This is the second in a series of three articles involving topics related to aircraft financing – specifically the evaluation and documentation of the aircraft itself.  My objective is to help banks who become involved in aircraft financing to better understand the collateral they are dealing with and the revenue opportunities of this market.  The first article highlighted shortcomings in many aircraft financing policies and attempted to debunk several myths about aircraft financing.  This specific article focuses on the aircraft appraisal itself, who is qualified to provide a report to the bank and the importance of the material within an aircraft appraisal report. 

Let’s start with a typical situation that comes up daily - a banker faced with financing an aircraft and let’s presume that this banker has financed an aircraft or two during their career but it has been some time since their last experience or this may even be their first experience.  Let’s also presume that this banker has three reports on their desk.  Report #1 is little more than a number on a piece of paper.  It may have been obtained through a website or telephone conversation but there may be little else on the page other than the aircraft’s registration number.  Report #2 is commonly called a “desktop appraisal” and contains a few additional pages of information and details about the subject aircraft.  It may or may not be signed and the name of the evaluator may or may not be on the report.  Report #3 is a more formal aircraft appraisal report.  It contains quite a bit more detail about the subject aircraft and the name of the appraiser is clearly identified on the report and the report is signed.  For the purposes of this situation, let’s also presume that the final number on each of the reports is the same although this is rarely the case.  Here are the questions facing the banker.  Which of these reports should the bank accept and why?  Which of these reports is the most accurate and trustworthy?  How much do these reports cost?  You may be surprised to learn that all three of these reports technically qualify as an appraisal because each of them contains an opinion of value and by definition this is what an appraisal is.  Think about this.  A casual conversation with someone (who may or may not know anything about the subject aircraft) regarding an aircraft which results in a figure technically caries as much weight in some banks as someone who physically examined an aircraft and records and who provided a detailed report of findings!  The banker in question also faces a critical choice at this point that will determine the risk level they have committed themselves to and which they have committed the bank to.  Sometimes it is a simple choice that involves proper risk management techniques and in other situations the choice is as serious as supporting bank fraud (intentionally or not).  There are other issues to consider as well such as insurance and the filing/recording of the bank’s Security Agreement but the focus here will be on the evaluation and documentation of the aircraft as part of the bank’s aircraft financing efforts.

Let’s start with the first question.  Which of these reports should the bank accept and why?  The answer will depend on the bank’s aircraft financing policy along with the goals and objectives of the bank.  Some of my banking clients have a simple statement in their policy that says (in essence) when an aircraft loan comes up, call me for further instructions.  In these cases, I speak with the banker about the project and we put together a plan that will document the bank’s collateral and ensure a successful transfer of ownership before any funds are disbursed.  In other cases where no policy is in place, the banker is left to figure a process out or make the process up as they go along which leads to a variety of problems for the bank.  These policies may simply state that an appraisal of some sort must be obtained but there is no stated requirement regarding the qualifications of the appraiser or how the result is obtained so the cost to obtain these services tends to be the overriding factor.  After all, if the selling broker is willing to provide an “appraisal” then why hire someone impartial that increases the cost to the bank and the buyer?  However, if we were talking about real estate, then this position would raise several red flags – as it should.  Since all three reports meet the technical qualification of an “appraisal” or an opinion of value, then a number from anyone or any resource will meet the requirements of the policy – regardless of their accuracy, reliability or the accountability of the evaluator. Taking any number from any report is not a strategy I recommend to my clients and choosing a report based on how much it costs to obtain the final opinion of value can be very risky as we will find in the final article.

An important point to realize when financing aircraft is that all aircraft are not alike nor do they command a certain “value”.  Many individuals have a misconception that a “private jet”, for example, must be worth at least $1,000,000 or more – regardless of its age or condition.  After all, it’s a BUSINESS JET!  In this market, this is certainly not the case.  There are private jets worth well over $1M but there are also quite a few whose only real value is scrap value and it is critical to know which one is being used for collateral purposes.  A discussion over the phone with the selling broker or the buyer may not highlight which jet is under discussion. 

