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2018 marks one decade since the global economic downturn brought an abrupt end to the prosperity the business aviation industry had been experiencing. OEMs had been riding a bubble of exuberant prosperity that saw a record 1,317 business jet deliveries in 2008, but that changed swiftly.
At NBAA’s annual convention in October of that year, the usually bustling show floor took on the atmosphere of a funeral home lobby, with small groups discussing in hushed tones the latest financial market casualties. Before the crash, the super-heated business jet market had some models of used large-cabin jets selling at a premium, above new list price, to those who felt they couldn’t wait for their slot in the production backlog. That dynamic had many industry financiers scrambling to make deals as fast as they could, in many cases requiring borrowers to put forward little to no down payments, leaving the lenders shielded by only the seemingly unassailable value of the jets themselves. In the words of one industry veteran, “If you had a phone, you got a loan.”
That frenzy might have lulled some experienced lenders into a false sense of security, which manifested itself in their relaxing loan criteria. It also attracted many inexperienced lenders to the market, drawn by the seemingly depreciation-proof aircraft assets. “Before the crisis, business aviation was essentially a perpetually growing industry,” explained Donald Walsh, senior vice president for business aviation with Stonebriar Commercial Finance, adding that aircraft values had to that point proved resilient across economic cycles. “The corresponding sense of safety was reflected in investment decisions, [and] in the quest for growth, many finance providers, banks and non-banks, stretched and expanded into each other’s space. For a while, overheated capital and aircraft markets camouflaged the risks. But once the crisis hit, the industry was suddenly retrenching, capital seized, and prices fell at unprecedented levels.”
Many aircraft buyers during those frothy times soon found themselves underwater as private jet values tumbled in the aftermath of the recession. What was once so coveted became easily available, as owners looked to unload their aircraft for a variety of reasons, ranging from personal or corporate financial distress, to the resulting decline in flying hours as companies looked to conserve cash.
The percentage of business jets for sale worldwide hit a high-water mark of 17.67 percent of the fleet in July of 2009, according to statistics from industry data provider JetNet. Many finance providers suddenly found their lending portfolios cratered with aircraft that were in some cases worth half of their previous value.
“Throughout the period, lessors experienced residual write downs on their lease portfolios, lenders were forced to write off losses in their loan portfolio, and others either exited aviation financing or cut back substantially,” said Rudy Tenore, president of V2 Aviation Consultants. “The larger and more established lenders weathered the crisis and continued to provide financing alternatives.”
With their aircraft worth less than what was owed on them, some borrowers simply parked their jets and walked away, leaving the lenders to clean up the mess. “The crisis and its ensuing impact on the business aviation market reminded everyone that business aircraft are depreciating assets that do, in fact, lose value over time, ” said Ford Von Weise, director and head of global aircraft finance at Citi Private Bank. “Business aircraft values experienced a huge asset price bubble that the crisis quickly deflated and taught everyone that business aircraft values are just as volatile as [those of] other financial asset classes.”
With an abundance of used aircraft flooding the market, the airframers slashed production accordingly, with the total annual deliveries of new business jets not exceeding 874 in any year since that banner 2008 output.
Even a decade later, the effects on the aviation finance industry have not entirely faded. “There are a few financiers who are still living with the multi-year transactions that were booked in the run-up to the financial crisis,” explained Michael Kahmann, principal at Kahmann Consulting. “For lessors, this is seen in residual positions that exceed fair market value and an attendant requirement to re-lease aircraft rather than sell and immediately recognize the residual loss.” For loans, he noted the equivalent would be balloons that are greater than fair market value and therefore require “re-writes” to bleed down the banks’ book position over time.
A DIFFERENT TIME, A DIFFERENT MARKET
Today, the business aviation landscape is much different. That swollen preowned inventory has dropped nearly in half, to less than 9 percent, according to JetNet. Prevailing wisdom has long demarcated 10 percent as the dividing line between a seller’s and a buyer’s market. Indeed, those plentiful young, used bargains that were present in the market just a few years ago are now gone. That has led to the long hoped-for stabilization in prices. “That’s really where we see the recovery today,” said Paul Cardarelli, JetNet’s vice president of sales, at NBAA’s annual convention in October. “It’s trending to be an increasingly strengthening seller’s market.”
