FEATURE Aviation

Cash king for aircraft buys, but leasing now on rise by Curt Epstein

While the United States has spent the last year virtually mired in ­political tur- moil, the financial markets have appeared relatively­insulated from the chaos.

But that prosperity has not spilled over to the business aviation industry. Those www.ainonline.com who finance business jets and other elements of the private air-transportation business sector are grappling with new dynamics, trying to make sense of why record profits and a steadily growing stock market have not led to more­people and companies buying and using aircraft.

Over the past year, the Dow Jones Industrial Average grew by nearly 30 percent, rising from 18,000 in November 2016 to more than 23,500 last month, while the S&P 500 rose from 2,100 to better than 2,500 in the same span. The Nasdaq Composite Index saw even better performance,

with a more than 30 percent increase year-over-year, reaching a peak of more than 6,750. © 2017 AIN Publications. All Rights Reserved. For Reprints go to

Aviation International News \ December 2017 \ ainonline.com FEATURE Aviation Finance

“Record stock prices in 2017 are based on expectations for higher corporate profits,” explained Gus Faucher, chief economist with PNC Financial Services Group. “Markets are forward looking, and they have largely discounted political volatility, expecting this to pass. Instead, investors think corporate profits will continue to rise thanks to improving demand from solid U.S. and global economic growth, rising prices, reduced regulation, the weaker U.S. dollar, and corporate income tax cuts.” Likewise, the U.S. unemployment rate in October was 4.1 percent, the lowest since Decem- ber 2000, while the Federal Reserve Bank of Atlanta estimates that the U.S. gross domestic product (GDP) could finish out the year with a surge at a 4.5 percent annualized growth pace. “The current economic expansion began in June of 2009, and is now the third longest in U.S. history,” Faucher told AIN. “With few imbalances in the economy, the expansion will continue well into 2018, and possibly longer. U.S. economic growth slowed slightly in the third quarter because of Hurricanes Harvey and Irma but will receive a boost in late 2017 and early 2018 from rebuilding that is funded by federal aid and payments; job growth will pick up as businesses rehire after the storms.” Against this backdrop, the business jet industry is set to deliver its lowest yearly total of new aircraft since 2004, at approximately 620 units. While many experts in the business aviation finance community believe that such financial indicators are still valid, they are clearly no longer the bellwethers they once were for the industry. “Those indicators are still relevant, but it used to be that we could look at USD, GDP and U.S. corporate profits and that would tell us where the new business jet sales were going,” said Kirsten Bartok Touw, managing partner of Virginia-based AirFinance. “Today, while the U.S. is still the largest component of new aircraft sales, it is no longer so dominant that U.S. GDP or financial markets correlate with the new aircraft sales, or the percentage of used aircraft for sale.” U.S. corporate profits have maintained a largely positive trajectory since the global finan- cial crisis, but “there’s kind of a reset now of the relationship between corporate profits and business jet cycles.” explained Paul Cardarelli, vice president of sales for industry data www.ainonline.com provider JetNet. Speaking at the annual JetNet IQ summit in September, he explained that in many cases those profits came without prosperity. “In those years, [companies] weren’t necessarily selling more widgets but [were rather] shutting down inefficient plants, restrict- ing payroll and finding other devices to make themselves profitable.” Others suggest that aircraft buyers now have more variables at play than ever before. “Consideration should also be given to the velocity of money, how quickly it turns over, combined with measures of economic confidence,” said Ford Von Weise, director and

head of Citi Private Bank’s global aircraft finance. “Potential aircraft purchasers have been © 2017 AIN Publications. All Rights Reserved. For Reprints go to