The use of “beliefs and assumptions” also speaks to the manner in which aircraft are evaluated or how the overall process evolves.  Generally, there are two basic concepts when evaluating aircraft.  The first involves the use of publications and the effort to “shoe horn” the subject aircraft into the “average retail” configuration.  This type of approach involves the use of “rules of thumb”, SWAGs, assumptions and picking numbers that look right or meet particular criteria with very little analysis involved.  The use of this method introduces several “degrees of error” – some more serious than others and the resulting opinion of value should not be relied upon.  The other method uses a “clean sheet of paper” approach and focuses on gathering specific details about the subject aircraft and making decisions about the final opinion of value based on what is found through first-hand research.  The “degrees of error” are reduced and there are fewer assumptions or “rules of thumb” involved.  In my opinion, the “clean sheet of paper” approach leads to a more reliable result and assumptions are greatly reduced or eliminated altogether.

When examining the three reports mentioned, some bankers will also ask additional questions.  One key question includes – who is providing this information or report and are they “qualified”?  In many cases, an appraisal is developed and accepted from someone inside the bank (possibly the banker completing the loan).  In other cases the appraisal is accepted from the buyer of the aircraft (the bank’s customer) or the broker with very few questions from anyone at the bank.  Because the aircraft appraisal industry is not regulated, anyone can technically qualify as an aircraft “appraiser” and provide an opinion of value.  There are no minimum qualifications, training or certification requirements and typically none specified in the bank’s lending policies.  The use of internal resources, brokers or buyers is not a recommended approach when there is a need to obtain an impartial opinion of value.  Bankers should also remember that the buyer and the broker have a direct interest in the outcome of the deal and tend to be biased.  This does not mean that buyers, brokers and dealers are bad people or dishonest but just that they are biased.  Furthermore, neither the broker/dealer nor buyer has ANY incentive to identify or discuss the aircraft’s market value with the banker nor is there any incentive to identify any attributes about the subject aircraft that would negatively influence the bank’s lending decision.  In fact, the selling broker’s/dealer’s key objective is to obtain as much money as they can for that aircraft as part of the sale (think about the business jet whose value is “scrap value” here).  Evaluators internal to the bank may also be under some pressure to “make it happen” regardless of any facts they may have – or not have.  Corporate objectives and revenue targets can also influence evaluation/lending decisions.  Over recent months, internal bank auditors have been recommending the use of “qualified” outside appraisal sources for this very reason.

There is an article on my website entitled “What You Should Know Before Hiring an Aircraft Appraiser” that covers more detail than I can address in this article and it discusses the attributes of professional and unprofessional aircraft appraisers.  In summary it states that the bank should be using someone who is unbiased and disconnected with the deal and someone who is following a nationally recognized set of appraisal guidelines and ethical behavior if the objective is to obtain a creditable, reliable and unbiased opinion of value.  It should go without saying that the individual in this case should also have some background in aviation.  The professional aircraft appraiser should not be thought of as a “deal stopper” but someone who is providing unbiased, critical information about the asset to the bank.  What the bank chooses to do with this information is another topic.

The second question – Which of these reports is more accurate and trustworthy? – may be a little misleading since we presumed that all three reports have the same result or number even though this is rarely the case because “opinions” vary between individuals as do the methods of developing these opinions.  The answer to this question really gets to the heart of “who” does the bank trust and what information/process do they trust.  It also involves the appraiser’s “support” of their opinion of value.  If all parties are in agreement about the final opinion of value then there is very little discussion and a mistaken belief that Report #1 is as accurate and reliable as Report #2 or #3.  However, situations routinely arise wherein the final opinion of value is questioned by the bank and/or the buyer and/or the broker/dealer. This type of condition occurs when the market is changing rapidly or the broker/dealer has misrepresented the aircraft in some manner but it is at this point when the banker knows the value of the report(s), information they have in front of them and the professionals they are working with.

Evaluation methods that do not rely on first hand analysis of factual data are manipulated very easily.  As a result, those reports most trusted by the banking industry contain key details supporting the final opinion of value and those details are obtained from a physical examination of the aircraft and records by a trained professional.  Evaluators who routinely (or solely) use desktop methods typically do not possess the knowledge skills and abilities to perform a field appraisal and it shows in the report itself.  Developing an opinion of value is fairly straightforward when assumptions are made regarding the status of all log books, verification of the airframe time, damage history, condition of the airframe itself, verification of documents on board the aircraft and airframe/engine mods – just to name a few key items.  Using reports that are unsigned which contain no statement or scope of work (what the appraiser actual did or did not do to obtain an opinion of value), the appraiser’s relationship to the aircraft, market data supporting their opinion of value or any calculations are indications of a superficial analysis.  We will also see in the last article that making assumptions about key value point can prove to be problematic when repossessions occur and there is no real reason for the bank to avoid obtaining first-hand information about the aircraft from an independent third party.