Used aircraft inventory, along with economic factors such as gross domestic product, corporate profits, and wealth creation, have long been tied to the health of the industry. Business jet deliveries have historically been tied to leading economic indicators such as the U.S. GDP and the Dow Jones Industrial Average, and using that metric, new aircraft deliveries are lagging. The U.S. has now had 35 consecutive quarters of GDP growth, while the Dow reached 26,000 for the first time in January, and saw a peak of 26,828 in early October. The Standard and Poor’s 500 hit the 2,900 mark for the first time this past summer. The U.S. unemployment rate, which hit 10 percent in October 2009, has steadily declined since then, reaching a nearly 50-year low of 3.7 percent in September. “We are finally beginning to see a sustained recovery in business aviation aircraft values that is reflective of the overall very strong economy,” said Citi’s Von Weise. “While some in the industry believed that the old metrics used to assess the health of the industry were no longer relevant, aircraft values did not increase in lockstep with the GDP, equity markets, and other historically linked indices.”
While those once-strong correlations may have frayed somewhat over the past decade, they can’t yet be disregarded entirely, according to Kirsten Bartok, managing partner of AirFinance. “They do still apply; however, what we now see is the industry is truly global,” she told AIN, adding that while the U.S. currently accounts for more than half of the overall business aircraft market, it can’t support the industry alone. “If one economy stumbles, that can impact global unit sales, especially for new aircraft. While the U.S. economy can be strong, if the Russian economy stumbles, if we see an Asian economic flu, or the commodities tumble, that does impact sales.”
CASH IS KING
Cash remains the preferred method for purchases of jets in the U.S. According to JetNet data, of the more than 2,350 FAA-recorded business jet transactions over the past year, little more than one-fifth involved financing, down considerably from the 40 percent-plus seen in the years before the economic downturn. After that point, aviation financing became more restrictive as lenders tightened their loan criteria. “During this period, buyers found themselves having a very hard time finding financing, which pushed them to use cash,” said Wayne Starling, the former senior vice president and national sales manager for PNC Aviation Finance, who was recently named as executive director of the International Aircraft Dealers Association (IADA). “That moved the cash buyers to the highest percentage of all times. Today, if you take enough time, you can find a financing program to assist you to buy almost any type and age aircraft you want.”
“Many business jet buyers pay cash because even though aircraft are expensive acquisitions, the price is still insignificant to their profile,” said Stonebriar’s Walsh. “It also simplifies the closing process and potentially adds negotiating power. For the ones that do consider financing but don’t need to finance, whether pre- or post-closing, the decision usually comes down to an optimal use of cash analysis.”
The trend of using cash for aircraft purchases accelerated in the aftermath of the economic downturn. “With interest rates at historic lows over the past 10 years, cash acquisitions were running as high as 75 percent,” explained Tenore, an industry veteran with more than a quarter century of experience. “Currently in a rising interest rate environment and a strong equity market, cash is being redirected into investment opportunities and other capital expenditures.” As result he added, there has been an increasing level of demand for financing and refinancing requests of late.” Another trend that is increasing, according to many in the aircraft finance industry, is customers closing the deal in cash, and then seeking financing at their leisure.
For those qualified customers, there are still plenty of eager lenders. “Financing is coming back in vogue as business people realize there is plenty of financing available,” noted Sam Harris, president of Jetloan Capital, who sees the pendulum swinging to the point where it may once again reach the 50-50 balance between cash and financing, last seen in the fourth quarter of 2004.
Liquidity is present in the market and funding is readily available from a variety of sources including the traditional major lending banks, smaller regional banks, and new companies that have carved out a niche specializing in aviation finance. “Many of the larger banks tend to view aviation finance as a means to attract and retain high-net-worth clients, explained David Labrozzi, chief operating officer with Global Jet Capital, which entered the market in 2014 and acquired GE Capital’s Americas business aircraft portfolio the following year. “Although there continues to be substantial liquidity in the market, when it comes to business aviation finance, banks have continued to adjust their business models to focus on relationship banking through corporate and ultra-high-net-worth clients,” he told AIN. “In some ways liquidity is more focused in this regard and allows a benefit and credibility to aviation-focused non-bank lenders.”
