Understanding Aircraft Finance​

Welcome to another Asset Insight podcast covering the aircraft ownership lifecycle. I am Tony Kioussis, president of Asset Insight and your host. We are discussing aircraft finance today, and joining me is Jim Blessing, vice president at AirFleet Capital, a company that has been helping entities finance their aircraft since 1994. Jim, welcome to our educational podcast series covering the aircraft ownership lifecycle.

Jim Blessing (01:00):

Thank you, Tony. It’s a pleasure to be here and we appreciate your considering us for this.

Tony Kioussis (01:04):

There’s some really great opportunities here for our audience to learn about finance. Let’s start off by discussing the typical characteristics of an aircraft loan. What are they?

Jim Blessing (01:15):

An aircraft loan is a little bit like a home mortgage insofar as it’s often as expensive as a home for a lot of people, but what you’ll find with an aircraft loan is that the loan decisions and the closings are much quicker than what you would experience with a home mortgage. So sometimes when you say a home mortgage creates consternation with someone that, oh boy, I got to go through all that. It’s actually quicker and less painful than a home mortgage insofar as it happens with a rapid underwriting process and closings are often through an aviation title and escrow firm in Oklahoma City or an aviation attorney that may have an office in Oklahoma City, not necessarily in person but conducted via fax, phone, email, things like that.

Jim Blessing (01:58):

An aircraft loan is also different from a mortgage from the standpoint of it is typically a term of up to 20 years, and you’ll find that the paperwork is less than what you’ll find with a home mortgage. So for example, paperwork-wise, you may expect with a home mortgage to put together quite a few months of bank statements. Typically with an aircraft loan you might only have to provide your most recent. So it’s a little simpler. That’s just one example.

Jim Blessing (02:25):

Another difference with an aircraft loan. If you pursue an aircraft loan through an aircraft lender in our community, there’s typically no right to offset if you don’t have existing business accounts with that lender. So if you have your business relationship with the First Bank of ABC, and you’ve got all of your business accounts with that bank, if you pursue an aircraft loan with a different entity that’s purely an aircraft lender, they won’t have the right to offset against any of those business accounts that you have. In other words, if you fall into a past due situation, they can’t just pull money out of those other accounts that you might have with Bank of ABC.

Jim Blessing (03:01):

Another difference with an aircraft loan from other types of loans, if you properly structure it you can deduct it in your business, and you’ll find that aircraft lenders today are pretty experienced with unique loan structures, special purpose entities, partnerships. There’s different levels of complications that an aircraft lender can see on a regular basis and be comfortable with including hypothecations, which might be different than what you would find from a local lender.

Jim Blessing (03:30):

Lastly I’d say on the typical characteristics of a loan, the underwriting often involves a review of tax returns, financial statements, and credit, which again is similar to a home mortgage. Again it is done quite quickly. We’re typically looking backwards at two or three years of historical income to see if the levels would support the contemplated purchase, looking to see if credit has been established and managed at a level that would support this level of a purchase, and taking an additional look at the collateral which we’ll probably talk about a little bit later. What’s the collateral worth, and how does that collateral purchase fit within the financial profile?

Tony Kioussis (04:11):

You used a couple of terms that some folks may not be familiar with. One of them was “hypothecation.” Can you explain that a little bit?

Jim Blessing (04:20):

Oh, sure. Hypothecation, that’s where an individual takes the loan out in their own personal name, but registers the aircraft to an entity. So the ownership entity is technically not a part of the aircraft loan, so the ownership entity hypothecates its interests to the individual through a side agreement. It’s typical … Well, we’re finding it more and more common for tax reasons to distance the entity that owns the aircraft from the actual obligor.

Tony Kioussis (04:46):

The other item that might be a little unfamiliar for anyone that hasn’t dealt with an aircraft acquisition is the use of an escrow company and how that comes into play. Can you go through that a little bit?