The last question involves the price paid for each report.  Unfortunately, there is no single answer here but pricing generally is related to the effort and the type of individual involved.  In other words, the bank receives what they pay for.  For example, if the bank goes to a website and pays a few dollars to get a Market Analysis or a number on a piece of paper based on a limited set of data, they can expect limited support and questionable results.  Banks that require professional assistance or desire professional results will pay profession rates but they will also get reliable information and a report that meets or exceeds industry recognized standards along with support from a trained professional appraiser should any questions or issues arise.  Generally, the price paid for a report should be reflective of the type of aircraft under consideration and the effort involved.  Professional rates usually begin at a few hundred dollars for single engine piston aircraft to several thousand dollars for larger business jets and helicopters. 

The only question we have not addressed so far is “why”.  Why should the bank undertake the time and expense to better understand their collateral at all?  After all, the local broker tells the banker that this aircraft is worth $X and he must know what he is talking about – right?  The person buying the aircraft is a pilot and they must know what they are buying – right?  Or, they are only financing a small portion of the overall value so there is no real need to document the collateral as it is too expensive to follow bank policy – right?  The answers to these questions gets back to the question of cost and the one cost that is not discussed very often - that is the cost to the bank of making a bad lending decision based on inaccurate or incomplete data.  In these cases, the costs of obtaining professional assistance are relatively insignificant when compared to the costs associated with losses related to a bad lending decision (loss of the aircraft’s value, additional costs associated with the effort expended by internal resources, legal fees, etc.) and it is these types of losses that we want to avoid or limit. 

Unfortunately, the person who initiates the loan at the bank generally is not accountable or responsible if the loan goes into default at some point in the future or they may have left their position altogether.  In default situations, the bank finds out how good their aircraft financing policy and collateral management program really is.  In too many cases, there are a number of “surprises” along the way which could be avoided very easily and cost effectively.

The final article will focus on aircraft repossessions and disposals and how proper collateral management helps avoid “surprises”.

As an Aircraft Consultant, I routinely help banking clients in all phases of the aircraft lending process and I can help your bank too.  Many in the banking industry have questions that they want to ask but they may believe them to be too basic.  I think that the more information available to all parties, the better the decisions being made and I welcome any question or any discussion on this topic.

Mike Simmons has written and published many articles on the subject of documenting and evaluating aircraft and worked with a variety of banking clients both large and small as an aviation consultant assisting them in their aircraft financing policies and day to day projects.  The aircraft he has been involved with over the years includes single engine piston models all the way up to business jets such as Challengers, Gulfstreams, and Citations along with a few helicopters along the way.  Mike’s assignments have taken him all across the U.S. including Hawaii.  As a normal course of business, he has observed several bankers over the years making questionable decisions when financing aircraft because those questionable decisions were the easy thing to do at that time, the banker may have been unsure about the right action to take (unaware of the services that could have been helpful) or they simply did not have good data to work from – and these are the types of situations that Mike attempts to highlight along with other options to consider.  The objective is to help banking clients make solid business decisions based on creditable, reliable information.

Mike Simmons                                                         
President
Plane Data, Inc.
800-895-1382
www.planedata.com

This is the first in a series of three articles involving topics related to aircraft financing – specifically the aircraft itself.  My objective is to help banks who become involved in aircraft financing to better understand the collateral they are dealing with and the revenue opportunities of this market.  This specific article will highlight some of the more common observations that I have seen after 19 years of evaluating and documenting aircraft for a number of banking clients across the U.S.  and how many problem areas could have been easily avoided with more reliable information.  I would also like to introduce a few aircraft financing techniques that may help the bank better manage their risks thereby allowing banks and bankers to make more informed decisions based on analytical data. 

