The first article in this series highlighted the fact that aircraft are like no other collateral the bank lends against and banks should therefore not treat this collateral like everything else they lend against. For example if we think about real estate and repossession situations, the bank does not have to worry that someone will remove an acre of land and take it across state lines or that a few rooms of a house may be removed before the property is repossessed. A house may be damaged of course but once repaired properly the house rarely suffers decreased value from a “damage event” unless serious repairs are involved. However, the repossession of an aircraft makes the point about their uniqueness very clear and this article will focus on typical issues that I have witnessed over the years and how these situations could be easily avoided. I will leave the legal issues to the attorneys along with the physical aspects of repossessing the aircraft and focus mainly on the evaluation and documentation of the aircraft itself. Of course there is no appraisal report on the market that will keep an individual or business from going into default but there are tools available that can give bankers a “heads up” so that they can make more informed decisions about their next steps and the related collateral. What banks choose to do with this information of course is another matter.
One observation I have made over the years is that “doing nothing” or avoiding the collateral at all costs is an easy action to take for many in the banking industry. In many cases the banker who initialed the aircraft loan is not involved with “Special Assets” and they have little or no visibility of the issues involved with repossessing the aircraft so they see very little need to make any changes to their efforts or the current lending policy. From their perspective there does not appear to be any problem. The banker involved with repossessing the aircraft has little or no input regarding bank policy and they see the repossession issues as “just another day at the office” so there is no incentive to make any changes to the current lending policy on this front end either. Unless someone at the corporate level sees an exposure with the bank’s aircraft financing efforts, then they rarely have any desire to take action because aircraft financing and the associated risk is only a very small part of their everyday issues so once again, the easy decision is to do nothing or ignore the problem. But, as someone once said, the very definition of insanity is doing the same thing over and over and expecting different results. No bank or banker wants to be involved repossessing aircraft and they certainly want to take “reasonable” measures to avoid it but unfortunately their current aircraft financing policies are such that they create the very problem they are trying to prevent. Of course the next question is – if a change is needed, what changes to the current aircraft lending policy do you make in order to reduce risk? There are several recommendations I would make that can help.
When I have been involved with repossessions, there are common issues that seem to reoccur and I would like to point out a few strategies that could have prevented serious problems had they been implemented or included as part of the bank’s aircraft financing policy. These concepts work for any bank of any size as I have noticed banks large and small avoiding these efforts with essentially the same final results. Only the size of the exposure is different.
Aircraft financing policies in many cases tend to be non-existent or fragmented so that bankers are allowed to do the minimum amount of effort to complete the deal (qualifying the borrower aside). The person who initiates the loan completes the deal and moves on to the next opportunity. There was truly very little effort involved in documenting the collateral or understanding/addressing any title issues and the file typically goes into a desk drawer or vault – which may be fine for real estate (even though more paperwork is required due to regulations) but a risky strategy for aircraft. Typically, no follow up activity is undertaken by the bank regarding the collateral until the loan is satisfied. If problems of any sort arise, they are handled by someone else in another department possibly in another state and in more recent times even by another bank/banker after the initial bank when into receivership. Here are the problems that I see routinely and how they could be managed more effectively or avoided altogether.
At repossession, the aircraft and records are not “as expected”. This is the most common issue an appraiser sees and the easiest one to correct. At the beginning of the lending process, obtain a professional aircraft appraisal report that involves an on-site examination of the aircraft and records. The appraisal report should document what was found initially along with an analysis of these records. A good example involves the bank’s Security Agreement. Many boiler plate Security Agreements have statements indicating that the term “aircraft” includes all log books and avionics but who inventoried these items at the beginning of the loan and where is this effort documented? Did the log books ever exist for this aircraft and were they original and complete? When the aircraft is being repossessed it is common for documentation to be missing (such as the log books) and avionics may be removed as well. The absence of these items can represent a significant impact to the overall value of the aircraft. In other situations, the aircraft itself really does not exist (possibly never existed) or it is not in an airworthy condition and hasn’t been for some time. If the bank elected to use the single page “appraisals” or simply looked up a number from a publication thereby using many “assumptions”, then the cost of that decision will become obvious very quickly if any legitimate examination of the aircraft and records is involved. It also becomes quite difficult for the bank to “prove” what was or was not part of the aircraft if legal challenges arise.