Jim Blessing (05:00):

The title and escrow companies, there’s a good number of them in Oklahoma City that have offices within the FAA registry at Oklahoma City. So when you close a home, you’re used to sitting down with an escrow agent, signing the documents. They notarize them in front of you. Then they take the documents back and perform the closing at another location. With an aircraft purchase, you set up an escrow account with an escrow agent with a company that’s licensed and bonded and typically has a location within or a desk within that FAA registry and when they get the word “go,” which means that funds have been released, they’ll take the documentation that is already in station there, bring up to the window, and have it filed and stamped with the FAA. And so it happens much quicker than what you might experience with a home mortgage because the escrow representative is right there within the FAA’s facilities.

Tony Kioussis (05:53):

Let’s go into what someone should expect in the market today who’s searching for aircraft financing, especially as it relates to the great environment and the impact of the COVID-19 pandemic.

Jim Blessing (06:07):

Talking about where we’re at today and where we’ve come from is important in answering that question. The finance market today is very different from where it was in 2008 and 2009 and I think that looking at the last significant downturn, you could try and make a parallel that the finance sector is going to have a lot of challenges, but the finance sector at the start of 2020 was very strong. We didn’t have a bubble leading into this year. We had credit that was readily available and we had an historically low interest rate environment. That said, lenders today are restricting a little bit in some segments. They’re tightening access to credit in certain industries. They’re sensitive to markets that might see a higher default rate, and then you overlay that with lenders are or have been active in supporting the stimulus measures that are COVID-19 related stimulus, like everyone’s heard of the payroll protection program or PPP, and there’s other stimulus measures. The Main Street Lending Program is going to be coming out soon.

Jim Blessing (07:07):

Those programs are all backed by banks, further backed by the SBA but the banks that are engaged in those have seen a significant increase in demand for loans and therefore it’s kind of stressed the system. So the system is dealing with people who typically work a nine to five. Everybody jokes about the banker’s workday nine to five and at 5:01, the day is over. But you’re finding these lenders working 10, 12, 14 hours a day, 7 days a week to support getting money out for these stimulus measures.

Jim Blessing (07:37):

What it then does to people requesting new credit is it just backs up the system. Decisions take longer. You might find that some lenders have less appetite because they’re lending out so much money for PPP or other programs. They don’t have as much appetite as they usually do for an aircraft loan specifically, but our message to people is that there’s still a lot of credit available. That they need to plan further ahead for credit decisions. They’re just going to take longer because of these other stresses to the system, and the banks are also dealing with in additional to stimulus support, and in addition to looking at potential increases in defaults, they’re also looking at loan deferrals. When this all first started with COVID-19 the FDIC put out an interagency memorandum that allowed banks to put loans on deferral for a period of time if the customers are experiencing a hardship, and so they’re dealing with that in addition to these other things.

Jim Blessing (08:31):

So combine all that. You can see that it’s a significant amount of activity that the banks are dealing with and it’s way above activity levels that they’ve historically had, and I’m going to venture to say not many of them are in the hiring mode because they’re not sure what’s going to happen in Q3 and Q4 but the positive out of all of this again is that credit markets are very active, rates are historically inexpensive, and business aviation has seen pockets of activity throughout all of this.

Tony Kioussis (08:56):

Let’s talk about small business owners many of whom are owner pilots. What’s unique to financing these individuals and might the financing process be different in those cases?

Jim Blessing (09:08):

Small business owners, they’re typically entrepreneurial businesses and they often fly their own aircraft so they don’t often have a management company or a flight department, so they’re managing their own aircraft and sitting up front. That’s a little bit different than what we see from maybe the lighter jet buyers who might bring in an aircraft management company and might not necessarily sit up front. A couple other unique things that we’ll see, and I’m going to actually correspond this back to our prior point on the current lending environment. For small business buyers that have applied for the payroll protection program, they shouldn’t expect any challenges with their financing today. They’ve just gone out and gotten a loan. It’s a prudent decision. It’s something that they needed to do to continue to support their business, so they shouldn’t expect obtaining a PPP loan as a negative.

Jim Blessing (09:57):

However, if this small business has put some of their debt on deferral, which is the other stimulus program that I mentioned, then that does have an impact on that small business to be able to secure new debt. In some cases lenders are saying, “Once the deferrals are over and your hardship no longer exists, then let’s talk about getting you into a new asset or a new airplane.” Those are some things that small business owners might see today.