The #1 item any bank or banker needs to understand about aircraft financing is that aircraft are like no other asset the bank lends against.  Therefore, aircraft should not be treated like every other asset the bank lends against if the objective is to reduce/manage risk and make informed lending decisions.  If handled properly, aircraft financing can be extremely profitable but there is more fraud, deceit and misrepresentation of the facts in this industry than you may want to realize.  There is no one source or individual to point to in every situation but the atmosphere is one wherein facts which are not verified or details which are not disclosed may lead to erroneous conclusions, evaluations and decisions. 

A common thread through most issues is the bank’s aircraft financing policy or more appropriately the lack of an aircraft financing policy or a single knowledgeable resource.  In many cases, these policies contain outdated or incorrect assumptions about the best methods of evaluating and documenting the collateral and in other cases the policy is ignored or overridden altogether.  In the past, the focus has been more on “making the deal happen at any cost” (and many banks have paid a huge penalty for that strategy) but current trends appear to be more cautious.  However, bank policy and employee efforts have been slow to reflect this trend.

I have worked with several banking clients over the years in the development of their aircraft financing policies and those banks that generally do well and face fewer issues with banking regulators place more emphasis on the aircraft itself along with routine scrutiny of the borrower.  Policies that need more work usually reflect thinking that “aircraft less than $X do not need a formal appraisal (more on “formal appraisals” in the next article)”.  My usual response to this thought process includes questions such as – who determines that the subject aircraft is below or above $X and what is the basis for that analysis?  Is there really a belief on the part of the bank that somehow the aircraft that is $0.01 below the stated threshold is somehow an insignificant risk and efforts should be made to avoid any analysis of the collateral?  How does the bank address the value of their collateral as the aircraft or market fluctuates?  In other words, the deal that closed a week ago (when the aircraft was below the threshold) now involves an aircraft that is well above the threshold due to market conditions or improvements of the aircraft itself.  How is this situation adequately addressed in the policy and who is charged with doing this function and how often is it completed?  What is stopping the bank from doing a proper evaluation of all aircraft and documenting the results?  If we were talking about a piece of real estate at the same dollar value, would we make the same decision?

The answers to those questions leads to another gap in aircraft financing policies regarding who/how aircraft are evaluated and documented.  I find it interesting when involved in repossessions that there is rarely any appraisal report on file for the aircraft in question.  What is typically found is little more than a number on a piece of paper with very limited supporting documentation.  A banking representative in charge of this project attempts to support this missing documentation by stating that the bank relied more on the strength of the borrower than the asset itself (relationship lending vs. asset based lending).  However, I find the reasoning behind that position difficult to support given the fact that the loan is in default and the only reason I am being hired as a Professional Aircraft Appraiser/Consultant is due to the diminished strength of the borrower and the bank’s need to assess and liquidate their security interest in the asset they did not think was important at the beginning of the loan – and which is now substantially less than they thought it was worth.  Having documentation on file to support the bank’s collateral decision should be a firm requirement of any bank policy because relationships can and do change over time.  In comparison, real estate transactions require some type of appraisal to be part of the lending process (due to regulations I’m sure) but for some reason aircraft that may have dollar values exceeding an average house several times over may have very little information on file to document the contents and condition of the aircraft.  When aircraft are involved, understanding a specific aircraft’s market value (and how it was determined) is one of the most important attributes in the overall decision making process.  It should not be glossed over or avoided for any reason.

The first myth I will bust is the belief that the market value for any aircraft can be found in a variety of publications and all the evaluator has to do is make a few “adjustments” to determine the actual value of any aircraft.  The reality is that there is NO public database of aircraft selling prices and the “adjustments” an evaluator needs to make involves more parameters than one might think.  Many evaluators may believe that the final number is “close enough” but this is really an irrational belief because that type of conclusion would really involve an analysis comparing the results from at least two data sources over many makes/models of aircraft over a period of time and it is unlikely that the evaluator with that belief has completed that level of analysis.  I perform that type of analysis routinely and I always find the results interesting but rarely consistent. 

