As economy picks up, so too will aviation financing rates

 - October 4, 2007, 10:25 AM

Unlike insurance rates, which are decreasing slightly or at least stabilizing, aviation financing rates have apparently bottomed out and were on the rise last month.

However, like home mortgage rates, interest rates for aircraft are still near historic lows. What direction they go next is impossible to predict accurately, but current economic conditions seem to point in a continued upward direction.

Joe Dini, group manager of Merrill Lynch Capital’s business aviation finance division in Bedford, Mass., said the “tenor and tone” of the May meeting of the National Aircraft Finance Association (NAFA) indicated an upswing of activity. “Prices of used aircraft have stabilized, the manufacturers are booking orders and the telephones are ringing for financing. After a couple of down years, we expect this year to be level and to see an uptick in 2005.”

With some 45 members, NAFA represents about 90 percent of the major lenders and lessors in domestic general aviation finance. Another 45 or so banks do one-off loans or leases every year. Dini just took over as president of the association.

“The low rates of recent years were an economic incentive for many clients,” said NAFA past president James Dickerson, who is the national marketing executive for Bank of America’s aviation division. “Interest rates have ticked up, but we have not seen any slowdown in activity. Last year was a record year for us, and we expect to meet or exceed that activity this year. Lenders are optimistic about the future of the general aviation market.” He sees the firming of pre-owned aircraft prices as a particularly good sign. “In February, for the first time in three years, the Aircraft Bluebook and Vref reported that used aircraft prices were flat or up and the supply had dropped from 17 or 18 percent to 15 percent.”

The recent increase in rates even seems to be stimulating financing activity somewhat. Said Bill Allen of Center Capital, a financial institution in Bedford, Texas, “We’ve seen some customers who were on the fence, waiting to see if interest rates would go up or down, and actually making the decisions to buy now that they’ve seen rates going up.”

Dickerson and John Newton of Cessna Finance in Wichita said they’re seeing more people requesting fixed-rate loans rather than the variable-rate loans they had been seeking for about the last year. Others are converting their variable-rate loans to fixed rates. Another unusual aspect of the current market, said Newton, is that many banks are staying in the aircraft lending business because they have amassed large capital deposits during the recession. “This money needs to be put to work, so banks continue to lend on aircraft, yachts and other large-ticket items,” he said.

Finding out what current financing rates are, or even average rates, is just about impossible. Although some finance organizations will publish specified rates as part of a marketing program over a fixed period, most rates are negotiated one-on-one.

Aircraft type and the value of the specific machine being financed, its intended use, its location and, of course, the financial standing of the company or individual seeking the loan or lease are all relevant when determining the interest rate.

Lenders use a variety of published indices to establish a starting point to determine the interest rates they charge, and the borrower will sometimes specify a preferred index. In the U.S., many lenders traditionally use the prime rate for relatively simple domestic loans and one of the London Interbank Offered Rates (Libor) for more complex domestic and international loans. Lenders often index variable-rate loans to the prime rate or one of the floating Libor rates (30- or 90 day, for example), while fixed-rate loans are often based on the five- or 10-year U.S. Treasury bill rates or the
Libor swap rate.

Many people, while familiar with the prime rate, don’t realize it is not set by Alan Greenspan, chairman of the Federal Reserve Board. Instead the Federal Reserve sets the interbank interest rate, which drives banks’ prime lending rate. The Libor rates are benchmark interest rates used for many adjustable-rate mortgages, business loans and financial instruments traded on global markets. “A lot of Fortune 500 companies, which are used to dealing with Libor rates, will ask to use them when financing an aircraft purchase,” said Newton. “Cessna gives the customer the choice of which index to use, but we try to use the prime rate and the three-month Libor rate primarily.”

Allen said Center Capital’s rates depend on the transaction. “For fixed-rate loans, we generally use a Treasury note or longer-term rates, while for variable-rate loans we generally use one of the shorter-term floating Libor rates. But what rates we use really depends on the individual transaction, so it’s hard to make blanket statements.”