Aviation International News \ December 2017 \ ainonline.com FEATURE Aviation Finance sitting on cash for a few years now, yet they are not buying aircraft due to a general lack of economic and political confidence.” According to industry data provider JetNet, private jet utilization has been increasing since the trough of 2009 and is now approaching the levels seen in 2003 at about 4,400,000 cycles a year. However, the fleet today is 50 percent larger fleet than at that time. “There are too many aircraft in the system right now and they’re living longer that we ever expected them to,” noted industry analyst Roland Vincent, creator of JetNet IQ. “We updated our so-called survivor curve for the industry,” he said, explaining that the curve, which measures how long an aircraft stays in operation, now doesn’t go to zero until just beyond 50 years. “That’s unheard of,” he added. That longevity, along with overproduction, has contributed to a glut of pre-owned aircraft that helped spur the lingering erosion in prices and residual values in the aftermath of the global recession. “The overhang of way too much used inventory has caused major value reductions, causing many people to not upgrade, as the delta between new and used [pricing] has become too great—and thus painful,” said Allen Qualey, senior advi- sor and president emeritus of 1st Source Bank’s specialty finance group. He added that his company is seeing “a meaningful number of business aircraft, primarily jets, that are being maintained under a low-utilization program…as some say they don’t really need it, but the value has dropped to the point it doesn’t make sense to sell it.” “The largest competitor we see are people that kick tires with a new or newer airplane, and say they can’t make the switch between what they owe or what they paid for their airplane, what it’s worth today versus the brand-new airplane,” noted David Labrozzi, chief operating officer of Global Jet Capital. “This has happened all over the world in all the markets.” Speaking at the JetNet IQ summit in September, he described one UK customer who moved from aircraft ownership into an operating after learning his 10-year old large-cabin jet was worth less than 30 percent of its initial value. “Is 10 percent [depreciation] per annum the new normal?” asked Chris Partridge, head www.ainonline.com of aircraft finance, lending and deposits with Deutsche Bank Wealth Management, rhetori- cally. “Clients are really quite unhappy when you say we will amortize your at that sort of amount per annum.” “Unfortunately, you really have to take a long-term historical approach and recognize that residual value curves are now steeper than they used to be,” explained Touw. “Buyers don’t always want to hear it, but it is the new reality.” Despite the recent drastic decline in aircraft values, some experts believe the situation

could abate. © 2017 AIN Publications. All Rights Reserved. For Reprints go to

Aviation International News \ December 2017 \ ainonline.com FEATURE Aviation Finance

“I do believe that depreciation rates on used aircraft will moderate and be less severe than in the past two years,” predicted industry veteran Michael Kahmann. “The high rate of depreciation in the past is, in my view, unsustainable, and a few of the key macro indicators, such as reduced OEM sales as well as lower used aircraft inventories and higher secondary market transaction velocity, should help this value-moderation trend.” Close Deals with Cash Cash remains the preferred method for purchases of new jets in the U.S., according to analysis from Michael Chase, principal of Chase & Associates. Based on his research, 73 percent of the buyers of new aircraft in the U.S. use cash, at least for the initial purchase, a level that has remained relatively constant since 2006. “Cash is king to the extent one cannot find a better use to deploy funds elsewhere,” said Geoffrey Kaufman, an industry financing consultant and president of Connecticut-based Corporate Aviation Solutions. “The flipside to this statement would be that aircraft residual values are too much of a wild card to forecast; therefore, it may be better to let someone else shoulder that risk.” “Big business and the ultra-wealthy still have significant cash war chests,” added Joseph DiLallo, BMO Harris Equipment Finance’s head of aircraft finance and leasing. “Unless they use their cash for business acquisitions and capital expenditures or expansion, many will continue to use cash versus financing when acquiring jets.” That model may hold for the U.S., but JetNet IQ’s quarterly survey suggests that internation- ally, the dynamics may be different. The company questions more than 500 aircraft operators globally each quarter, and its results indicate that when international buyers are entered into the mix, the desire for financing seems to increase. To the question “Currently, what is your pre- ferred method for funding your aircraft purchases?” just slightly more than 45 percent reported that cash, or cash followed by financing, was their preference for new aircraft purchases.

Preowned Taking Off www.ainonline.com For preowned aircraft sales, things continue to improve, with a year-over-year increase in transactions of 5.9 percent in the first seven months of 2017. According to JetNet’s third quarter 2017 market information, just 10.4 percent of the worldwide business jet fleet is for sale, the lowest level since before the Utica, N.Y.-based company began track- ing such data in 2005. “We think the political climate is relevant, with a more pro-business and pro-business aviation administration having an impact on demand,” stated Alex Overstrom, head of avia-

tion at PNC Aviation Finance. “That appears to be playing out right now, as greater market © 2017 AIN Publications. All Rights Reserved. For Reprints go to

Aviation International News \ December 2017 \ ainonline.com FEATURE Aviation Finance confidence and investment are driving the lowest levels of pre-owned inventory since the financial crisis, and as a result, pricing appears to have found something of a floor.” “It represents a market that is recovering, there’s no question,” agreed Vincent. “I see all kinds of signs of that: utilization is up, charter flying is up, pre-owned transactions are up, and the sentiment of the owner/operator community, that’s rebounded from where it was.” For late-model, pre-owned aircraft such as the Gulfstream G550, the market has tight- ened considerably, with 23 transactions over the last year for the type. “If you want an aircraft of that category and vintage, there’s almost nothing available. It’s all been gobbled up because they were seen as such good value for the dollar,” said Vincent. “The supply

