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Aviation Finance FEATURE Aviation Finance 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 relatively insulated 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 more people 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 insurance 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 lease 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 debt 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.
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