As part of my normal reporting, I typically run an analysis using one of the published guides – but not in the way you might think.  The publication, of course, is a general guide only and should not be used to appraise a specific aircraft (a paraphrase of the publication’s disclaimer) but there are other limitations and inaccuracies that become apparent as any evaluator works through the process.  In a good number of cases (I would estimate about 30% - 50%) the publication could not be used as the sole resource to reliability determine a specific aircraft’s market value.  The shortcoming is due to issues associated with attributes such as damage history, missing log books or log book entries, airframe/corrosion issues, and so forth.  In those instances another resource must be called upon or the evaluator has choices to make about going forward and most of these choices are not good ones thereby creating problems for the bank in the future due to an incomplete analysis or erroneous results/conclusions.

Another common myth is that the bank has a sufficient “cushion” in their “LTV” percentage such that they are covered in the event of any repossession.  The unfortunate reality is that the evaluation approach initially used (the use of an unreliable publication to determine the aircraft’s value, using third party information about the aircraft from a source connected to the deal, etc.) means the bank most likely over-extended on the loan to begin with.  The 20% or 30% “cushion” that the bank is counting on in many cases simply does not exist or it has evaporated due to the manner in which the asset is disposed of.  There is a mistaken belief that selling the aircraft at auction or turning it over to a broker/dealer will result in obtaining the aircraft’s market value.  However, a “liquidation situation” (wherein the aircraft needs to be liquidated within X days) does NOT result in 100% of the aircraft’s market value but in something much less.  How much less depends on the liquidation timeframe (some aircraft take over a year to sell under normal market conditions), how the original value of the aircraft was determined, when the aircraft’s value was determined and what may have changed since the initial evaluation.  The traditional 70% or 80% LTV is generally inadequate for this purpose.

So what is the best solution to solve these shortcomings?  Banks that are at the next level in their aircraft financing efforts utilize some type of risk management plan involving an unbiased third party along with solid factual information at the beginning of the loan along with periodic analyses of the aircraft over the life of the loan.  The process typically starts with a Market Analysis or Certified Appraisal of the subject aircraft and it may involve Collateral Inspection Reports, Certified Appraisal Reports or an updated Market Analysis during the life of the loan to avoid surprises.  Re-visiting the aircraft on a periodic basis can also identify new financing opportunities for improvements related to engine overhauls or avionics upgrades.  Using factual data at the beginning of the lending process allows the bank to make intelligent, informed business decisions thereby sending higher risk situations to their competitors.  Some banks try artificial methods of limiting their risk by limiting the age of the aircraft or the type of borrower but this is only a short term solution and it actually limits the bank’s ability to service a larger market (more revenue) that is available to them.

The heart of any risk management plan is an understanding of the aircraft and its records and how these are related to the overall value of the aircraft in the current market – which should be part of any legitimate appraisal report.  However, this brings up earlier questions such as – what is a legitimate appraisal and how are they obtained?  How does the bank know they have a legitimate report and what is actually contained in these reports?  Who is qualified to perform an appraisal and how much do they cost?

The answers to those questions and more are the subject of the next article.

As an Aircraft Consultant, I routinely help banking clients in all phases of the aircraft lending process and I can help your bank too.  Many in the banking industry have questions that they want to ask but they may believe them to be too basic.  I think that the more information available to all parties, the better the decisions being made and I welcome any question or any discussion on this topic.

Mike Simmons has written and published many articles on the subject of documenting and evaluating aircraft and worked with a variety of banking clients both large and small as an aviation consultant assisting them in their aircraft financing policies and day to day projects.  The aircraft he has been involved with over the years includes single engine piston models all the way up to business jets such as Challengers, Gulfstreams, and Citations along with a few helicopters along the way.  Mike’s assignments have taken him all across the U.S. including Hawaii.  As a normal course of business, he has observed several bankers over the years making questionable decisions when financing aircraft because those questionable decisions were the easy thing to do at that time, the banker may have been unsure about the right action to take (unaware of the services that could have been helpful) or they simply did not have good data to work from – and these are the types of situations that Mike attempts to highlight along with other options to consider.  The objective is to help banking clients make solid business decisions based on creditable, reliable information.

Mike Simmons
President
Plane Data, Inc.
800-895-1382
www.planedata.com

Too often we get lazy, take the easy way out and give customers Working Capital Lines of Credit to meet their short and long term needs rather than analyzing the situation and numbers to find a solution that build up the borrowers balance sheets. When the business has changed, for better or worse, once we have found out the “why’s” we need to figure out what the impact will be.  