Jim Blessing (10:20):

A couple other comments I’d make on that. When we look at a small business that’s buying an aircraft and we look at the financing side, you’ll find entrepreneurs that keep their money in the business, and you’ll find others that take all of their money out of the business. Likewise, you’ll see that they keep all of their net worth in the business, or they take their net worth out of the business. So you’ll see that an appropriate financial review of a small business is typically going to need a global approach, a global cashflow approach. What’s the financial health of the business? What’s the financial health of the individual? Let’s put the two of those together because often they’re one and the same. It’s got to be a much broader global approach in order to see if the business has all of the cash or if the individual just takes all the cash out, which we see both of those.

Jim Blessing (11:04):

And lastly, I’d say for small businesses you’ll often see unique structures and tax appetites. What I mean by unique structures, if an individual is buying an airplane and they have an operating company, we might see one structure where they set up an LLC that’s owned by that operating company and then the depreciation and other expenses can pass through to the operating company. Or we might see where the LLC rolls up to the individual, not through the operating company, and then the depreciation rolls up to the individual to offset the profits from the operating company. That’s all based on what the tax planner feels is the right fit, and we’ve got some really good aviation tax planners that keep us on our toes.

Tony Kioussis (11:46):

What are some of the changes in the financing as collateral size increases? Say you’re going from a piston aircraft to a turboprop to a light jet.

Jim Blessing (11:57):

From a big picture standpoint we’re trying to see, can the individual withstand not just the cost to acquire the aircraft, but also the cost to operate the aircraft? So somebody going from a high performance single engine piston to a turboprop, if I just use an example here of somebody going from a newer Cirrus to a newer TBM, then the operating cost differences are a certain consideration. But if they’re going from a newer Cirrus to a 1970s King Air, then the operating costs are entirely different consideration. So we look at, what is the collateral they’re moving from and to, and do they have experience with managing that level of collateral from an operating cost standpoint, or do they have the wherewithal to be able to withstand an annual inspection that goes from 5 or $10,000 a year to 50 to $70,000 a year? And we use that same thought process with moving to a light jet, and two great examples of that.

Jim Blessing (12:53):

Individual who calls and they’ve owned a real small airplane and they are looking to upgrade to a 1970s King Air that hasn’t had a lot of upgrades to it, but it’s a really good price. It’s a $300,000 King Air. Well, the cost to get into that airplane might be minimal, but the cost to maintain it and operate it over time could be really significant, and that has an entirely different frame of how we would look at the risk there. The second one I would say is someone getting into a 5 or $600,000 light jet where it might not be on engine programs. It might be a little bit older. It might be the last person that ever owns this airplane, and then you’re evaluating, okay, can they withstand the cost to own this? Then if they are the last owner and they don’t have an exit strategy, or there’s not a market exit strategy that would exist at that time, does that impact the ability to finance this today?

Jim Blessing (13:41):

Another layer I’d throw on here with the light jet side, talking about the engine programs. Engine programs have a good impact on a lender’s comfort level with financing the aircraft. A full coverage engine program on a light jet means that a significant portion of that aircraft value is going to be retained, and thinking through the fact that these lenders are putting a 15- or a 20-year loan on these aircraft, you can see where knowing that the engine value is consistently retained gives everyone a comfort level with offering a 15- or 20-year loan. If it’s a pro rata of coverage on an engine program, you have to step back and see what’s that coverage, what’s the potential additional financial exposure, and then is the lender comfortable with that financial exposure being borne by the individual buying the airplane, or do you think that that would come back to the customer? And so that’s part of the conversation.