FINANCE vs CASH U.S. MARKET

NEW 25% (224) 27% (125)

2nd Quarter 2nd Quarter 2008 2017 Total Aircraft Total Aircraft 881 469

75% (657) 73% (344)

PREOWNED 44% (648) 30% (544) www.ainonline.com

2nd Quarter 2nd Quarter 2008 2017 Total Aircraft Total Aircraft 1,479 1,830

56% (831) 70% (1,286)

Cash Financed © 2017 AIN Publications. All Rights Reserved. For Reprints go to

Aviation International News \ December 2017 \ ainonline.com FEATURE Aviation Finance of nearly-new airplanes is pretty well getting picked over, causing buyers to either choose new, or settle for older equipment, and we’re seeing both,” Qualey agreed. Donald Dwyer, managing partner of Connecticut-based aircraft brokerage Guardian Jet, is seeing many first-time buyers coming out of fractional programs, purchasing older aircraft and refurbishing them for about what it would cost to buy 200 hours a year on a newer aircraft. How customers are paying for those pre-owned jets has changed since the financial down- turn, at least in the U.S. “The percentage of financed versus cash retail transactions for busi- ness jets was roughly split 50-50 from 2000 through September 2008,” noted Chase, who bases his research on FAA filings. “But then in 2008 came the start of the economic meltdown, at which point securing debt financing for pre-owned business aircraft purchases became a more challenging task for buyers. New rules were established, and credit became difficult to obtain even for large, credit-worthy organizations. Thus the pendulum swung in favor of cash as the method of most preowned jet transactions.” As an example, he cited the second quarter of 2008, when 56 percent of the 1,479 preowned aircraft transactions were closed with cash. By contrast, in the second quarter of this year, 70 percent of the 1,830 sales were cash deals, he said.

Business Jet Full Retail Sale Transactions U.S. FAA Financial Documents

100% 100%

Start of Economic meltdown Start of Economic meltdown 90% 90% FINANCED FINANCED 80% 80% www.ainonline.com

70% 70%

60% CASH* 60% CASH*

50% 4Q 2000 4Q 2003 4Q 2006 4Q 2009 4Q 2012 4Q 2015 2Q 2017 50% 4Q 2000 4Q 2003 4Q 2006 4Q 2009 4Q 2012 4Q 2015 2Q 2017

*FAA-registered aircraft without debt intruments or lease are presumed to be cash-

SOURCE: JETNET; ANALYSIS BY CHASE & ASSOCIATES © 2017 AIN Publications. All Rights Reserved. For Reprints go to

Aviation International News \ December 2017 \ ainonline.com FEATURE Aviation Finance

“Most lenders are much more selective today than they were five or 10 years ago; we’re not falling over ourselves to lend to marginal credits, charter companies, dealer floor plans,” said DiLallo. “This is because lots of U.S. financiers sustained large impairments or writedowns resulting from credit defaults, lease-end returns and sharply declining jet values.” While for preowned business jets, the cash-payment level is now similar to that of new purchases, the pendulum may be starting to swing back to the pre-downturn norms. “We are seeing a return of buyers who want to finance instead of paying cash,” said Sam Harris, president of JetLoan Capital. “We believe that the mind-set that financing is hard to find and hard to achieve, is starting to change.” He explained that, historically, when rates are low, as they are now, many entrepreneurs believed they could earn a better rate of return investing in their business than the current cost of capital, leading them to seek financing for the aircraft. “That philosophy appears to be making something of a come- back,” he said. “As confidence in the economy grows, we’re seeing a trend toward companies expanding and preserving cash to fund the growth,” added 1st Source’s Qualey. “Rising interest rates are motivating some buyers to lock in now with swaps or simple fixed-rate loans, rather than utilizing their revolving lines, which have floating rates.” For some buyers, the immediacy of a cash transaction allows greater flexibility to jump on that great bargain deal, an opportunity that has clearly begun to become more scarce. “Many of our clients are using cash to purchase an aircraft and then later financing the acquisition,” said Citi’s Von Weise, “the advantages of doing so are greater purchase leverage, easier closing processes and shorter time frames. Given the extremely low level of debt these days, many sophisticated clients looking to optimize their balance sheets are leveraging the aircraft after the initial closing and using the debt to better leverage their portfolio returns.” The comfort zone on the age of the aircraft varies from lender to lender, and for most there are no hard and fast rules, only guidelines. “Old aircraft are often classified by the age of 10 years,” explained Labrozzi. “With a structure appropriate to the airplane and www.ainonline.com relative to the customer profile, this is not a primary concern.” For others, the make and model of the jet could have an impact. “We have been stable at 15 years for jets, possibly shorter, depending on the model,” noted Robert Kent, president of Scope Aircraft Finance. “We usually look at 25 years as the dividing line for turboprops, but we make occasional exceptions.” For those aircraft buyers who have not been in the market for financing recently, things are certainly not the same as they may remember. “This is a different environment today

compared to the freewheeling days before the recession,” said Chase. “Since the economic © 2017 AIN Publications. All Rights Reserved. For Reprints go to

