Number crunchers recall industry ups and downs
The zero-based budgeting of the 1970s has transformed this year into ground-zero-based budgeting. When aviation faces economic crisis, it returns to basics–productivity, time saving and security. These core values of business aircraft remain the bedrock. All else is changeable.
Profound changes in aviation led the industry’s top names in corporate aircraft acquisition, finance, registry and legal issues to the Seventh Corporate Aircraft Transactions and Fractional Ownership Conference hosted by the Strategic Research Institute. The gathering in New York City, July 11 to 12, was held 10 months after September 11, and 10 minutes by taxi from Ground Zero, where the Twin Towers of the World Trade Center used to stand.
Some came for updates on seemingly ancient issues; others came for predictions. Most came for reassurance that business aviation could thrive again. The consensus was, that it could: as long as participants braced themselves for new bureaucracy, more complex paperwork and longer processing times in the short term.
Beyond Ground Zero, scandals in accounting have cratered market confidence. Airport access has become more limited; insurance costs have soared; and lenders and guarantors have become skittish. Aircraft transactions, from scrutiny during registration to tax and accounting incentives have become more complex and enigmatic.
In the 1970s, corporate aviation was giddy with growth; the 1980s were a time to recall that an asset billed solely as the world’s best tax investment could also fly. In the early 1990s, NBAA split the difference: its No Plane No Gain campaign trumpeted the productivity, security and time savings afforded by corporate aircraft. Since September 11, these basics are newly vital.
John Rodgers, a self-described “green-eyeshade man” who directs the FAA office of aviation policy and plans, said “September 11 was a tragedy, but it essentially reversed the trend of decline for the previous 18 months.” Rodgers’ office compiles records for 32 aircraft types tracked by ATC under domestic IFR departures. In January 2000, business jet activity was considered to be growing. That March, the Nasdaq plunged 500 points, and general aviation declined alongside, through September last year. A month past September 11, after most airspace restrictions were relaxed, bizjet activity has recovered faster than commercial airlines.
Rodgers reported that with the June 28 opening of New York City’s public-use heliports, “the National Airspace System is now 99 percent the same as before 9/11.” Reflecting on the recovery, Rodgers considered the effects of Enhanced Class B airspace, when the “inverted wedding cake” on charts was smoothed to a cylinder. “The new space under that cylinder was the major impediment to general aviation.” To cite the FAA term, such encased aircraft have since “flushed out,” though attendees complained of the lingering scent.
As of October last year, said Rodgers, commercial airlines suffered a 16.9-percent drop in IFR departures while GA saw a lower but still costly 15.2-percent decline. Each has steadily improved, but general aviation has done so at a faster clip. By April this year, airline departures remained down 3.7-percent compared with the previous April while GA departures had risen 2.3 percent.
Conference delegates questioned the validity of the statistic: a challenge Rodgers has heard before. “Give us better numbers,” tossed back Rodgers, who urged more participation in the yearly General Aviation Activity and Equipment Survey. One problem is that of definitions. Rodgers’ office defines “corporate aircraft” based on the aircraft’s ownership, while “business aircraft” are defined based on usage, so FAA tracks each separately.
Rodgers cited AvData for fractional ownership flight hours, which since September 11 have enjoyed unusual growth. Ownership swelled to 4,900 shares in 668 aircraft by year-end 2001, from only 548 shares in 1996. Rodgers said he expects a faster rate of growth.
Insurance coverage remains readily available but expensive, said Rodgers. “If anyone says they can’t get insured, come see me. I’ll send you to a broker.”
Doug Carr, director of government affairs for NBAA, posted a slide, “Aviation 10 Months Later: What has happened?” Nineteen new public laws have been enacted, 16 resolutions approved, and 75 pieces of legislation saw at least some floor action. “Of primary concern is that the Transportation Security Administration focus is security, not aviation. How much is too much?,” Carr posed one week before TSA under secretary John Magaw resigned abruptly.
He warned that under TSA, as many as 65,000 employees will interpret laws that have yet to be developed. “Their attitude so far is, ‘We’ll tell you when you need to know.’” Carr said that the best near-term break in the clouds is that TSA is focused on commercial airlines. “This gives us some time to plan, but eventually, they will get around to business aviation.” Despite three major legislative attempts, GA is the only class of operator directly affected by government action on September 11 that has not been compensated. Carr said that in early July the Bush Administration denied relief again, saying it had other measures in effect for GA, “but I don’t know what they mean by that,” he said.
