The market to buy and finance preowned business aircraft has ramped up to astonishing levels since the onslaught of the pandemic. Inventory has fallen to all-time lows while prices have increased to surprising heights.
Brokers have purchaser-clients anxiously waiting in the wings for the right aircraft to become available. Other purchasers have raced to buy aircraft regardless of the aircraft’s age, condition, or pedigree.
Need for Speed and Fairness
To act expeditiously in this fast-paced sellers’ market, purchasers can greatly benefit from engaging an aircraft broker and aviation lawyer before entering the market to buy a preowned aircraft. These professionals should have extensive knowledge, tested negotiating skills and years of experience handling purchase transactions.
The seller should field a similar team to facilitate a reasonable purchase/sale process. These teams must work together to benefit their principals and shield them from making avoidable mistakes.
Regrettably, certain seller teams have opportunistically used their strong position to force purchasers to reduce transaction deadlines, truncate or even eliminate aircraft inspections, and accept other burdensome contract terms. These seller tactics seem unfair, unnecessary, and disruptive.
Under market pressure and production quotas, lenders and lessors not only compete for willing borrowers or lessees but also for purchasers who intend to pay cash. Like it or not, cash purchasers enjoy a timing advantage against financing and carry little documentation baggage to closing.
As you might expect, financiers often express frustration that the “cash is king” reality deprives them of financing or leasing deals. So too does the perception of some cash purchasers that they will pay cash to avert the “brain damage” caused by a financier’s diligence and documentation.
Although financiers will respond promptly to their customer’s needs, financiers cannot fly over their bank policy and regulatory strictures. Rather, they must establish the aircraft’s collateral value and conduct due diligence that includes an assessment of the creditworthiness, character, and cash flow of the purchaser/lessee and any guarantor.
This process requires purchasers to provide substantial financial, personal, and tax information to the financier to obtain an internal approval and a written term sheet covering the financing.
Still, financiers can timely perform by planning with their customers to move as quickly as possible. In a time crunch to buy an aircraft, purchasers may consider buying the aircraft with cash and then enter into a cash-out loan or a sale-leaseback—meaning refinancing—thereafter.
Cash Purchase Risks and Opportunities
As high as 70 percent of purchasers pay cash to buy an aircraft. Although cash deals have positive attributes, buying with cash is not risk or cost-free. Whether the money to buy comes from a bank account, a margin account, a line of credit, or a stock sale, cash carries an imputed cost of capital.
Using cash may even trigger unintended consequences. For example, in the currently volatile stock market, funding a margin call or selling stock at the wrong time to pay for an aircraft can cost a bundle compared to financing.
In addition, using cash may lead to lost opportunities to deploy the money in business at higher returns than financing rates or reserve cash to ride out multiple crises the world faces, including a bear stock market and untamed inflation. Cash deals even fly in the face of the ancient OPM principle—using “other people’s money.” Thus, buying with cash may entail risks and costs that few purchasers can afford to or should ignore.
When To Select a Financier
Purchasers and their team should optimally start looking for the right financier before negotiating a letter of intent (LOI) and obtain terms sheets from financiers no later than signing an aircraft purchase agreement (APA). Until the purchaser selects an aircraft, signs the APA and passes internal credit approvals, a financier can typically only provide indicative terms, conditions and economics to finance a business aircraft.
This sequence gives financiers lead time to assess a purchaser’s aircraft choices and complete their credit approvals, which can take two to four weeks, despite APA deadlines. Financiers should provide a credible timeframe to approve and document their financing transaction. If a financier needs more time to secure approvals, a purchaser can ready a “Plan B” such as refinancing post-closing.
Aircraft financiers exist in diverse sizes and capabilities. The optimal transaction financier, in my experience, blends a strong, customer-centric business model with substantial aircraft financing expertise and a low cost of capital.
Although these financiers may easily meet those criteria, purchasers should not hesitate to select other banks or finance companies despite higher financing costs. Doing so may enable a purchaser to obtain faster approvals, more flexible terms, or creative debt/lease structures. Purchasers should regard strong personal relationships with any aircraft financier as having the utmost significance before and after funding.
Financing Structures, Amounts, and Terms
As is well known, the U.S. Federal Reserve Bank intends to raise interest rates multiple times this year. The increases will likely push financing rates higher for aircraft loans and leases.
In addition, the often-used variable rate index in the U.S., the London Interbank Offered Rate, or USD Libor, ceases on June 30, 2023. Many financiers have replaced, or will replace, USD Libor with the Secured Overnight Financing Rate (SOFR) or other widely-accepted index rates such as U.S. Treasury or published prime rates.
A prospective purchaser may reasonably decide to use an operating lease with level rents or a fixed-rate term loan with level payments to cope with increasing interest rate hikes. Variable-rate loans also make sense if the purchaser can obtain a lower initial interest rate relative to fixed-rate loans, use swaps to set fixed payments, or use other structures to mitigate rate risk.
Either way, the time is now to obtain less costly financing. Also, owners and lessees may benefit from refinancing existing aircraft loans or leases mainly to extract money from owned aircraft, lock interest or lease rates, and manage long-term cash flow.
Premium aircraft purchase prices in the seller’s market naturally lead purchasers to apply for larger loans to pay for an aircraft. Lenders may increase the original loan amount for a strong borrower or guarantor, with less reliance on the aircraft collateral value.
A lender may also entertain providing more financing for a known customer or one who does, or will do, other business with the bank. However, lenders usually order an independent aircraft appraisal. A lower-than-expected aircraft value probably will limit higher loan advances.
Similarly, lessors may consider paying a somewhat higher price for an aircraft in calculating lease economics. Like lenders, lessors run numbers based on their cost of funds, credit analysis of the lessee and guarantor, and other pricing metrics.
Lessors may only pay a premium purchase price if they receive a supportive aircraft valuation, achieve their target yield and cash flows, and use reasonable “residual value” assumptions in pricing. An aircraft’s residual value generally refers to the fair value of the aircraft when its lease expires. Lessors need time to generate these numbers and values; a purchaser should plan accordingly.
In a world dominated by negative headlines, the seller’s market for used business aircraft exhibits resiliency and positivity despite the low inventory and high sales prices of such aircraft for sale. With elevated pressure to move quickly to close competitive aircraft purchases, cash purchases may be easier but not necessarily better than financing. Whether a person acquires a business aircraft with cash or financing, the market demands speed to succeed, and purchasers seem ready and willing to meet the challenge at almost any cost.
This blog is purely informational and reflects the author’s experience and legal practice. It does not, and should not be construed to, provide legal advice of any kind, express or implied, or create a lawyer-client relationship. Persons involved directly or indirectly in any issue covered in this blog should inquire of appropriate counsel, senior executives, brokers, and other trusted advisors on the subject matter above. The opinions expressed in this column are those of the author and not necessarily endorsed by AIN Media Group.