While some long-time major financiers such as GE, CIT, and Element have left aviation finance, some new players are entering the arena, attracted by the recent rebound in sales activity and prices. “It’s only in the past 18 to 24 months we have seen new lenders previously not in the aircraft finance space start to explore the market,” said Marc Yahr, vice president with L&L International, an aircraft brokerage that also provides financing through a partnership with CMG Capital.
“There are several new lenders in the industry as financial institutions continue to search for ways to diversify their balance sheets,” agreed Robert Kent, president of Scope Aircraft Finance, adding that barriers to entry are high for a bank that does not have the requisite expertise. “Borrowers are justifiably leery of putting their faith in an inexperienced provider.”
“Occasionally we see a smaller regional bank tiptoe into the small-to-midsize space, but there hasn’t been a new [major] entrant since Global Jet Capital,” said Bartok. “With the exit of CIT, Element, and GE, the overall effect is we still have fewer lenders.” She attributes the hesitancy of some lenders to enter the market to new capital requirements and the need to show regulators evidence of liquidity.
As an example of a smaller lender, there is Seacoast National, a Florida-based community bank with nearly a century of history. It moved into the aircraft finance arena fairly recently, expanding its marine and recreational vehicle loan division due to customer demand in the mid-2000 boom years. The company, which just joined the National Aircraft Finance Association (NAFA), survived the downturn and remains active in the aviation finance market.
“Our typical customers are high-net-worth business owners or professionals and small-to-medium-size corporations who are looking to purchase these assets,” explained Phillip Bartholomew, the bank’s yacht and aircraft finance specialist. “Our loans are typically up to about $9 million, which encompasses a huge percentage of the aircraft sales market.” He said the company manages to compete against the major aircraft financiers in the mid-Atlantic, the Northeast, and Europe by understanding the market for the collateralized asset and the customer’s needs.
“We don’t have a one-size-fits-all loan program,” Bartholomew noted. “Instead we spend a great deal of time earlier in the conversation trying to decide what’s going to work best for the customer and then crafting a solution for them.”
THE CURRENT CLIMATE
While long term loans and little-to-no down payments that were hallmarks of the pre-downturn era have largely disappeared in the years following, very secure borrowers can still find virtually any terms they want. “Since the crisis, the average term seems to have settled in around five years,” Walsh told AIN. “Before the crisis, seven to ten years was common.”
He noted that down payments and amortization periods can vary quite a bit depending on the transaction merits. “As a ballpark, 90 percent-plus advance, with a 20-year amortization is possible for a superior credit profile, and a 75 percent-plus advance with a 10 year-plus amortization could be expected for an asset-based structure,” which involves confidence in the asset (aircraft) value, the aircraft manager, and the structure of the deal as the primary form of repayment or exit strategy, rather than the wealth of the client, which is how banks generally underwrite.
In the Federal Reserve Bank’s most recent quarterly survey of senior loan officers, more than 17 percent of the respondents noted that they had somewhat eased their commercial and industrial loan standards for large and middle market firms (those with annual sales totaling $50 million or more) over the past three months, as compared to the just 1.4 percent that reported they had somewhat tightened their standards.
For smaller firms with sales of under $50 million, 3 percent of the lenders said they tightened their loan application standards, as opposed to the more than 10 percent, which indicated they had eased their criteria. In terms of the spread of loan rates over their institution’s cost of funds, for loans to large and midsize firms, 42 percent of the bank officials said they had narrowed the gap somewhat, making the lending terms more attractive to potential borrowers, while 10 percent reported increasing the spread.
“The financing market has once again become very competitive with many lenders reducing loan covenant requirements and offering extremely competitive interest rate spreads, combined with very high loan to value [ratios],” stated Von Weise, who is also the president of NAFA.
Another change from the pre-downturn era is that the time it takes to arrange financing has generally lengthened as lenders face much more scrutiny of their deals. What was once a matter of days has increased now to several weeks in most cases, to even months, as the lenders satisfy their anti-money-laundering and know-your-client (KYC) guidelines. For lenders, the regulatory penalties for making a mistake on a client’s trustworthiness can be severe.