Whichever index is used, the lender will tack on basis points (the “spread”) to come up with the rate charged the customer. For example, if the current Libor rate is 1.1 percent and the lender adds 400 basis points, the interest rate the customer will pay is 5.1 percent. If this is a variable-rate loan, the interest rate will be adjusted on the time basis agreed, such as monthly, quarterly or yearly. Dini said a high-risk customer might end up with a 500-point spread, while a customer considered to be a very good risk might receive only a 150-point spread.

Typical aircraft loans are for five- to 10-year terms, with amortization from eight to 20 years. Allen said lenders will frequently structure loans with a balloon payment at the end of the term. For example, instead of taking a straight five-year loan, which could–depending on the loan amount–require rather hefty monthly payments, a buyer could take a 10-year loan with a large balloon payment at the end. This has the benefit of lower monthly payments.

What often happens, said Allen, is that borrowers will refinance the loan when the balloon payment comes due. Loans with a 15- or 20-year amortization period and a balloon after five or 10 years provide even lower monthly payments and are attractive to borrowers needing to preserve cash flow.

Hot Issues

As reported elsewhere in AIN this month, general aviation manufacturers last month applauded the Senate’s passage of the Jumpstart Our Business Strength (JOBS) Act, which contains a provision extending for another 12 months–throughout all of 2005–the accelerated bonus depreciation “place in service” date for newly purchased general aviation aircraft.

The accelerated bonus-depreciation program will expire at the end of this year unless the House of Representatives follows the Senate’s lead and President Bush signs the bill. Several airframe manufacturers credit accelerated bonus depreciation with helping to improve sales and deliveries last year and during the first part of this year.

Dickerson of Bank of America said the accelerated bonus depreciation has clearly been a benefit. “I saw several transactions where clients bought new aircraft instead of used because of this program,” he said. The General Aviation Manufacturers Association claimed that the “bonus depreciation was the deciding factor in 35 percent of aircraft purchases after its passage last year.”

Cessna Finance’s Newton expects to see a large spurt of delivery activity at the end of the year as buyers seek to close financing before the program ends. This would be on top of the normally frantic deal-making at the end of the year, motivated by tax considerations.

The Patriot Act is another example of government activity affecting the aviation finance sector. A main objective of the act is to inhibit the flow of funds to and by terrorist organizations. The problem for lenders is that specific government regulations about how financial institutions should do this have not yet been established, though GAMA has issued guidelines. Thus, said Newton, “We’re all trying to abide by the intent of the act, which for the customer means we’re asking for a lot of information we never asked for before so that we know where the money is coming from and where it’s going.” This includes checking names on the government’s “bad guy” list.

Fortunately for customers, this doesn’t apparently add much time to the processing of loans, as long as borrowers are forthcoming with all the information requested. However, said Newton, “The procedures do create an ongoing burden for the lenders in their handling of monthly loan and lease payments.”

FAA-mandated equipment upgrades, especially the need for RVSM compliance, can create disharmony when aircraft sellers, buyers and lenders are trying to determine the value of older aircraft that have not been upgraded. This is not a small market as a whopping 22 percent of aircraft in the 20- to 30-year segment are currently for sale. Some buyers are taking aircraft without RVSM equipment, figuring they’ll just fly below FL270 (the highest altitude allowed for non-RVSM-approved aircraft starting next January 20). But when they look for financing, they might find the lender unwilling to finance the aircraft without discounting the value for the cost of the RVSM upgrade. The lender’s concern, said Allen, is the value of the aircraft in a year or two if the borrower defaults and the lender must repossess the aircraft.

Dini’s main concern is with the aviation finance industry itself. “I would describe it as an ever-changing landscape of lessors and lenders,” he said. “Boeing Capital dropped out of the market and the Bank of Scotland Lombard has entered it. Bank of America has acquired Fleet Bank, and J.P. Morgan Chase is buying another company. So we’re constantly responding. It adds confusion to the consumer, who may be used to going to company ABC and now he finds out it’s not ABC any more; it’s XYZ and his contact is gone.”

“The major players in aviation finance have changed every year for the past 10 years,” Dickerson explained. “Aviation finance is a specialty business, subject to special regulations and documentation requirements. An institution must have the knowledge and resources to be successful in this market.”