Former U.S. Secretary of Transportation Rodney Slater, now a partner in the legal consulting practice of Patton Boggs, LLP, told delegates, “The aviation industry has a friend in Andrew Card,” referring to the President Bush chief of staff who whispered the news of attacks in the President’s ear on September 11. Slater reminded delegates that it was their role as citizens to check the emerging TSA bureaucracy, and that legislators and regulators required their advice. “Democracy is a contact sport,” he said.
Effects of September 11
More than one conference speaker noted that the most immediate need for reform was to agree as an industry not to use the word “impact,” when referring to aviation, especially since September 11. Nonetheless, if not the word itself, its implications permeated all sessions.
Rudy Tenore, v-p of asset and business development for Fleet Capital Leasing of Providence, R.I., summarized the mood. “There’s an uncertainty that’s created by terrorism, and now the recent trouble with accounting firms. Customers are sitting on the sidelines saying they will wait another 30 days and see if the price [of aircraft] drops further.”
Joseph Dini, senior v-p of GMAC Business Credit/Business Aviation Finance, considered a snapshot of September 11, 2001, versus September 1991 and 1981. Dini compared the Dow Jones industrial index mortgage rates, prime rates and the values of the Canadair 600, Citation 550, Falcon 50, Hawker 700 and Gulfstream IV as a sample, and concluded that industry was in a slightly better position today. Dini added, however, “The only way to add used aircraft to the market is to sell new aircraft, or to close flight departments,” and the former is slow while the latter unfortunately continues.
Brinton Smith, v-p of private client services for Marsh Insurance, said that “Early on, I was trained not to suggest a liability limit to a customer.” Smith explained that most settlements remain sealed and that circumstances differ widely, but he offered recent examples for guidance. “The largest previous liability settlement was for $45 million for a general aviation accident, and for an individual, $34 million.” He claimed that the crash of the GIII in Aspen in March last year (see “Pressure on Pilots,” AIN July, page 1) that killed 18, may soon settle as the largest GA loss, and that underwriters are asking more questions.
Bruce McNeely, senior v-p of U.S. aircraft management services for Jet Aviation, said it holds liability policies of $300 million for each of its 75-aircraft fleet. “One of our competitors keeps $200 million, but we pay about the same amount,” he acknowledged. Frank Stancato of Boeing Capital, said that $50 million war insurance on a small-cabin airplane is adequate, if it is not flown internationally. “I’d say $150 million for a large-cabin airplane that’s internationally flown, but if there’s an incident…you’ll never have enough.”
Overall, said Smith, aviation insurance is only a
$2 billion market, relatively unregulated and relationship-driven. Lienholders have steered clear of liability, “so far.” But since September 11, war insurance has either evaporated or risen beyond the reach of primary owners. As a result, “Banks may become the next deep pocket for plaintiffs,” especially since reforms to manufacturers’ liability. “Knock on wood, there has not been a liability claim with a fractional owner.”
Like FAA’s Rodgers, Smith said the good news is that insurance remains available. He considered the pending Eclipse minijet twin and traditionally owner-flown models such as the Pilatus PC-12 single turboprop. “From an insurance standpoint we’d look at numbers alone, and say that a crew of two is generally safer. But by and large, the limits and deductibles are there for you, if you want to pay for them. They are ‘agreed values;’ you can negotiate what you want.”
Smith explained that Marsh has a highly affluent client base, with a tradition of privacy. “As a general rule you don’t disclose names unless you absolutely have to. But insurers are starting to ask the question, ‘Who exactly is behind those
limited liability corporations?’” Insurers spoke of new attention to background checks, but noted that when customers pay cash and bypass credit approval, the question of insurance does not emerge until the final step in the acquisition. Both Dini and Russell reported that they had excluded only a single customer after running a background check. “Hey, it must have been the same guy!” several audience members joked. For competitive reasons, no cross-checks exist.
The New Fractional Rule
In October 1999, FAA Administrator Garvey charged the fractional ownership aviation rulemaking committee (FOARC), to advise on revisions to the FARs. The FOARC conducted its business via an unprecedented collaboration of FAA and industry; a process which itself proved to be a landmark change. Previously, the level of candid exchange would have been considered illegal ex parte discussion during rulemaking.
