Companies neglecting to properly evaluate various financing options find themselves either unable to acquire the right aircraft to finance or having to bear the burden of an expensive financing option
Unlike commercial aviation, there are very few business aircraft leasing companies, making operating lease rates higher
Need for business aircraft financing: The popularity of business aviation has increased as individuals and companies have realised the value that business aircraft offers in terms of safety, comfort, and time savings. This encourages them to look at aircraft acquisition options in case chartering an aircraft is not a suitable one. However, as potential business aircraft users start evaluating the right aircraft in terms of new or pre-owned asset, its capacity, range and price, they should take into account the financing options as well when making a fully informed choice. The reason is that cash flow plays a very critical factor during the acquisition and life cycle operation of the business aircraft. Companies neglecting to properly evaluate various financing options find themselves either unable to acquire the right aircraft to finance or having to bear the burden of an expensive financing option which is difficult to manage over the period of operation. This article takes you not only through various financing options but also the advantages and disadvantages of each option. But let’s first start with why it is beneficial to review financial options before you start the process of aircraft acquisition.
BENEFITS OF AIRCRAFT FINANCING
- Liquidity: Cost of new business aircraft can range from $2 million for very light jets to $70 million for large business jets. This requires a significant capital outlay during the acquisition stage. Financing an aircraft through debt or lease significantly reduces the initial capital outflow by up to 80 per cent depending on whether the aircraft is new or a pre-owned one.
- Higher return on equity: As companies don’t have to put up to 80 per cent of the equity to finance aircraft upfront they can deploy those funds in businesses that could yield a higher return on equity than the cost of aircraft finance.
- On or off-balance sheet transactions: Asset-heavy companies choose to keep aircraft on their books and receive benefits of depreciation thereby choosing finance lease or debt financing options. Companies can choose to have an asset-light strategy prefer operating lease finance to carry out off-balance sheet transactions.
- Manage life-cycle costs and risks: If the aircraft owner wants the flexibility to change the aircraft in a few users depending on changes in business requirements, then lease financing could be more practical as compared to debt financing. Although, in general, a lease is more expensive than debt, the owner can manage cost versus flexibility through financing options.
FINDING THE RIGHT FINANCIAL PLAN IS AS IMPORTANT AS SELECTING THE RIGHT AIRCRAFT FOR YOUR MISSIONS
Three major factors that determine the nature and extent of financing:
- New or pre-owned aircraft: It is easier to find more financing options and cost-effective ones for a new aircraft versus for a pre-owned one. A new aircraft operates under manufacturer’s warranties and has predictable residual risk. This provides great comfort to the financing institutions on the risks associated with asset quality and future value. Hence the cost of financing and initial upfront deposit is lower for a new aircraft.
- Acquiring a pre-owned aircraft has a few challenges. First, a thorough technical due diligence is required to assess the existing quality of the asset. Factors such as the maintenance history, whether the aircraft was under maintenance programmes and who was the aircraft management company play important roles to determine the cost of financing. Secondly, the residual values of pre-owned aircraft fluctuate depending on market conditions. This poses a higher risk for the financing institution and hence not only the financing rates are higher, but the owners may also have to put up a larger deposit upfront (sometimes up to 35-40 per cent) to secure finance.
- The creditworthiness of the acquirer: For best financing options, start engaging with the financial institutions so that they can evaluate your company risk profile. A lot of documentation may be required by the financiers to evaluate the creditworthiness of the company. This significantly affects the qualification of the aircraft acquirer and impacts the cost of capital, structure and the tenure of the financing.
Financing options: Here are the four most commonly used and preferred structures for aircraft financing:
- Structured debt finance: It is a basic secured loan structure in which a lender provides a loan to a company to purchase an aircraft from a manufacturer or a seller (for pre-owned). The loan is secured by a mortgage or other security interest over the aircraft. The company owns the aircraft from the outset, the asset sits on the balance sheet of the company.
- Advantages of structured loans:
- Low cost of finance: For an asset-heavy company with good credit ratings, the cost of financing can range from three per cent (Libor plus margin) from international institutions up to nine per cent from local banks.
- The owner receives depreciation tax benefits.
- The owner can fully customize the aircraft and has no restrictions put on the type of operation that the owner can undertake.
- The loan tenure could range from 10 to 25 years depending on the asset quality and company creditworthiness which reduces monthly payments.
- Disadvantages of structured loans:
- The document requirements are extensive and may take a few months for the owner to qualify for the loan unless the owner already has an existing relationship with a financial institution.
- As the loan is a balance sheet transaction, there could be full recourse to the company.
- In case the business requirements change, the owner is now responsible for selling the aircraft in the market. Depending on market conditions, it could take between 3 to 12 months to sell an aircraft.
- If the company is not investment grade, the loan could be expensive and may cost between six and 12 per cent.
- Operating lease: In a standard operating lease, the lessor will purchase the aircraft from the manufacturer (if new) and seller (if pre-owned) and then lease the aircraft to the company/operator, called the lessee.
- Advantages of operating lease:
- The initial down payment could be as low as three to six months of lease rental as refundable security deposit.
- Lessee does not have to worry about the residual value risk.
- Depending on contractual conditions, the lessee can terminate the lease with few months of notice period.
- Operating lease is an off-balance sheet transaction and does not affect the lessee’s other loan covenants.
