Important Things You Should Know about Aircraft Financing

Financing an airplane is quite a different process than financing a car or boat. When buying your first plane, it is crucial that you are prepared and start the aircraft financing process as early as possible. Lenders assess not only your credit history but also the plane’s condition and the purpose of ownership. Although not all factors can determine how much you can borrow, they still play a significant role in the loan process.

Aircraft financing is not a regular business for most lenders. Since aircraft are specialty assets, they are subject to specialized laws often unfamiliar to lenders who usually do traditional real estate or equipment financing. Even larger national lenders with regular aircraft finance portfolios generally have a small group of lenders that deal with aircraft transactions.

Aircraft financing can be done safely and securely, but there are a few things you need to know first.

What You Need to Know

When considering financing an aircraft purchase, it’s essential to note that not all financing companies are the same. Some lenders specialize in aviation, while others have a more generalist approach and lack experience in aircraft financing.

Business aviation finance providers offer different packages based on the borrower’s needs, meaning that buyers looking for financing will need to find lenders that are more flexible and can tailor deals to meet their requirements.

When considering financing an aircraft purchase, it’s crucial to ask the following questions:

1. What type of business aircraft are you planning to buy, and does the lender have experience financing that type of aircraft?
2. If you’re purchasing from the pre-owned market, how old will the aircraft be? Note that as the aircraft’s age increases, the pool of lenders willing to offer finance becomes smaller.
3. How long is your preferred loan term? Keep in mind that some lenders may be more prepared to offer longer loan terms than others.
4. Where will the aircraft be based when it is operational? Consider working with a lender located in the same region as the aircraft to structure a deal based on their knowledge of the risks of basing and operating an aircraft there.
5. How risk-averse are you to value deterioration? If you’re concerned about the depreciation of the aircraft, a lease arrangement could be preferable, where the lessor determines how the aircraft is to be maintained and exposed to the impact on the aircraft’s value.

Overall, it’s essential to find a lender that has experience financing the type of aircraft you’re purchasing and can tailor the loan terms to meet your specific needs.

To begin an aircraft purchase transaction, you need to understand the basics of the process and how it differs from traditional equipment finance transactions. In the United States, the following steps are typically involved:

1. The parties enter into a Letter of Intent (LOI), and the buyer places a deposit on the aircraft. The LOI describes the aircraft and basic payment terms, and the parties negotiate a definitive purchase agreement to address the issues discussed below.
2. Since the FAA Civil Aircraft Registry is located in Oklahoma City, the parties usually engage a title company or law firm in Oklahoma to act as the escrow agent.
3. Most aircraft sales are on an “as-is, where-is” basis, so the seller arranges for an inspection to ensure the condition of the aircraft. The aircraft and related documents are subject to specified delivery conditions, but the buyer must confirm the condition before closing. Therefore, most buyers arrange (at their cost) for an inspection facility to conduct a visual and mechanical inspection of the aircraft and review the aircraft documents.
4. If the inspection facility finds any discrepancies from the required delivery condition, the seller corrects them to put the aircraft in the required delivery condition.
5. The escrow agent obtains and provides appropriate lien searches on the aircraft, and based on the lien search results, the seller obtains any necessary lien releases to be filed at closing.
6. The parties prepare, execute, and position closing documents with the escrow agent. These documents may include title transfer documents, prior lender lien releases, and any mortgage or other security documents required to document a new lender’s security interest in the aircraft.
7. Once everything is positioned, the parties hold the closing where all documents will be released and filed once funds transfer. Unlike real estate deals, for instance, these closings usually involve many parties in remote locations. As such, even pre-COVID, most closings are handled by phone and email.

Private Aircraft Financing

Obtaining aircraft financing for a private aircraft follows a similar structure to that of a car loan or mortgage. The lender is often a commercial bank that does not necessarily specialize in aircraft financing. Here is the basic structure for obtaining financing for a private aircraft as an individual or small business:

1. The borrower applies for financing and provides information about themselves and the aircraft they wish to purchase.
2. The lender performs an appraisal of the aircraft to determine its monetary value.
3. The lender performs a title search using the aircraft’s Federal Aviation Administration (FAA) registration details to determine if any liens or title defects are present.
4. The lender completes the necessary documentation, including a security agreement that allows them to repossess the aircraft if the borrower defaults on the loan, and a promissory note that holds the borrower responsible for any outstanding loan balance that cannot be covered through the repossession of the aircraft.
5. If the borrower does not fully qualify for the loan, a surety will be required from one or more third parties.
6. Once the documentation has been completed, the funds and title are transferred as required.

While aircraft financing for private individuals or small companies is usually straightforward, more complex financing agreements may be required for expensive aircraft.