While it is not a regulated bank, Global Jet Capital, which specializes in operating leases, still must adhere to those regulatory standards, especially because half its clients are outside the U.S. The company uses a network of third-party researchers to investigate the finances of potential clients abroad. “It gets a little dicey, but the work has got to be done,” Labrozzi told the audience at the JetNet iQ Summit in June.
Keith Hayes, senior vice president and national sales manager for PNC Aviation Finance, speaking at the annual JetNet iQ Summit this past summer, described how some customers will work with a broker for months to locate a suitable airplane, sign a pre-buy letter of intent, and go through the pre-buy inspections before thinking closely about how they will pay for it. “Then they come to us and say can we get financing on it, we need to close in two weeks,” he said. “Quite often, especially with our asset-based product, we can do that. But under a fully underwritten transaction, it’s very difficult.”
With the level of financial scrutiny now required, most lenders wish to be involved sooner rather than later in the process, which will contribute to a more trouble-free closing. “We add the most value when we’re engaged early,” said Joseph DiLallo, head of corporate aircraft finance and leasing with BMO Harris Equipment Finance. “Once we have the borrower’s financial statements and details on the jet, we can typically propose within a week and close within a month.”
For all lenders, the elephant in the room remains residual values. “Anyone who says they can predict long-term residual values with any level of certainty is not being truthful,” said Tenore. “All of the industry experts badly missed their targets during the last economic downturn.” He explained that the variables that can influence residual values are numerous and beyond the industry’s control. “Obviously, the longer you project out, the less the accuracy in the forecast. Add in geopolitical risk, economic downturns, new technologies, a restrictive regulatory environment, and an unprecedented event such as a major OEM bankruptcy, and residual value forecasting becomes very difficult,” he told AIN.
The past decade was marked by precipitous depreciation of aircraft residual values, the curve for which, at least for some models, has finally begun to flatten. “There are recent developments to suggest we are entering a more stable atmosphere,” said Walsh, noting that over the past 12 to 18 months the preowned market has rebounded as international buyers have become educated about the value of used aircraft and U.S. buyers are more willing to consider purchasing a previously foreign-operated aircraft.
PNC’s Hayes agreed that while the depreciation spiral has slowed on some aircraft (large-cabin, young, and U.S.-registered), he isn’t ready to make any blanket assumptions of residual values. “I think you truly have to look at every single deal, every single plane, every single age of the plane and make the determination based on that asset.” He told AIN that 2018 is shaping up to be a banner year for the company, which has closed more transactions annually since 2009 than any other aviation finance company in the U.S. and that this year’s activity is as high as its ever been in period since the downturn.
“People are concerned about what is going to happen in 2019,” Hayes said. “As the used market drops down to single-digit inventory levels and you get past the U.S.-registered fleet to aircraft with less desirable pedigrees, and as used prices begin to rise in some cabin sizes, at some point used aircraft buyers will take a more serious look at buying new aircraft.”
As the pool of young, pre-owned aircraft continues to dwindle, the criteria of what constitutes an “old” aircraft has not changed in the minds of many lenders. “From my perspective, age is a guideline but should not be viewed as a redline for lending or not,” said Kahmann. “To me, an old business jet is and always has been primarily one that will be difficult to remarket if repossession is required.”
While most prefer to lend on jets 15 years old or younger, there are always exceptions. “There’s more to it than just age,” said DiLallo. “While our guideline keeps us focused on zero- to 15-year-old jets, there are some five- or 10-year-old jets we won’t finance, and certain 16- to 18-year-old jets that we may be comfortable with, based on the specifics of a particular jet and the specifics of the particular borrower.” Buyers may feel that such aircraft are bargains in the current market and in many cases won’t seek financing, but should they do so, lenders will make sure they are properly insulated.
“Financing risk levels increase on older aircraft for a number of reasons, including but not limited to higher maintenance costs, regulatory restrictions, and new and more efficient replacement models,” said Allen Qualey, senior advisor and president emeritus of 1st Source Bank’s specialty finance group. “In cases when they are financed, terms of the financing are less attractive.”
