Aviation Finance: Low rates and competition create a borrowers' market but the economy may hold some suprises
A vibrant level of new aircraft deliveries, strong sales of used aircraft, low interest rates and competition among lenders have provided banks and other companies involved in the financing of business aircraft with greater activity this year than last year. But the business aviation industry is notoriously cyclical, and recent signs may indicate the end of the current buyer’s market for loans and leases, though exactly when this will happen is impossible to say.
Most of the lenders interviewed for this report said they have financed more aircraft this year than last year. Business has “improved considerably” or is “definitely better” for some, while others reported that activity is about the same or only slightly better. Several specifically mentioned large-cabin aircraft as particularly active in both the new and used markets.
Several factors are driving current demand. “There’s a perception of an improved economy and pent-up demand,” said David Davis, vice president of 1st Source Bank, in South Bend, Ind. “Aircraft values have stabilized and there’s a lot of replacement buying going on.”
According to David Madden, executive vice president of Aircraft Banking Centers in Orlando, Fla., “Low interest rates and long-term financing options have unquestionably aided in turning the aircraft market around during this past year.”
Said Susan Foster, vice president of marketing for Cincinnati-based National City Commercial Capital, “I believe one of the biggest factors is demographics. Long-time business owners in their 50s and 60s who are financially successful have decided that they have the resources to own an aircraft and they do not want to travel on the airlines for all of the obvious reasons. They also seem to have confidence that things will be relatively good for the foreseeable future.”
There are also fewer acquisitions of business aircraft by “new money”–dot-com millionaires who helped fuel the bubble market for aircraft (among other things) in the late 1990s–according to one lender, who did not wish to be identified.
“It was the worst thing that could have happened for the industry,” Joe Dini, senior vice president of Sovereign Bank in Manchester, N.H., told AIN. “Aircraft do depreciate,” he explained. “When they appreciate in the used market, as they did during the 1990s, it’s not normal. People have to ask why this is happening. As we saw, prices came down steeply after that, which hurt a lot of owners and made them wary of the market. Now we have a normalization of prices.”
“I’m finding a lot more real buyers this year,” said aircraft lending officer Pam Cooksey of First Merit Bank in Akron, Ohio. “It seems that some potential buyers have become more comfortable with the decision to actually buy. A year ago, there were a lot of rate shoppers but not a lot of actual buyers.”
Madden of Aircraft Banking Centers added that real-estate developers and investors, along with owners of construction-related businesses, have contributed sig- nificantly to the recent increase in business aircraft sales activity.
Another factor is the 12- to 36-month production backlog for new aircraft orders, which is “pulling up used aircraft pricing,” according to Greg Babcock, vice president of aviation finance at U.S. Bancorp Equipment Finance in Englewood, Colo. Although prices for many used aircraft have increased, these values are generally back to where they should be under normal circumstances.
“It’s not so much an upward market as a stabilized one,” said Davis of 1st Source Bank. “After the bubble, the market over-adjusted aircraft values in 2002 and 2003. Now the environment is more stabilized.”
In fact, the inventory of used aircraft has decreased by 21 percent since its high point of 2,059 in November 2002 to 1,629 in September this year. There’s also a smaller pool of good used aircraft on the market, with only about 20 percent less than 10 years old. With supply down, prices invariably rise.
Most lenders said they expect their activity levels next year to remain near this year’s level. Strong backlogs of new aircraft reported by the manufacturers, the entry of good used aircraft into the market as many owners take delivery of these new airplanes to replace older ones and the increasingly recognized value and convenience of business aviation over the airlines are factors pointing to continued strong business for lenders.
Negative Factors Threaten
On the flip side, several general economic factors have the potential to slow aircraft sales. Though the ultimate economic after-effects of Hurricanes Katrina and Rita are difficult to predict, several lenders mentioned continued high fuel prices and rising interest rates as having a dampening effect on aircraft sales in the long run. The bigger, more difficult question, however, is how these and other factors will affect the overall economy, which largely influences aircraft sales.
“If you graph economic cycles against deliveries of new aircraft and used aircraft prices, there is a correlation,” Dini explained. “You will see the ‘eight-month lag,’ an industry phenomenon that sustains strong prices and vibrant deliveries of new aircraft for about eight months while the economy is clearly in recession. Then, when the economy becomes strong again, the industry takes eight months to show signs of price and delivery recovery.”
“The big unknown right now is fuel prices and their effect on inflation and interest rates,” said Madden. “Volume levels [sales of aircraft] are expected to increase as long as fuel prices stabilize and interest rates do not climb steadily.”
He added that the turboprop market, especially for the King Air 200, has been “red hot” this year. “These aircraft have always been an economic barometer for business aviation users,” he said. “They’re the first aircraft to plummet in price at the onset of troubled times and the first to soar in value during the early stages of economic recovery.”
Low interest rates obviously stimulate purchases of high-ticket items, while high rates do the opposite. Interest rates reached historic lows in 2003, but they are rising. This has actually stimulated some buyers. “Some of my customers have stressed that since values on aircraft are down somewhat and interest rates are rising, this is the time to buy,” said Cooksey of First Merit Bank. “More and more people are taking the step now.” How high interest rates will go and what the long-term effect will be is impossible for anyone to answer at this time.
Even if economic conditions cool in the coming months, lenders expect next year to be “reasonably solid,” or even stronger than this year. “We see continued growth and growing demand at all levels of the corporate aircraft market,” said James Dickerson, executive vice president of Banc of America Leasing’s corporate aircraft finance division in Geneva, Ill.
The “eight-month lag,” a consequence of the OEMs’ backlog of aircraft, is the main reason for Dickerson’s optimism. OEMs will continue delivering these aircraft over the next few years, and that means continued business for the finance community. And because many of these new aircraft are replacement buys, lenders expect a fair amount of business as the replaced aircraft go on the used market.
If the cost of oil levels or decreases, the Fed stops increasing the prime rate, the U.S. economy continues to grow without the threat of inflation, corporate profits remain high, more people continue to choose business aviation over airline travel, then the industry might just plow right through the current cycle with nary a shudder. By the time the OEMs’ backlogs decrease to more reasonable levels, new orders could be coming in steadily and the aviation lenders will have even more work to look forward to.