Aircraft Financing in a Volatile Environment

The business jet buyer is acutely aware of the interest rate environment. Whether the core business is commercial real estate, construction, or goods and services, the cost of borrowing is top of mind for growing a company. That awareness is especially sharp right now given the volatility of the past few quarters. My goal here is to lay out the core fundamentals of borrowing for corporate aircraft so you have a framework for your decision making. 

How Business Jet Rates are Priced 

There are a few benchmarks lenders use to determine the pricing of debt on aircraft. The most popular today is SOFR, which tends to be the most reactive to market movements. For instance, I had a deal recently that reduced by 20 bps between proposal and closing in the buyer's favor in a matter of thirty days. To achieve a fixed rate on a SOFR based loan, lenders will typically use some sort of swap contract index, such as the 5-year SOFR Swap Rate or the ICE Swap Rate. 

Another popular benchmark is the 5-year Treasury yield. The reason for this is that most aircraft transactions are structured as commercial loans with a term of 5 years, with a balloon payment due after the 60th month. This typically aligns well with the bank's cost of funds regardless of how they actually fund their loans. 

Lastly, and least popular, is the Wall Street Journal Prime rate. This rate is the least reactive on a daily basis as it is tied directly to the federal funds rate. The other two indexes (SOFR and the 5-year Treasury) are generally tied but not a direct correlation. 

Credit Spreads Drive Most Successful Outcomes 

Regardless of the index in which a lender benchmarks their rate, the key driving factor is the credit spread above (or below, often seen in WSJ Prime based rates). This is where there are some opportunities to use the market volatility to your advantage. 

The primary driver of credit spreads is the risk equation of the transaction. This is determined by the quality and remarketability of the asset, the post-existing debt and post-proposed debt cash flow of the company or guarantors of the transaction, and the liquidity position of the borrower. Assuming all of those factors are strong and easy to understand, the risk perceived by the lender allows for the tightest possible credit spreads. 

The final part of the credit spread equation is understanding which lender has excess capacity for lending, which allows for tighter credit spreads in extenuating circumstances. Here is where having expertise and relationships in the market are paramount. Banks to a certain extent have autonomy to decrease credit spreads when they have excess capacity, which is typically driven by lending targets in a given month, quarter, or year. Each lender has slightly different cycles in which this happens, which can provide an opportunity to save a few basis points in a transaction. 

Floating Rates are a Risk/Reward Equation 

The question of taking floating rate debt versus fixed rate debt is a conversation to have with a financial advisor, a CFO, or a trusted source, and it requires a risk calculation across the entire debt stack. Taking a floating rate can have advantages in the short term, but increased risk exposure in the long term. Those taking a floating rate often have a plan to purchase a swap contract in the future, when they feel there is little room left for rates to fall further. 

On the other side of that equation is taking a fixed rate at the time of closing, often with a prepayment structure from the lender in the event of an early liquidation of the asset or full payment. In a perceived higher interest rate environment, fixed rates can seem like an opportunity missed for rates to come down. I would challenge that thinking in the fact that the spreads in a volatile market with projected interest rate cuts often allow for a lower fixed rate at closing, where the realized savings in the short term can outweigh the benefits in the long run. Without going deep into the futures market, fixed rate options with limited prepays generally carry limited opportunity cost risk in aircraft borrowing. 

Structuring Matters 

Interest rate is one part of a three part structure. Loan-to-value and amortization are the other two important pieces to structuring an aircraft loan, and having the right lending partner to achieve your goals drives the successful outcome that you're looking for. Assuming you are buying a good aircraft for the right price, stronger cash flows driven by longer amortization or higher loan-to-value may be more important to achieving your goals than saving 25 to 50 bps. This is where structuring comes into play, and where a holistic view of the market matters. Regardless of how volatile or calm interest rates are, structure often wins in the long run and creates an excellent ownership experience. 

About the Author: 

Preston Holland is the Founder of Prestige Aircraft Finance, a leading aircraft financing company. With a large network of lending partners across North America and Europe, Prestige focuses on driving successful outcomes for their clients. Preston is also author of The Private Jet Insider newsletter and co-host of The VIP Seat Podcast.