Compressing the Spread

 - October 18, 2006, 5:23 AM

Interest rates for aircraft loans and leases are typically negotiated individually for each case, so lenders rarely publish their rates. Aircraft type, the value of the specific aircraft, its intended use, its location and the financial standing of the client, along with the down payment and length of the loan, all figure into the interest rate.

Lenders use a variety of indices to establish a starting point for the rate, although the borrower could sometimes specify a particular index. Traditionally, many U.S. lenders use the prime rate for simple domestic loans and one of the London Interbank Offered Rates (Libor) for more complex domestic and international loans. Fixed loans are often based on the five- or 10-year U.S. Treasury bill rates or the Libor swap rate, while variable- rate loans may be based on the prime rate or one of the floating Libor rates.

Today’s low starting points for interest rates, as determined by the various indices, have stimulated buyers. But lately there’s been another factor working in borrowers’ favor–competition within the finance industry. Said James Dickerson of Banc of America Leasing, “With the strength of the corporate aircraft market in the past two years, we have seen numerous new aircraft finance entrants.”

“This is the keenest competition I’ve experienced in 20 years,” said Greg Babcock of U.S. Bancorp Equipment Finance. “There’s more money chasing fewer deals and driving down the rate spreads to lenders and lessors. This has produced artificially low rates on new and pre-owned aircraft loans and leases.”

Though this is good news for buyers, it has made the lenders’ job more difficult. Whatever the index used as the basic rate for a loan, the lender tacks on “the spread,” basis points that make the loan worthwhile for the lender. If the spread becomes too small, it makes more economic sense for the lender to invest the money elsewhere. But the influx of new players into the market has forced lenders to accept smaller and smaller spreads just to get the business.

Dickerson said, “With growing demand for a limited supply of aircraft and an increased number of competitors for the financing, the cost of financing has decreased, causing a significant compression of margins for aircraft lenders.”

Susan Foster of National City Commercial Capital said several regional banks have entered the market, and David Davis of 1st Source Bank said that lenders without aircraft experience “will figure out some way to do the loan” when a current corporate customer or wealthy client asks about financing the aircraft. “They obviously want to keep the business in-house if they can,” he explained.

Said Babcock of U.S. Bancorp Equipment Finance, “The net effect [of this interest rate and yield compression] will be a shaking out of the corporate aviation finance industry with fewer lenders in the future.”