NAFA member, Adam Meredith, President of AOPA Aviation Finance Company, explains the supply side and demand side for aircraft loans.
Think of the supply side as AOPA Aviation Finance clients—people in the market to buy an airplane.
From our perspective, pilots need loans, so they should be the demand side. From our perspective, banks offer loans, so they should be the supply side. It’s actually flipped. Lenders represent the real demand side in this market. It’s a counterintuitive concept, I know.
In previous articles, we’ve talked about Fed rate changes from the perspective of the borrower, the actual supply side. We’ve talked about how the expectation that a lowering of Fed short-term money, usually 30-day money, may not correlate to a lowering in interest rates on long-term money (5-, 10-, 15- or 20-year).
There are two general reasons why: One is the Fed tends to signal its intent far enough in advance that lenders price in that new rate for subsequent loans. Another is due to a lender’s cost of business. Let’s say a lender requires a spread in its aircraft loan portfolio of 200-235 basis points above their cost of money to stay afloat. If their cost of money is 2%, then their average lending rate will need to be 4.35%. A Fed rate lower than that will simply not work.
Does that mean lenders miss out on lending opportunities? It depends. If a finance company is in the market for making loans, then yes. But if they’re not, then no. The “no” depends upon their appetite, or demand, for loan-making.
We think that banks are always in the mood to make a loan. After all, loans are a bank’s assets, and who wouldn’t want more assets, right? But there are unusual times, there are environments and there are situations when a bank has little or no appetite to assume more loans. This is one of those times.
The current pandemic and its deleterious effect on both the global economy and on Wall Street have banks concerned about what 2021 will look like. Couple that with the fact that the current low interest rate atmosphere has many banks already booked solid on loans as well as being at the lowest end of their profit margins on those loans, and we find ourselves in a unique moment where banks are willing to avoid the risk inherent in making aircraft loans.
The Fed dropping rates to historic lows will not always prime lenders to increase demand, regardless of a ready pool of pilots eager to transact deals. It doesn’t happen often, but uncertain times like these might even encourage lenders to raise rates to discourage lending until uncertainty eases.
This article was originally published by AOPA Aviation Finance Company on January 27, 2021.