The FOARC’s 27 members released a notice of proposed rulemaking (NPRM) which received 200 comments in 120 days, but “no real surprises,” according to Katherine Perfetti, national resources specialist at the FAA. The final rule is expected by the end of this year and will be effective within 60 days as Subpart K to FAR Part 91. New fractional programs must immediately comply while existing programs can phase in over 15 months. Part 135 operators can take advantage of modifications as soon as the rule becomes effective.
Perfetti said that the remaining work is internal. “When we asked which fractional programs are in which FAA inspector’s region, we got blank stares.” FAA is writing internal guidelines to interpret the rules, and “we’ve hit some sacred cows,” said Perfetti. But most conflict lies in differences between international and domestic application. “Internationally, they say that every time money is exchanged, that’s commercial.” No security provisions were in the NPRM, said Perfetti, and none are expected in the final rule. “TSA will likely have a look at that,” she added.
Eileen Gleimer, counsel for Crowell & Moring LLP, said that under Subpart K, the FAA will ensure that each fractional party in operational control is readily identifiable and that party understands the implications. For the first time, the FAA will recognize that owners can delegate management and aviation expertise to a third party in a manner that results in joint-and-several liability. Before each flight, passengers must be advised who has operational control and under what FARs the flight will be conducted, Part 91, 135 or 121. FAA will specify manager’s procedures, training requirements for flight crew and maintenance personnel, recordkeeping requirements, flight and crew scheduling and an internal safety reporting system.
Subpart K will likely impose an 85-percent requirement for runway length, which could be exceeded if an FAA-approved airport analysis is filed in the manager’s manual (in contrast, the runway requirement in Part 135 is 60 percent). Weather reports need not be FAA-approved but simply from a facility at the destination or nearby airport plus the destination’s current local altimeter setting. While Part 91 allows zero-visibility takeoffs, Subpart K will require RVR visibility of at least 600 ft. Part 91 requires no proving tests for aircraft but Subpart K will require 25 hours for initial operation of an aircraft for which two pilots are required, or for a turbojet.
Flight duty and rest time guidelines will equal or exceed those of Part 135, and establish minimum staffing of three pilots per aircraft and two passengers when passengers are on board. Pairing requirements to attain the minimum experience, plus background checks, new training and testing. There is no requirement for drug testing under Part 91, but Subpart K will now require an education program to combat drug and alcohol abuse. Gleimer smiled at FAA’s Perfetti and said, “I haven’t figured out what you’re going to teach them yet, but we’ll figure that out later.”
FAA is assigning inspectors, writing an inspector handbook and creating surveillance programs. An Advisory Circular and management specification templates are being prepared for an expected release in October.
Gleimer summed up by saying, “Once the final rule is published, FAA has lifted the de facto condition of ‘hands off’ to fractional operations. Ultimately, operators may conclude that operating under Part 135 will no longer look that difficult,” he added. “Owners will need to open their eyes, literally signing that they acknowledge civil liability. Some of them may go back to charter–there will be some settling of dust. Some of the small fractional providers may join the big gorillas.”
To Register or Not To Register
Erin Van Laanen, a shareholder of Oklahoma City’s McAfee & Taft and an expert in aircraft title examination, quoted from the FAA’s “words of wisdom,” with regard to adding fractional owners to the FAA Registry: “Don’t Do Them.” Adding her own thoughts, she said “They are a pain in the you know what.” The volume of registrations has become mind boggling, she explained and a severe drain on a shrinking workforce.
Beyond volume, Van Laanen’s chief challenge is explaining what a registry does not require. She listed a litany of papers that typically float to her office, most of which are irrelevant. “There are only three items required: the FAA Bill of Sale, the Aircraft Registration Application, and the Powers of Attorney or corporate resolutions appointing the fractional program managers as attorney-in-fact for each of the co-owners. Unless truth-in-leasing requirements kick in,” she continued, which require additional language and procedure.
An LLC must qualify as a U.S. citizen and must provide evidence as to ownership, its decision makers and signatories. FAA, however, has made no change to its registry procedures or owner scrutiny since September 11. Van Laanen reiterated that one rule has always been in effect, and remains so. “If you’re going to fly under Part 91, you can’t form a company specifically to fly your aircraft. A special purpose entity is not the way to go.”