Commercial Aircraft Financing

Commercial aircraft require a much larger investment to own and operate compared to general aviation aircraft. With costs often in the millions of dollars, commercial airlines usually cannot afford to purchase an aircraft outright.

Even if an airline had the capital, it wouldn’t make financial sense to tie up such a large amount of money in one asset when it could be financed at favorable terms. This would allow the capital to be used for other expenses or unforeseen circumstances.

There are three primary general structures for financing commercial aircraft:

1. Direct lending
2. Operating leasing
3. Finance leasing

It’s also important to note that there are other methods for financing commercial aircraft. Some less common examples include tax leases, Enhanced Equipment Trust Certificates (EETCs), leasebacks, and cash purchases.

Direct Lending

Direct lending is a loan that can be secured or unsecured that is provided to finance the purchase of a commercial aircraft. Due to the high cost of commercial aircraft, it is rare for a single bank to have enough capital to finance the purchase, so a group of banks, known as a syndicate, will often provide the loan jointly.

Typically, commercial aircraft loans are secured, meaning that the bank will repossess the aircraft in the event of a default. To create a security interest, a legal document is required that grants the financier (the borrower) the right to repossess the aircraft if the airline fails to pay the loan.

Unsecured loans for expensive aircraft are not common and are only available to companies with good credit and cash flow. However, they usually come with high-interest rates, making secured loans a more popular financing option for commercial aircraft purchases.

The Advantages/Disadvantages of Direct Lending

Direct lending offers airlines the advantage of being able to purchase and own their aircraft, which can result in tax benefits from depreciation deductions. However, there are also disadvantages to direct lending. Airlines have to take on significant amounts of debt to buy aircraft this way, leaving them vulnerable to market fluctuations and unexpected expenses and unable to easily adjust their fleet size.

To mitigate these risks, airlines can turn to lease agreements, which are another common method of aircraft financing. There are two primary types of lease agreements: operating leasing and finance leasing.

Operating Leasing

An operating lease is an agreement that allows the lessee, such as an airline, to use an asset, such as an aircraft, for a specific period of time without transferring ownership to the lessee.

Operating leases typically last no longer than ten years, which enables airlines to quickly expand their fleets without taking on the risk of owning assets that may no longer be needed if the expansion needs to be reversed. Operating leases also help reduce the risk of aircraft obsolescence, as airlines can update their fleets with more fuel-efficient, quieter, and environmentally-friendly planes, particularly in regions with strict environmental and noise regulations.

Lease agreements can be a suitable alternative for some airlines, particularly those in high-risk or less creditworthy countries, that may be unable to secure the financing needed to purchase aircraft.

Finance Leasing

Finance leasing, also referred to as capital leasing or sales leasing, is a long-term agreement that transfers more ownership of the asset (such as an aircraft) to the lessee (an airline) than traditional operating leases. Unlike operating leases, finance leases often give the lessee the option to fully own the asset at the end of the lease.

In finance leasing, a Special Purpose Company (SPC) finance company purchases the asset (aircraft). The structure of finance leases typically includes the following steps:

• The lessor (SPC) purchases an asset (such as an aircraft).
• The lessee has full usage rights over the asset.
• The lessee pays predetermined intervals and amounts for using the asset.
• Over time, the lessor recovers all or most of the asset cost plus interest.
• The lessee can choose to acquire full ownership of the asset.

A finance lease is similar to a hire purchase agreement, where the lessee will eventually acquire full ownership of the asset. However, finance leases have different accounting and tax considerations. For this reason, it may be more advantageous for the lessee to lease the asset through finance leasing rather than buying and hiring the asset.

Finance leasing is an attractive tax shelter for investors as they can deduct the depreciation of the aircraft and the interest paid to the lessor from their tax bill. Essentially, finance leasing offers some benefits of aircraft ownership to the lessee without the need for them to own the asset or obtain costly financing while still allowing them to deduct lease payments from their tax bill.

Conclusion

Complex financing and legal structures are commonplace when large sums of money are involved. Aircraft financing has enabled the aviation industry to meet demand and become an appealing investment option.

As the aviation industry continues to recover from the pandemic, finance corporations must prepare for the private and commercial sectors to reach pre-pandemic levels and beyond. This growth is expected to generate significant profits and tax savings.

Shearwater Global Capital is a worldwide aircraft finance company that offers personalized financing solutions to its clients. Our application process for aircraft purchases is fast and convenient, usually closing within four weeks, with the asset acting as collateral. Unlike large institutions, we do not have restrictions and lengthy procedures, so we can provide the best aircraft finance loan that meets our client’s requirements without involving intermediaries.

We specialize in limited recourse or asset-based finance loan structures that are customized to suit the specific needs of our clients. Additionally, we offer bridge and progress payment financing. Contact us today to learn more.