Jim Blessing (14:29):

I’d say the last thing about going upmarket with aircraft. I mentioned before a single engine piston, typically not a management company. When individuals transition upmarket and get into turboprop, more complex light jets, then we might look to see, okay, do you have somebody that’s going to help you manage that airplane now? Who’s that? What’s the name of the management company? How’s it going to be managed? Then it’s not uncommon to see the customer have a little bit of charter use, which will then impact the terms of the loan. Because then the management company is saying, “Okay, you can put the airplane in our firm. We’d like to have the ability to use it and offer other people to use it, and can we work out even a limited management agreement, limited use agreement?” So these are different considerations that we evaluate as clients go upmarket.

Tony Kioussis (15:13):

The pro rata coverage that you mentioned for engines on some of these older aircraft, and we now have light jets that are exceeding 40 years in age. A pro rata program on a light jet that’s up in that neck of the woods age-wise, I can’t imagine that that would be all that useful, especially if it’s one that the seller just added onto the aircraft as they were getting ready to sell it.

Jim Blessing (15:37):

Great point. I think sometimes clients don’t necessarily understand the difference between a full coverage and a pro rata coverage or even a hybrid, which is more for insurance means, but the pro rata on the older aircraft is less valuable. We’ll look at it and say, “Okay, this is an engine that has a 4,000 hour TBO, and it’s got 3,000 hours on it right now and it’s being enrolled in a pro rata coverage but the bulk of that overhaul cost is going to come due within the next 1,000 hours.” Typical customer might fly that airplane 2, 300 hours a year, so then you’re doing the math saying, “Okay, that’s 7, 8, 10 years. We’re going to have an event that’s a significant financial event. How will that impact our customer at that point in time? Do we think that we’ll be in a position to support that from a finance standpoint if they come back to us and want to roll it in, and if not, what’s the plan?” And that might prevent us from being able to put a proposal in front of a customer.

Tony Kioussis (16:27):

We probably should have defined pro rata coverage to begin with because that is not necessarily something that people are familiar with, but pro rata coverage basically means that part of the engine’s scheduled maintenance costs are covered, and that depends on when the aircraft and the engine specifically was enrolled on an engine program and how much time had accumulated toward the overhaul on the engine. So if the engine was enrolled after it had accumulated 25% of the time before the overhaul was required, the program would pay for 75% of the overhaul and the owner would pay for 25% of the overhaul.

Jim Blessing (17:08):

That’s right. That’s exactly correct.

Tony Kioussis (17:10):

The reason why I mention it is because if you get some of these airplanes that are 75 or 80% of the way to an overhaul and suddenly they’re enrolled in one of these programs, there’s really not that much value to a pro rata program if the engine is that far toward its overhaul requirements.

Jim Blessing (17:29):

From a lender’s perspective, it’s a matter of risk. It’s always a matter of risk, so how is the risk lessened with the pro rata program if someone’s high in the lifecycle of the aircraft? It’s really not lessened that much. It doesn’t change the dynamic. If the aircraft only has 200 hours on it, or the engines only have 200 hours and it’s pro rata, well then you’re talking about a 3,800-hour delta, which is significant. But if you’re talking about only 25% of the useful life left and that’s the coverage that’s available, then the customer needs to be made aware that at overhaul they’re responsible for 75% of that overhaul cost, and that is significant and if they get to that point and aren’t in a position to overhaul it, then we’ve got another airplane that’s sitting on the ground.

Tony Kioussis (18:09):

These are some of the finance considerations that need to be made that are off to one side. Are there other unique financing considerations that people should keep in mind?

Jim Blessing (18:20):

From our standpoint, there’s different levels of complexity in things that we evaluate. You know, our underwriting groups, typically the bank underwriting groups, they’re not underwriters that have CPA degrees and attorneys that are within the credit analysis group, so customers have their attorneys and CPAs set up sophisticated structures that then need to be unwound, and so when we talk to a customer that might have a sophisticated structure we’ll often say, “Hey, could you help us upfront? It’ll expedite the review if you can already tell us how to unwind this.” Maybe your CPA puts together some sort of a global cashflow for you so that you know how much money you made that year because your tax returns don’t really tell you how much money you made that year.