Suppose your customer has gotten new customers and needs to add equipment to meet the demand. That equipment uses inventory and manpower, produces finished goods which generate receivables, all of which require cash/ working capital. Or, maybe customers are paying slower because of the economy. The bills still need paying, but there’s now a gap to plug. Or the borrower added a new retail location that needs store fixtures, people, inventory and attendant operating costs. Two of these scenarios have typical long term requirement(equipment financing and fixtures), but all three have long term working capital needs.

The needs can be met by analyzing the permanent increases in inventory, receivables and operating costs amortizing it with the profits generated by the new activity. If the new customer is expected to increase sales $100k/ month, and the average COGS is 70%, they will need about $200k in permanent working capital for that customer assuming turnovers remain the same. Let’s look at the difference between a term loan and a line of credit:

The example shows a need for $185k in long term working capital that I have financed long term and would be amortized with profits/ cash flow generated from the increased sales. If it were funded through an increase in the line of credit, the result would be a decrease in working capital of $30k at a time when they need more, not less. Even after 12 months, the balance sheet looks better with the term financing. Long term working capital solutions forces borrowers to build up their balance sheets by repaying debt rather than relying on short term borrowings.

 

Long term working capital needs arise in many different situations, such as lost business and uninsured expenses connected with natural disasters or weather. The slowing down of receivables collection, or, my personal favorite, when the owner(or bookkeeper) falls for the Nigerian 419 scam.  All of these require cash immediately and the businesses should be able to repay the loan out of future cash flow from operations.  Assuming the borrower was viable before, and the business is otherwise unchanged, they should have sufficient cash flow to repay the loan. This also assumes you haven’t lost confidence in the owners.

Long term solutions can also be used to clean up your borrower’s balance sheet through rational debt restructuring into truly short term debt they can clean up annually, and long term they amortize from profits. If, in the above example, we term out the LOC with the new debt, the borrower could be debt free in 6 years just from the increased profits on the new machinery. This forces the borrower to put capital into the business through amortization and makes for a stronger borrower. And you can sleep better at night.

This article was written for InsideBanking by Frank Murray of Bennington Capital. He can be reached at frank_murray@benningtoncapital.com.

So your customer calls you out of the blue at 3 PM on a Thursday letting you know he is releasing paychecks tomorrow morning and doesn’t have enough in the account to cover. You:

a.      Do nothing. The checks probably won’t be processed until Monday and doing anything would ruin your weekend plans.

b.      Put a hold on the accounts for next month’s loan payments.

c.      Allow him to overdraw the account. Or,

d.      Find out from your customer why he’s short.

If you choose d., you can find out which of the above(except b.) is best. You want to know what caused the shortfall, when is the cash expected to come in to cover the checks, and why didn’t he call earlier?  Avoiding emergencies like this are one of the primary reasons to talk with your customers constantly and stay informed.

Many years ago, I had several customers who were in heavy construction- roads, bridges and sewers, who were all working for the largest city in the State. The city’s policy had been to cut progress payments every Thursday and release checks after banking hours at 4 PM. One week, the city informed everyone they had mailed the checks because Friday was a holiday and the office was closing early Thursday. All but two of my customers were going to have the problem described above.

For three customers, a. was the rational choice. Most of their employees deposited their paychecks into other banks and the checks wouldn’t clear until Monday at the earliest. They never had an overdraft. Two other customers’ employees cashed their checks at our branches, and we decided c. was best. The potential overdrafts weren’t large, and the potential overdraft charges would exceed the profit on any loan we could make. One customer was given a short term loan. He was getting a seven figure check and had written several hundred thousand dollars in checks to suppliers to take advantage of discounts, as he always did.

Another option you have instead of a., making  a short term loan or c. is to factor the receivables. There are several reputable firms that will factor one off, no monthly minimum charges or requirements for continued usage. The best time to establish the relationship is before you get the call on Thursday.

The fifth option you have is a line of credit. Since you know your customer and business well, you should be able to put a facility in place for just such an emergency. If the needs are going to be seasonal and recurring annually, the SBA Capline program offers lenders a 50% guaranty on advances and you can get up to a five year term. One condition that every true working capital line of credit should have is 30 annual clean-ups. If they can’t, then you need to structure a different facility to better meet the borrower’s business cycle and cash flow.

An original article by Frank Murray