping the deal in-house. The bank was already very familiar with the client and his financials; the bank’s aviation group had done several deals of this size and type before; the client’s substantial financial holdings with the bank allowed the bank to stipulate, and the borrower to agree to, using his accounts as collateral for the loan.
Banks love to leverage liquid assets over the airplane. It’s much easier to reach into an account to make oneself whole if a loan goes bad than it is to sell an aircraft, no matter how popular the model. And not insignificantly, pointing out that allowing another bank to finance the aircraft would open the door to that other financial institution potentially enticing the client (and their money) away, helped motivate our client getting, far and away, the most competitive rate and best structure possible.
Still, that’s a very rare, real world example. That said, AOPA Aviation Finance may find great deals for folks who’ve got investments with certain lenders. At the end of the day, whether your financial situation is typical or “unicorn,” our process will match you up with the best lender for your circumstances.
This article was originally published by AOPA Aviation Finance Company on December 10, 2019.