Financing executive jets is very much a specialist operation and banks or funds that target the executive jet market have to have the dedicated resources that will enable them to build up the depth of knowledge that they will need to lend successfully into this many faceted and difficult market. The attraction for funders is that this is by definition a market comprising either high net worth individuals or the more successful corporations, but it is also a market where the value of the product on offer can vary hugely depending on where we are in the economic cycle. So calculating residual values, which is a staple part of any asset based lending operation, is a highly complex matter.
Chris Miller, Managing Director of Guggenheim Partners, Business Aircraft Investments group which specialises in financing the acquisition of medium cabin sized executive jets talked to E&VAI about his approach. At the time of going to press Miller was scheduled to be one of the speakers at the business jets financing conference being organised by the Lagos FBO Evergreen Apple, for 7 May, at the Lagos Wheatbaker Hotel (see the article on page xx). “We do almost all of our lending outside the US, which means that Africa and other emerging markets are of particular interest to us,” Miller comments, explaining his interest in participating at the event.
We are an asset based lender and base the decision on whether or not to lend as much or more on the value of the asset rather than exclusively or wholly on the creditworthiness of the individual concerned. This has helped it build up a successful loan book of customers outside the US. “There are many reasons why an individual may not be in a position to fulfil all the traditional requirements of mainstream bank lending,” Miller points out. A common reason among many emerging market clients is that the individual has a range of holdings in a variety of private businesses that may not have audited accounts. The absence of an audit certificate and a published set of accounts makes it extremely difficult for traditional lenders to fulfil their usual due diligence requirements to agree a multi million pound loan to such an individual.
“This absence of published, audited accounts to verify the individual’s wealth creates an opportunity for us since we use external agencies to research the individuals, to establish their bona fides and to enable us to be comfortable that they are the sort of people that we would feel relaxed doing business with. We try to gauge their character and to see how they are viewed as individuals in their region, as well as trying to verify that they are wealthy enough and have access to a sufficient flow of cash to enable them to meet their financing costs,” he comments.
Inevitably when you deal with emerging markets the twin issues of corruption and money laundering raise their heads. However, Miller points out that it is something of a false dichotomy, not to mention a hypocrisy, to point solely at emerging markets as a source of corruption. Advanced markets have more than their share of fraudulent and criminal activities and if the last crash showed anything, it showed that the likes of Bernie Madoff with his $65 billion fraudulent “Ponzi” scheme are able to perpetrate frauds in the West on a scale that dwarfs most emerging market fraud. “In the US our corruption is just masked and we are largely blind to it. But we see it very clearly in emerging markets where it is more blatant and less opaque. Often times Ultra High Net Worth Individuals in emerging markets have something in their past that may cause concern to any lender, but we try to find out as much as we can about our potential clients, while focusing on the asset as the real source of our collateral,” he comments.
The amount Guggenheim will lend depends critically on how marketable the jet itself is. For newer and more marketable aircraft the advance could be as high as 80%. However, a completely new aircraft type, by definition has no pre-owned track record for the loan manager to fall back on. This would cause the amount advanced to fall. Similarly, where an aircraft type has a long history of sitting for 250 plus days or more in the pre-owned market before selling, that too, would reduce the advance down. For every jet we have to think about how long it would take after a borrower defaults for us to repossesses and then remarket the aircraft, ” Miller says.
There is also a minimum level of lending that makes sense. The base costs to the lender for doing the deal do not scale with the size of the deal. The legal fees for repossession, for example, are pretty much the same whether the jet concerned is a VLJ costing £4 million or a Gulfstream at $28 million. “If you go about giving loans on $4 million aircraft you have very little cushion. We do limited recourse lending, which means that the client can give the jet back to us at any point. The primary recourse that Guggenheim has is the client’s commitment to maintain the jet in very good order. “As part of any deal we do, require an independent third party to manage the jet, not just the owner and his/her pilot, and we enter into an agreement with the aircraft manager. If the client defaults on payment, then the aircraft manager undertakes to take possession of the jet and deliver it to us at a location that we specify,” Miller notes.
The one real risk that a lender has to keep in mind when advancing funds to clients in emerging markets is the risk that the asset itself will be impounded by local government or tax authorities who are targeting the individual, and who simply do not care about the finance house’s prior claim to the plane. Brazil outlined this risk in spades when it impounded some 22 foreign registered jets on the ground at Brazilian FBOs last May, over a dispute involving alleged non-payment of import taxes. “India and Brazil are special cases here. Governments in both countries have a tendency to see business aviation as a potential source of tax revenue, instead of seeing it as a jobs creator and taking the longer term view. Just about every bank outside of India would be highly reluctant to lend against an Indian registered business aircraft. “It is not that India is lawless, it is simply that it can take years to get htrough the Indian Courts to get a ruling. This again, is why Guggenheim values its relationships with emerging market based operators. They are the experts in dealing with official bureaucracy and know how to operate aircraft in those markets.
One of the features of a Guggenheim loan is that the lender reserves the right to mark the aircraft to market continuously. So if the loan is taken out in a boom period and demand and values then take a dive, they can demand an accelerated pay-down of the principal to keep the loan-to-value ratio at acceptable proportions. “This is a good feature, but if the loan-to-value ratio deteriorates too quickly, then the borrower may just walk away from the aircraft. So you have to monitor the pre-owned market very closely as a lender,” Miller says. He points out that if Guggenheim felt that values in the market were deteriorating badly then they would significantly lower our advance amounts or refrain from lending until things stabilized and would manage their portfolio, the way a private equity house might in a downturn. One of the early warning signs of an impending crash is a sharp increase in speculative buying of aircraft, which, as yet, is not happening. In 2006 and 2007, before the crash, a large percentage of every OEM’s orders pipeline comprised speculative buying where the “owner” never had any intention of taking possession of the aircraft but was simply positioning themselves to “flip” the contract for a profit in next to no time. “I knew of one speculator in 2006 who purchased an order position for an Ultra Long Aircraft and sold that order contract three months later to another speculator for a profit of about $3 million. That Speculator in turn sold the aircraft upon delivery 12 months later for a profit of nearly $12 million. The client knew he was overpaying but the delivery delay to order one directly from the manufacturer was so long by then that he didn’t care. When the crash came the value of that Ultra Long Range Aircraft fell by about 45%. That’s what happens in boom times. Middle men should not be making $12 million and more by flipping a jet under normal market conditions. That is a sign significant market correction is looming,” Miller notes.
Thankfully, that is not the state of affairs that we are seeing today. The speculators in Miller’s story would have done well if they had taken their profit and retired gracefully, but they got themselves more and more over-extended on further speculative buys and their businesses crashed without trace when the market for new jets vanished as the global financial crash took hold.