Jim Blessing (19:01):

So a tip that we’ll have for customers that have more sophisticated financial structures is that they might want to consider incorporating that if they don’t want to go through a comprehensive review of the cashflows. We might have a customer that owns 25 companies and each company is a franchise of either a restaurant or a hotel, and this is not uncommon, and each of those companies passes through something to the individual or even passes up to a holding company that passes it through to the individual. So a lot of times you’re trying to unwind the cashflows, so the hotels might have significant depreciation which doesn’t give a real cashflow picture through to the larger holding company or the individual, whereas the franchises might have startup costs that are onetime expenses that don’t pass through a real picture of what the cashflows are. So stepping back and saying, “Okay, how do we get a handle on the global cashflows?”

Jim Blessing (19:51):

From our standpoint, if there’s a large number of companies involved with the underwriting, it’s better to say, “Hey, what did your CPA give you that told you whether you made or lost money last year? And provide that to us. Give us a copy of that.” It’s not uncommon for the customer to not even really appreciate what the tax returns show from a cashflow standpoint. The tax returns are complicated. The tax laws changed in the last couple years, and they might not realize that, “Wow, my tax return showed a loss, but my CPA said I made a lot of money, so this doesn’t make any sense.” That’s what we have to unwind. So I’ll say when considering financing and considering different levels of complexity that you might have with your financial structure, involving a global cashflow picture might help at the onset with expediting the review.

Jim Blessing (20:32):

Other things that we see that are unique from a borrower’s perspective, an individual that buys and sells companies for a living that starts up businesses, turns them around and then sells them a couple years later, they might see a different review of their analysis. It might be less income driven and more based on their net worth. That’s a different type of a financing program which we can talk about.

Jim Blessing (20:51):

Other people who are seeing large swings up and down in income year over year, they might have to spend a little bit more time explaining why the swings in income are up and down like they are. If a customer has a recent job change or a career change, they might have to explain how that impacts their financing and what I’ll say in that case is it’s one thing to change jobs. It’s another thing to change careers. Let’s say you’re a computer programmer in Silicon Valley and you work for a popular IT company that we all recognize the name of and you move to another IT company we all recognize the name of. That might not be a significant deterrent from receiving financing. You’re doing the same thing. You’re in a stable work environment generally speaking. It’s just having to explain the change.

Jim Blessing (21:31):

Another tip I’d say. If you’re in the middle of a change in marital status like a divorce, you might find that lenders will put a pause on offering financing until that divorce is finalized. Just because you don’t know what the outcome of the divorce is. You might think that you’re going to have a settlement and then everything will be X or Y at the conclusion of that settlement, but until that’s finalized, we won’t know that for sure.

Tony Kioussis (21:54):

Continuing the thought process of unique financing considerations, there’s a number of people that own a business aircraft and also have a second fun airplane. Any difference when it comes to financing those folks?

Jim Blessing (22:07):

A fun airplane. It can be a number of different aircraft that are the fun aircraft that are evaluated differently than a business aircraft, so I’m just going to give you a few examples here. Let’s say number one fun airplane is I want to buy a P-51, a T-34, some sort of a vintage warbird that I can go fly on the weekends. Vintage warbirds can be difficult to obtain financing on just because of the difficulty in finding a value on them. If they have an active resale market like a P-51 and a T-34, it makes it easier. But if you buy something more unique, like a Grumman Widgeon which is a vintage airplane or some other older vintage warbirds, you might find that the solution is to have an independent third party appraiser go out, look at the airplane, establish a value, and then get the lender comfortable that here’s where the value is and this is what the market looks like.

Jim Blessing (23:02):

They might also need to project out what the values might look like going forward. That can be difficult on one-off aircraft, but with an active resale market, the P-51, the T-34, while they might not be readily available for off the shelf value, you should be able to get a value from a third party.

Jim Blessing (23:18):

Another unique segment is experimental aircraft. If somebody wants to go out and buy an RV-7 or an RV-10 as a fun airplane to fly around on the weekends. With experimental aircraft, we’re looking for an active resale market for that particular experimental. Van’s Aircraft, a great example of one that has an active resale market. So if we have a customer coming to us, wants to buy an RV-7, we’ll typically look for five or six other RV-7s that are out there that are in the market and what they sell for and we’ll come up with a summary of comparable aircraft to help establish the value.

