The global banking crisis may have subsided for money-center banks, but aircraft financiers have not emerged unscathed or free of the turbulence plaguing other U.S. banks.
The current banking crisis started with the collapse of Silicon Valley Bank on March 10, Signature Bank on March 12, the takeover by UBS of Credit Suisse on March 19, and the FDIC takeover of First Republic Bank and sale of its deposits to JPMorgan on May 1. These closed banks, except Signature, actively made private aircraft loans, as do UBS and JPMorgan today.
It is a credit to private aircraft lenders and lessors that have not limited or exited their aircraft lending or leasing businesses amid volatility in banking, including frequently reported deposit outflows from, and credit tightening by, U.S. local and regional banks.
The bank crisis may not materially alter the financier’s pre-crisis credit approval process. However, financiers may reluctantly spool down aircraft financing for reasons such as reduced liquidity, increased regulatory capital, intensified risk management, higher cost of funds, and wider risk-adjusted interest rate spreads.
Understandably, aircraft lessees and borrowers may feel cautious in these circumstances and either take a flight to the safety of banks regarded as “too big to fail” or pay cash to buy aircraft. This situation can occur even as local, regional, national, and international banks continue to compete for, and can still provide substantial amounts of, aircraft financing on competitive terms. “Risk on” family offices and private equity funds may provide aircraft financing where an opportunity arises.
On the real deal front, customers should, in all financing inquiries, remain alert to and compare credit approval criteria and timing, financing costs, loan-to-value advance rates (LTV) against aircraft values and material contract terms.
Understanding Credit Standards
Aircraft lenders have told me that, despite the importance of aircraft collateral value, the magic sauce in approving an aircraft loan centers on the borrower’s and any guarantor’s creditworthiness. True tax and operating lease lessors apply a similar analysis but also place additional emphasis on the assumed aircraft residual value, which generally refers to the realizable net proceeds from the aircraft’s sale, lease, or other disposition at the end of a prevailing lease term.
In short, financiers expect their customers to meet robust asset and credit criteria, including the “Five C’s“ of creditworthiness: character, credit history, capacity, capital, conditions, and collateral value.
Managing Higher Financing Rates
Financiers have little choice but to increase their interest rates and expand interest rate spreads in response to the Federal Reserve Bank’s rising interest rates, the recent banking crisis, and other economic challenges. Additionally, banks face recession fears, the U.S. debt ceiling fracas, and their unique crisis factors that have caused or may still result in deposit withdrawals, increases in regulatory capital, or lowered investment ratings.
These outcomes may further increase their cost of funds, contract their available capital for financing, and reduce their financing competitiveness.
As part of managing financing costs, customers can and necessarily should obtain lending or leasing quotes from several sources. Optimally, customers will request bids from specialized aircraft financiers, appropriate relationship banks, and capable wealth management advisors. From my discussions with financiers, it appears that, despite the market conditions, certain financiers can still obtain credit approval faster, offer lower rates, and require fewer arduous contract terms than other financiers.
To manage cash flow and for other good reasons, customers should ask prospective lenders if they lease aircraft. Some lenders do offer an aircraft leasing product but prefer lending.
With the end of the London Interbank Offered Rate on June 30, customers should understand the differences between floating rate indexes used by their financiers, such as the American Interbank Offered Rate (AMERIBOR) and the Secured Overnight Financing Rate (SOFR). Customers may find SOFR or another index may provide a lower rate than AMERIBOR.
A floating rate under any interest rate index, including AMERIBOR or SOFR, will increase or decrease while the loan is outstanding. Conversely, the fixed rate will not.
To maintain maximum flexibility, a customer should ask banks for the right to hedge—“swap“—all or part of any floating rate loan into a fixed rate loan one or more times during the loan term under the rules of the International Swaps and Derivatives Association. Such a right enables a borrower to swap to fixed rates during the loan term if the Federal Reserve lowers interest rates or for other strategic reasons.
In considering hedging their loans, borrowers should ascertain the fees for hedging, the potential penalty for breaking a hedge, and the very strict, minimally negotiable terms of the hedge ISDA Master Agreement 2002 (MA). MAs almost always contain more burdensome provisions than the borrower’s other loan documents. If breached, the MA may cause a loan default that otherwise would not have occurred under the borrower’s other negotiated loan documents.
Negotiating Loan Documents
Lenders can test their credit and collateral risk in the following four ways—cumulatively:
Financial covenants. Certain bank lenders already use financial covenants in loan documents, but market conditions may induce others to do the same. For example, a bank may require a customer to maintain certain unencumbered liquidity, tangible net worth, and lien-free deposit at the financier bank. Borrowers should question the need for or strictness of these terms early in discussions with their banks.
Discounting aircraft value. Over the last few years, the demand for, and sales price of, private aircraft have skyrocketed due to the pandemic and other factors. Financiers may discount the financeable sum to minimize negative collateral value exposure and avoid calls for an LTV “true-up.”
Flight-hour penalties. Certain financiers already require, and others may adopt, a penalty for excess flight hours (EFH) flown above the hours permitted by the lender. For example, a lender may cap permitted utilization at 300 to 500 hours per year. Designed to preserve collateral value, customers should calculate the EFH penalty for flight operations under Parts 135 and 91 to calculate their true financing costs.
Loan-to-value ratio. Although certain bank lenders already use an LTV “true-up” in their loan documents, more lenders may add an LTV provision. An LTV typically requires a borrower to prepay its lender, on the lender’s demand and at agreed intervals, a potentially significant principal amount that reduces the principal balance approximately to the originally agreed LTV. Borrowers may suffer a double whammy if the LTV true-up payment incorporates EFH and the borrower also pays an EFH penalty.
Aircraft financiers compete in a fragmented financing marketplace. Despite the bank casualties in the crisis and market volatility, most financiers can and will continue to finance private aircraft with structures and terms that substantially mitigate their credit risk at their customer’s expense.
To cope with current market conditions and obtain financing, customers should, for the foreseeable future, seek multiple financing quotes, brace for higher financing costs, and expect financiers to harden their contract terms.
As the banking turbulence eases, no one should be fooled by any calm in transactions that may be the calm before another economic storm that threatens the availability of reasonable aircraft financing.
This blog is being provided for general information and should not be construed as legal advice or as a legal opinion, or as a recommendation for a particular action or inaction regarding any specific facts or circumstances on the subject matter. You are urged to consult your attorney or other trusted advisor concerning your specific situation and to answer any specific legal or financial questions you may have. The opinions expressed in this column are those of the author and not necessarily endorsed by AIN Media Group.