Aviation International News \ December 2017 \ ainonline.com FEATURE Aviation Finance meltdown, regulators have increased their scrutiny of banks, which have in turn increased their due diligence processes for customers seeking business aircraft loans.” Among the regulations affecting banks is Basel III, a global voluntary regulatory frame- work on bank capital adequacy, stress testing and market liquidity risk. “Basel III has had major impacts for large business aviation financiers,” explained Citi’s Von Weise, who is also the current president of the National Aircraft Finance Association. “The first and most obvious impact is that it is no longer profitable for many banks to offer loan terms longer than five years. Also, since aircraft loans are longer term than many other comparable loan products, the required reserves under Basel III have increased dramatically in comparison to Basel II, thus decreasing overall loan profitability, with all other factors being equal.” Customers with a stronger credit position require the lending institution to devote less of its required loan reserve level to covering those transactions. “This has resulted in in an increased focus on lending to the best credits, resulting in more aggressive transaction structures and pricing for these very attractive ultra-high-net-worth clients, since we can achieve higher returns on decreased spreads due to the resulting lower loan reserve require- ments,” Von Weise noted. Many in the private wealth management sector cater solely to customers with whom they have an existing relationship, but the number of players in the business jet finance market has begun to grow again. While some former stalwarts such as GE Capital and CIT have left the market, companies such as Global Jet Capital (which acquired much of GE’s former business aircraft portfolio, along with much of its staff), Stonebriar Commercial Finance and others have stepped in. “There are many new lenders that have entered the market in the last few years, and more are coming,” said JetLoan’s Harris. “Banks have realized they have to make loans to generate earnings, and they like aircraft asset type, relative to other assets.” Global Jet Capital specializes in , and Labrozzi believes that recent developments in the financing field could curb some newcomers. “Traditional bank lenders have continued to tighten their focus on bank customers, which includes a corresponding customer invest- www.ainonline.com ment in assets under management,” he told AIN. “This trend as well as the changing capital/ rules and the possibility of continuation of reduced values could be deterrents for new entrants. Simply put, the banks have their market, and we have ours.” The amount of available financing does seem to be growing, according to recent industry surveys. In UBS’s Business Jet Survey results from early October, while 76 percent of the respondents believed financing conditions had remained the same, 21 percent indicated that they felt that financing had improved. Yet, the bank noted, while “finance for 10+ year old

aircraft is next to impossible, the all-time low asking and selling price of these vintage aircraft © 2017 AIN Publications. All Rights Reserved. For Reprints go to

Aviation International News \ December 2017 \ ainonline.com FEATURE Aviation Finance is proving there are acquisition deals to be done.” The UBS analysts added, “We are certainly seeing more purchasing on behalf of buyers, and those buyers are looking for financing.” The Terms of the Deal The global economic downturn, and its resulting business aviation slump, which saw aircraft values decline drastically in some cases, cratered many lender and lessor portfolios. While most of the pre-recession leases have expired, some companies are still trying to digest those losses and either re-lease the aircraft or sell them off at market prices. Yet some seasoned financiers believe that newcomers to the lending market may fail to learn from the past, and expect to see what they believe is the inevitable return of aggres- sive pricing, reduced down payments and longer terms, the same factors that led to some lenders getting their fingers singed. “Credit conditions have been relatively benign for the past seven or eight years, and so invariably players in this market, particularly new entrants, forget that this is a business where you can lose money on credit,” Overstrom told AIN. “Rates have been low for a long time, and banks are stretched to find attractive areas to deploy their capital and aviation finance is one of those areas.” “Eighty to ninety percent advance rates are the norm,” noted DiLallo. “Loan terms are shorter today than in the past, mostly five-year terms, some seven, rarely longer.” Even with reduced terms, lenders now find themselves in the position of virtually shoot- ing in the dark when it comes to predicting residual values on the aircraft they are loaning on or leasing. “The tough part for us is how do you predict residual value curves for a new OEM or a clean-sheet aircraft,” acknowledged AirFinance’s Touw. “That exercise is really tough-to-impossible these days.” “It’s really no more difficult for lenders to predict jet values five to ten years in the future than it is for economists and Wall Street to predict global GDP growth, corporate profits, and stock market levels five to ten years in the future,” quipped DiLallo, adding that jet values have dropped faster during the past decade than the industry has ever seen. “But in all seriousness, www.ainonline.com while it’s difficult for even the most active, experienced financiers in the market to forecast future jet values, many lenders build sound, profitable jet finance portfolios by prudent client selection, proper deal structuring, pricing discipline and portfolio diversification.” Looking Ahead While most of the major forecasts predict modest growth ahead for the business jet indus- try starting as early as 2018, the financing experts AIN spoke with believe current geopoliti- cal factors should be factored into expectations.