- Disadvantages of operating lease:
- As a standard, the cost of lease finance is higher as compared to structured finance. The rates are between 7.5 and 14 per cent.
- Boutique leasing companies could demand an upfront deposit which could be upto 10 per cent of the aircraft value, thus removing the incentive over structured finance loan.
- The lessee does not receive tax benefits of depreciation.
- The aircraft lease return conditions could be restrictive and hence the lessee could face a large potential expense if the aircraft is not maintained well.
- To protect aircraft value the lessor could place restrictions on aircraft operations such as regional, airports or height restrictions.
India has always been a challenging market in which to obtain financing for business aircraft
Unlike that of commercial aviation, a major challenge for business aviation is that there are very few business aircraft leasing companies. Hence the operating lease rates are higher as compared to those for commercial airlines.
- Finance lease: In comparison to an operating lease, in a standard finance lease, there are two major differences: 1) it is a balance sheet transaction for the lessee, meaning the aircraft will show up as an asset on the lessee’s balance sheet. Hence the lessee is able to receive depreciation benefits. 2) There is an option or a right (usually an obligation) to purchase the asset at the end of the lease period from the lessor.
- Advantages of finance lease:
- The duration of the financial lease is higher than that of an operating lease. This results in lower monthly lease payments.
- The interest rate on finance lease is marginally lower as compared to that of an operating lease.
- As the aircraft would be eventually bought, the lessee does not have to worry about aircraft return conditions.
- Disadvantages of finance lease:
- The lessee takes the residual value risk and hence there is no asset value protection.
- Usually, the finance lease cannot be terminated before the end of the lease period. Hence the owner bears the risk of asset value.
- ECA (Export Credit Agency) financing: If owners qualify, then ECAs are attractive form of finance for purchasing new aircraft, especially large ones. ECAs are export-import banks that exist to improve exports of local aircraft manufacturers by directly financing or guaranteeing the purchase of aircraft by foreign buyers. In an ECA financing transaction, the ECA can either make direct loans or guarantee loans made by other lenders (ECA lenders) to an owner. Typically, ECA has a financial lease structure (Orphan SPV structure).
A joint and several absolute, unconditional payment and performance guarantee may be required from the parent company (if there is any) along with personal guarantees of the majority shareholder(s).
ONCE YOU HAVE FINALISED THE FINANCING STRUCTURE, NEGOTIATE WITH FINANCIERS TO PROVIDE BETTER RATES, TENURES AND OTHER LEVERAGE POINTS
The cost of financing could be at fixed rate or variable rate, which is usually a small margin over 3-month Libor. The owner receives up to 80 per cent of the net aircraft cost, which includes any ECA fee. The loan can be amortized between seven and 15 years and paid either monthly or quarterly. The borrower is required to maintain the aircraft under maintenance programmes and should have relevant risk coverage.
There is no prepayment penalty for partial or full pre-payment. Such ECA loans are usually arranged by a boutique firms called ‘Arrangers’ who liaise between ECA, ECA backed lender banks and the borrower.
- Advantages of ECA financing:
- The cost of financing is very low. The margin is around 2.5 per cent over Libor. This typically works out at 2.85 to 3 per cent interest rate.
- The loan tenure starts from seven years onwards
- Disadvantages of ECA financing:
- The documentation hassles with respect to ECA loans require an Arranger and is typically suited to large companies.
Suggestions for evaluating and successfully receiving the best financing options
- Begin early: Finding the right financial plan is as important as selecting the right aircraft for your missions. It is best recommended to start early, even as you draw up a budget for your aircraft. When engaging with financial institutions you will realise that the process takes much more time than anticipated. The last thing you want is to find an amazing aircraft to acquire and no proper finance for it.li>Model cash flows to choose debt versus loan: Engage an aviation financial consultant and have your accountant work with him/her to model out your cash flows with debt or lease financing options. Create financial models and simulate options such as interest rates, tenure, balloon payments, charter revenue etc. and evaluate what works best for you. Often you will find through modeling that one form of finance is way more attractive than the other.
- Use existing relationships and credit ratings to get better deals: Financial institutions add on a lot of risk factors when providing financial solutions to new owners. This makes the cost of financing expensive. Often two different buyers receive markedly different financing solutions for the same asset. Hence use your existing banking network who know your creditworthiness to find the best deals. Banking references and company ratings help in securing better deals.
- Use aviation lawyers and consultants to understand proposal technicalities and associated risks: Acquiring an aircraft is a complex proposition. A lot of deals don’t get consummated because the buyer does not have the detailed knowledge to power through an intricate structure of activities. Using experienced consultants helps speed up the process of aircraft acquisition and helps buyers make informed decisions. Remember, a simple deal may not be the best one for you.
- Negotiate: Always reach out to multiple financing companies for financing options. Conduct due diligence calls to ensure that you fully understand their proposals and start building comparison sheets. Once you have finalised the financing structure, negotiate with financiers to provide better rates, tenures and other leverage points.
- Close: In today’s market, you have to move quickly on financial and legal matters while closing an aircraft deal. If you do the above steps, then you are likely to receive various financing options. Decide which one best fits your business and cashflows and close the financing option. Good aircraft are hard to find. But once you do, having a strong financing option often providesleverage over other buyers.