Jim Blessing (23:50):

A third kind of fun airplane would be like a back country airplane. These are your vintage Cubs, or even your modernized Cubs. A fully restored 1940s Cub. We’ve financed a couple of those lately. Then you’re talking about how did the airplane get restored, how has it been modernized, and how do we get our hands around a value on that? And oftentimes we’ll have to outsource that to a third party expert. With the modernized Cubs, the light sport aircraft Cubs, those values are a little bit easier to get your hands around because a lot of them are trading regularly. You can see them traded regularly and you might find them in some of the popular value guides.

Jim Blessing (24:29):

Lastly, and we don’t see this as often as a second fun airplane but we do see it from time to time. Customer wants to buy a helicopter to go up and commute back and forth to another location that they have close by before they get into their business airplane, and when you’re looking at helicopters it’s a different market and I’ll say specifically on the Robinsons, they have a 12-year life limit so that necessitates a different structure and a different approach to the financing. You have to figure out where they’re at in that lifecycle, and then put terms together that would support that lifecycle. Now, that said, if you’re buying a Robinson that’s 11 years old and you’re going to need to have the overhaul performed next year, you can typically finance that overhaul. That’s some airplanes that we would consider to be fun and how we look at different fun airplanes.

Tony Kioussis (25:10):

I appreciate the explanation. They make a lot of sense, and it shows why AirFleet Capital is such a respected entity within the aircraft finance community. How does AirFleet operate and what makes the company different? In other words, what do you want people to know about AirFleet Capital specifically?

Jim Blessing (25:30):

Well, it starts with who we are. Our people. Our staff includes aircraft owners, pilots. We’ve got a couple CFIs on staff, an A&P mechanic on staff, people who have owned FBOs and flight schools, and then on the other side of that we also have prior bank executives at the highest levels. We have gentleman on staff who’s been the president of a bank and owned a bank, and another gentleman who has experience as an executive vice president of a bank. We have both the aviation and finance experience.

Jim Blessing (25:56):

In addition to that, we’re a unique company. We have a small number of bank relationships at any given time, and we sole source for the majority of those relationships. Each bank has its own unique appetite and unique characteristics, but we work with them to provide them with a portfolio that they’re looking to build and in conjunction with that, by having multiple banks that support us, our brand is able to remain consistent in the marketplace regardless of banks entering and exiting the market. And over the course of the past 15 years, we have had a lot of banks and financial institutions enter and exit the market and we’ve been able to maintain a consistent brand throughout that cycle.

Jim Blessing (26:32):

In addition to that we’ve got, and this is rather unique on our side, an in house underwriting and credit analysis team. We also have an in house loan contracting team and this loan contracting team last year contracted over 400 loans. This is all done in house. We have a sister company which is under the same roof which is an aircraft loan servicing company, and so we’re servicing a larger number of our customers.

Jim Blessing (26:54):

So we’re keeping our hands onto that client relationship from the very first conversation until the end of their ownership cycle, so throughout the entirety of their ownership cycle we want to be in front of them and supporting what they need to do.

Jim Blessing (27:06):

We also have experience owning and operating the aircraft that we support. We like to think that we understand the aircraft purchase transaction because we’ve been through the purchase transaction. We’ve been through the pre-buy inspection. We’ve been through the financing process ourselves. We understand what’s involved because we’ve been through it, and that gives us a different level of experience. We’ve now been in business for over 25 years. We’ve financed over 7,400 airplanes. Every single day we’re learning something new about how to do better at what we do and applying it to our business.

Tony Kioussis (27:36):

Thanks for taking the time to talk with us today, Jim. AirFleet Capital is a great service to the industry and we appreciate what you folks do, and greatly appreciate the education for our clients.

Tony Kioussis (27:51):

This has been another Asset Insight podcast covering the aircraft ownership lifecycle. Please visit our ever-growing podcast library at AssetInsightPodcast.com and select from any number of topics discussed with business aviation industry experts. This is Tony Kioussis and as always, thank you for listening.