“In the near term, our biggest concern is that these geopolitical issues introduce a greater © 2017 AIN Publications. All Rights Reserved. For Reprints go to

Aviation International News \ December 2017 \ ainonline.com FEATURE Aviation Finance degree of uncertainty in the market, and therefore drive down confidence, prompting busi- nesses and investors to defer making investments, including in corporate aircraft,” said PNC’s Overstrom. “Obviously if some of the conversation moves beyond rhetoric, the impact would be far more devastating, but as it stands now, we are most focused on confidence.” “There has always been, and there will always be, geopolitical unrest,” noted BMO Harris’ DiLallo. “I think what’s different is the way it’s being managed by today’s world leaders. There’s more volatility and less predictability. This slows or stalls decision making by businesses and indi- viduals regarding spending on expansion and capex, including jet purchase/upgrade decisions.” Barring a major upheaval, Touw sees improvement in the mid- to large-cabin business jet segments, while Kent is eyeing the Pilatus PC-24. “There is more demand for that new model than the factory can produce in three years, and we hope it brings us some incremental financing opportunities,” he said. With improvements in the world economy, Labrozzi noted an increase in activity in the super-midsize category. “Activity is up in virtually all of the developed private aircraft markets around the world,” he told AIN. “Overall supply is not as broad as it was a year ago in many markets. We’re seeing ongoing reduction in manufacturer production, a more healthy economy and healing of financial markets as it relates to buyers. It’s all coming together to help stabilize the market.” n

Sage Advice AIN asked industry experts what aircraft finance advice they would give to a friend looking to buy a business jet. Below are their responses.

“First, work with a firm that has an expertise in aviation finance. This is a relatively nuanced field, and it’s important to work with a team that understands the nature of the transaction and the best way to finance and protect your asset. A lot of banks will

do one or two aviation-related loans per year, and almost by definition they can’t be www.ainonline.com experts. The second point that I think is important is to make sure you understand the financing options available to you. There’s a wide array, and it’s important to find the solution that works best for each situation. For instance, many buyers don’t understand that it is possible to get a non-recourse, non-financial, asset-based loan. That’s a really enticing financing option for buyers with complex financials or who don’t want to dis- close their tax returns or financials.” Alex Overstrom, head of aviation, PNC Aviation Finance © 2017 AIN Publications. All Rights Reserved. For Reprints go to

Aviation International News \ December 2017 \ ainonline.com FEATURE Aviation Finance

“Start with your primary bank, but get proposals from several of the top experienced jet lenders to obtain the best terms available.” Joseph DiLallo, head, corporate aircraft finance and leasing, BMO Harris Equipment Finance

“First of all, the more financial information you can provide, the better. Second, decide if you want to finance it through your existing private banking relationship, as you will get a better rate, higher loan-to-value and better service but will have to provide a full personal guarantee. If this is not preferred, then consider a more equipment finance style lender, who will have more flexibility on the underlying credit support but at a higher spread.” Ford von Weise, director and head, global aircraft finance, Citi Private Bank

“Start early and build relationships. There are many different financiers out there, but each one has a specific niche and it may take a while to find the one who is a perfect fit for you.” Kirsten Bartok Touw, managing partner, AirFinance

“The best advice is to choose an airplane that will satisfy 85 to 90 percent of the mission requirements and go newer, not larger if possible.” Allen Qualey, senior advisor and president emeritus, 1st Source Bank’s specialty finance group

“I would first have to ask my friend what is important to him/her in a loan, and then

identify financing options based on the answer.” www.ainonline.com Robert Kent, president, Scope Aircraft Finance

“Maintain in the airplane, match the term of the debt or lease with a longer- than-expected ownership/lease horizon, select an experienced lender that doesn’t flip its paper post close.” —David Labrozzi, COO, Global Jet Capital © 2017 AIN Publications. All Rights Reserved. For Reprints go to

Aviation International News \ December 2017 \ ainonline.com