The business aviation industry has encountered intense downdrafts this year connected to the Covid-19 pandemic. Ironically, the same forces have increased certain charter flights, spurred newcomer acquisitions of whole and fractional shares in aircraft, and highlighted the value of business aviation.
Concurrently, the August 27 issue of JetNet iQ Pulse revealed significant untapped interest in borrowing or leasing (financing) to make aircraft acquisitions, stating: “Since the onset of the Covid-19 pandemic and amongst respondents with an opinion, about two-thirds indicate that they plan to use some sort of financing to acquire their next new aircraft.”
Understanding Today’s Aircraft Finance Markets
A few brief insights into the two dominant types of aircraft financing, “true leases” and secured loans, will help understand the interest in financing jet aircraft in a market typically dominated by cash purchases.
A true aircraft lease is a transfer by an owner/lessor of the right to possession and use of the aircraft to a lessee for a lease term in return for rent and other consideration/value. In a true lease, the lessor provides 100 percent financing by purchasing the aircraft and leasing it to the lessee.
Lessors expect the lessee to return the aircraft to the lessor at lease expiration, buy it during or at the end of the lease term, or renew the lease. Lessees enjoy the corresponding rights to drop off the aircraft to the lessor and walk away (after meeting the aircraft return conditions), purchasing the aircraft, and renewing the lease.
A typical aircraft secured loan requires a borrower to grant a “security interest”– a lien –on an aircraft to the lender/secured party to secure the borrower’s payment or performance obligations under the loan documents. A lender does not own the aircraft; it just has an interest in the aircraft as collateral.
Customers typically borrow between 50 percent and 80 percent of the price of the aircraft and make up the difference with the customers’ cash or, for refinancing, the value of the equity in the aircraft. These percentages fluctuate up or down for different lenders and loan structures, with a relatively few lenders advancing up to 100 percent loan to the value of the aircraft agreeing to a term of up to 20-years.
Five Incentives To Finance Business Jets
Most customers in the U.S. have at least five incentives to finance their next (or first) aircraft:
• Cheap money. The Federal Reserve (FR) recently announced a policy shift that the FR will average inflation rates to allow about a 2 percent inflation rate before increasing interest rates to tame the inflation. The FR projects that interest rates will remain near zero for years to come. Financiers should, for the foreseeable future, offer customers very low rates consistent with the FR action.
• No to low cash outlay. Many potential customers should readily appreciate that, rather than stroking a check for a new or used jet, they can more prudently or profitably use their cash elsewhere in their businesses for capital expenditures, investments, or, particularly during the pandemic, working capital.
• Tax write-offs. If the lessor adheres to applicable federal tax law, including the lessor’s maintenance of residual value under the federal true lease guidelines, the lessor may be entitled to claim bonus depreciation on the new or used leased aircraft per the Tax Cuts and Jobs Act of 2017.
In a loan transaction, the borrower, as the owner, may be entitled to bonus depreciation of the aircraft and other tax write-offs allowed under the Coronavirus Aid, Relief, and Economic Security Act plus bonus depreciation despite some personal use of the aircraft.
• Lessor/lender competition. Most aircraft lenders and lessors compete aggressively on interest rates or lease economics to win business to the extent consistent with their respective business models, regulatory constraints, and internal credit policies. However, financiers will, except for the most creditworthy customers, expect customers to sign documentation that contains strong covenants, defaults, and other restrictive terms on aircraft and business operations.
• Customized lease and loan structures. Structuring lease and loans constitute an integral part of competition among financiers. To facilitate planning and cost management of aircraft operations, a lessor can, within tax and other limits, create flexible structures that contain fixed and variable rents, options to purchase the aircraft during the lease term or at lease expiration, terminate the lease during the lease term or renew the lease term at lease expiration.
Lenders can offer various loan structures that drive down periodic loan payments and achieve other customer goals. These loans might include a payment term of five to 12 years, asset-based financing (that primarily relies on aircraft value for re-payment), one large “balloon” or total principal payment at the end of the loan term, 10- to 20-year amortization periods, interest-only structures, and limited personal guarantees. Borrowers should negotiate early payoff rights so they can, at will, exit the relationship, refinance the aircraft loan, or use available cash to pay off the loan.
Though cash is king for many aircraft buyers, up to 70 percent of potential business aircraft owners or operators intend to finance the acquisition of their next new aircraft. The same should roughly be true for anyone interested in acquiring a used aircraft.
Such financing can afford these potential customers cheap interest/rent rates, no or low cash use, and an immediate opportunity to buy or lease aircraft. For the business aviation industry, any boost in transaction volume this year, prompted by an expansion of financing, would be most welcome and perhaps generate a little optimism for a better 2021.
Note: The content provided above is intended for informational use only and does not constitute legal or other advice. Each person involved in these transactions should consult his or her aviation team advisors.
David G. Mayer is a partner in the global Aviation Practice Group at Shackelford, Bowen, McKinley & Norton, LLP in Dallas. He provides comprehensive legal services worldwide on private aircraft matters, starting at any point in time from inception of any person or entity’s aircraft search, ownership, leasing, or financing experience through aircraft operations. His work includes providing support for purchases, sales, leasing and lending matters, regulatory compliance, federal, state, and local tax planning, risk management, insurance, aircraft operations, hangar leasing/purchases, and dispute negotiations. David frequently represents aircraft owners, flight departments, lessees, borrowers, operators, sellers, purchasers, and managers, as well as lessors and lenders. He can be contacted at email@example.com.