Van Laanen said that the biggest change to registry is that it “has been dragged screaming into the computer age.” As of the first week of August, the registry’s cumbersome but cost-free microfiche records were expected to be replaced by CD-ROMs readable by PDF, and costing $5 to users.
Studies in Fractional
Jet Aviation’s McNeely reported that many fractional providers had chosen Jet Aviation’s charter operation for supplemental lift, primarily for consistency. “We have a branded product. Our airplanes look alike inside and out; our training standards are the same across the board. There are no issues as to who is the owner and who is the operator,” he said. “The FAA knows exactly which belly button to push.”
McNeely said each aircraft is flown 70 to 100 hours monthly, and added that cross-mode deals are common among wealthy clients, for example the combined charter of a Jet Aviation jet and company yacht. But Henry Schachar, COO of Marquis Jet Partners (see AIN, March 2002), thinks the future will bring younger clients and of more modest scale. “The Marquis is a card for 25-hours of occupied time. NetJets is the sole provider, and we buy shares from NetJets like everyone else,” said Schachar. “The difference is that we own all the hours that we sell.” Marquis is now the largest NetJets owner and just launched Marquis Jet Europe to expand its current network. Marquis has offices in Los Angeles, New York and West Palm Beach.
The Marquis program requires a 100-percent prepayment for the 25-hr block. “About 95 percent are first-time clients,” Schachar said. “We’re a one-year program with the premium that goes with that. We are the highest priced aviation solution. Most clients go into fractional as an investment–but we are a transaction.”
He said the typical Marquis customer is “maybe 15 years younger than at NetJets, with not as high a net worth. That makes our base potentially 10 times larger.” Schachar noted that his numbers were anecdotal. “We don’t ask income or age when people apply. We’re not interested in good credit: the whole model is based on cash up front.” The Marquis flight profile is 80-percent personal-and-leisure travel. “Owners tend to burn through the 25-hour card in about nine months then renew,” said Schachar, “so essentially they are 35-hour owners.” Marquis adds its markup to NetJets shares, then passes through all operating costs. “It’s not like we’re taking a $7.00 hamburger from NetJets and selling it for $11.00,” he said.
Bonus Depreciation for Aircraft
Under the Job Creation and Worker Assistance Act of 2002 (HR 3090), property with a 20-year or less recovery period, such as aircraft, acquired after Sept. 10, 2001 and before Sept. 11, 2004, and placed in service by Jan. 1, 2005, qualify for a 30-percent special depreciation allowance. This bonus allowance is taken in the year the asset is first placed in service, explained Edward Kammerer, counsel for Edwards & Angell, LLP of Providence, R.I.
“After the first year, the depreciable basis of the aircraft is reduced by the 30 percent for the purpose of calculating the regular depreciation, that is, you depreciate the remaining 70 percent over the applicable recovery period. The net effect is faster depreciation, not more. Benefits are greater in tax year one and smaller in all subsequent tax years.”
Kammerer’s opinion was that HR 3090 is not simply for single-owner aircraft and not simply for “new” aircraft as narrowly interpreted. “Bonus depreciation should apply to fractional shares,” he said, making the analogy of a GM dealer who holds a car before reselling it from the plant to the car buyer. “The fractional share becomes inventory for resale, so long as it’s not made part of the core fleet. The bonus should apply to the share owner when it’s purchased, as though it’s a new aircraft.”
In effect, unsold shares in a fractional aircraft are inventory being held for resale, and serve as “demonstrator aircraft” until sold. The fractional program manager might sell a quarter share, then if the remaining three-quarters are treated as inventory and remain available for sale, Kammerer finds it “a credible position” to treat the sole share owner as operating the remaining shares as a demonstration. “There is no language in HR 3090 about the timing of the later sale of these shares,” he said. “In theory, they can be sold a year later and still qualify as new to that co-owner, and qualify for the bonus depreciation.”
But Kevin Russell, senior v-p of NetJets, reminded delegates to act with caution. “You must sell eight eighths of that airplane to customers, each of whom can take advantage of bonus depreciation,” he said. “People not sharing that information with their clients are going to get in a lot of trouble with the IRS.” Russell is working to allocate pending deliveries to the right owners, closing them all on the same day. NetJets provides interim leases as necessary, until all owners are on board the deal.