Another looming concern for older aircraft is the U.S. mandate for ADS-B equipage, which will take place at the end of 2019. According to MRO provider Duncan Aviation, as of the beginning of October, only 52 percent of the U.S.-registered business jet fleet had been upgraded to ADS-B compliance, while only 30 percent of turboprops had been so equipped.
“I think this is an issue that perhaps has not been fully appreciated by financial institutions, either with respect to lending requirements on new deals or with respect to managing transactions in those institution’s portfolios,” said Bartok. “The growing realization seems to be that there may not be enough maintenance slots remaining over the next 15 months to accommodate all of the planes that need these technical upgrades, and as a result, a lot of planes will either be grounded or operated in a suboptimal fashion after the deadline passes.”
Given those options, experienced lenders are taking proactive steps. “We closely monitor every jet, and every borrower in our portfolio,” said DiLallo. “For every jet we have financed, or consider financing, the jet is either already NextGen-compliant or there is an agreed-upon plan and timing to become compliant.”
Once again, as new lenders move back into the periphery of the market, some see old habits beginning to creep back in. “I don’t think as an industry we have learned much, as memories fade and newcomers who have no experience jump in with both feet without doing their homework,” Qualey told AIN.
“Some lenders have begun to go back to the same inappropriate long amortizations and light down payments that caused problems after 2001 and again after 2008,” said Kent. “Each cycle, as the market heats up, lenders begin to make concessions as they chase loan volume.”
IADA’s Starling offered a warning to potential lenders: “Do not get caught up in trying to win business by out-structuring a deal outside what your guidelines are,” he said. “If losing one deal is going to create a major problem for you, then you probably already have a problem.”
APPRECIATION FOR DEPRECIATION?
At the end of December 2017, the Tax Cuts and Jobs Act went into effect, and in addition to slashing the tax rate for corporations, it increased and extended bonus depreciation for business aircraft through 2026, and expanded its benefits to include used aircraft that meet the appropriate criteria.
Aircraft placed in service after September 27, 2017 could be eligible for 100 percent expensing, according to Troy Rolf, an attorney with GKG Law. He notes that for qualified aircraft placed in service on or after January 1, 2023, the bonus depreciation rate under the Act will be reduced and phased out over a number of years according to the following schedule:
• 80 percent for qualified property placed in service after December 31, 2022 and before January 1, 2024
• 60 percent after December 31, 2023 and before January 1, 2025
• 40 percent after December 31, 2024 and before January 1, 2026
• 20 percent after December 31, 2025 and before January 1, 2027
• and 0 percent (bonus expires) for aircraft placed in service after December 31, 2026.
Some have attributed this act to helping spur the recent preowned boom. “The IRS rule changes, namely the ability for a 100 percent write-off against earnings for new and preowned aircraft purchases, has provided a further boost and is contributing to the sustainability of the recovery,” said Walsh.
Others believe the results are yet to be seen. “If someone could use the [depreciation] tax benefits before, they can use them now, and if they couldn’t use them before, they can’t use them now,” said Keith Hayes, senior vice president and national sales manager for PNC Aviation Finance. “We have had a lot of discussions and think there will be a lot of activity in the fourth quarter, driven by the requirements of bonus depreciation and the longer time it has taken this year to do the tax analysis, driven by the changes in the law that accompanies the purchasing decision.”
Before making their decision on depreciation, buyers have some important factors to consider, according to Nel Stubbs, vice president at industry research and data-provider Conklin & de Decker. “While this may sound like a good tax break to an aircraft buyer, the question remains, can I take this 100 percent deduction on my tax return?” she said. “Some things that should be considered when asking this question are, is the aircraft ordinary and necessary and can the buyer meet the 50 percent qualified business use of the aircraft for subsequent years?” Stubbs added that there may be heightened IRS attention on the business’s tax return that could trigger an audit as well. “Remember: just because the 100 percent bonus depreciation is available, this large of a write-off in one year may not be for everyone and the modified accelerated cost recovery system (MACRS) depreciation schedule may be the better option for the buyer.”
This report was originally published on AINonline on November 21, 2018.