“Engines” have not been discussed but they should be identified separately and in some cases using their own Security Agreement. Engine values can range from few thousand dollars in the case of a single engine piston to several hundred thousand dollars in the case of turbine aircraft – and turbine aircraft typically have two or more engines. In older aircraft, most of the aircraft’s market value may be found in the engines themselves. These engines are designed to be removed and replaced quite easily and changing engines in turbine aircraft is fairly common. If you have a “catch all’ Security Agreement that includes the engine(s), the question is – which engine? Did someone provide a serial number of the engine at the beginning of the loan? Was that number checked? What does the bank do if the engine is removed (for legitimate maintenance reasons) and now installed on another aircraft? Who holds the lien (if there is one) on the engine now installed on the subject aircraft? Where is the first engine?
The bank’s Security Agreement typically allows the bank (or the bank’s representative) to make routine visits to check the collateral but banks rarely see the need to do this for some reason. However, these types of inspections should not be avoided. Over time aircraft change for many reasons and the bank has the capability of understanding at a very early point if the owner is running into financial difficulty. One sure sign is the number of hours being flown each year. Aircraft are expensive to fly and maintain. When the owner is financially healthy then the aircraft is flown/maintained routinely but when the owner becomes financially strapped then the number of hours begins to decrease or flying/maintenance is halted altogether. Of course there are also issues with damage history since the loan closed or maintenance records that go missing which impact the aircraft’s value as well. Keep in mind that over the years there may be improvements that the bank financed (such as engine overhauls or avionics upgrades), and the bank should verify at some point that this work was completed. At a minimum they should take action periodically to update their records. One way to get a better handle on these situations is to obtain a Collateral Inspection Report. The Collateral Inspection Report is not an appraisal as no opinion of value is provided. However, it does capture key attributes about the aircraft since the initial loan and verifies the contents and condition of the aircraft. The Collateral Inspection Report is also a great tool to verify that upgrades financed by the bank have actually been completed. Having periodic Collateral Inspection Reports in the bank’s file shows internal and external auditors that all efforts are being made to manage the bank’s risk. Furthermore, since no evaluation is included, the aircraft does not need to be identified as a “troubled asset” unless the bank chooses to do so. The “troubled asset” issue aside, it would also be good to have the aircraft periodically re-appraised to better understand the bank’s collateral position and the direction the market is taking as the aircraft market tends to be cyclic.
The bank has no lien on the aircraft. There is absolutely NO excuse for this type of situation to occur but it does. Typically, the banker did not understand what effort was involved when securing the bank’s lien position and they believed that a UCC filing alone was adequate – or that no other paperwork was involved at all other than having the borrower sign the appropriate paperwork. In other situations, a cloud existed on the title and the banker thought a simple letter to the FAA would clear things up. Of course, when dealing with a government agency, a simple letter rarely solves the problem. The final result can be that ownership of the aircraft never really transferred or the bank’s Security Agreement was never filed/recorded with the proper agencies. It goes without saying that the bank should always understand the aircraft’s title situation and if ownership will transfer BEFORE disbursing funds because once funds are disbursed it will be difficult to get all parties together to resign any documentation or correct paperwork. When turbine aircraft or helicopters are involved, another agency must be considered (the International Registry) to properly secure the bank’s lien(s) making the process even more complex for all parties. If the title issues are not properly addressed, there may be very serious problems for the bank and the bank’s customer when the time comes to repossess or sell the aircraft.
One solution is to obtain professional assistance. Part of my overall service to my clients involves title work (obtaining the title search, highlighting clouds, resolving issues, etc.) but banks can also obtain the same assistance by using a legitimate title company. However, when working with the title company, understand what information/service is being provided and what questions to ask. Asking a title company to provide a title search, for example, is one thing. Knowing what action to take as a result of that search is another and simply sending documents to the FAA may not be sufficient if clouds exist. Routinely I see banks attempting to handle aircraft title issues on their own with less than satisfactory results. Also, if the owner of record is John Smith, make sure that John Smith is selling the aircraft (obvious I know but it does come up). I have also seen some title companies identify clouds when others did not even though both companies were looking at the same file (supposedly). Title problems are normally addressed by the seller but the final authority may be the buyer’s Purchase Agreement if they have one. The Purchase Agreement aside, the bank (and buyer) need to understand WHO is going to clear these title issues, HOW the issue will be cleared and WHO is going to provide evidence that they are addressed before funds are disbursed. The bank that elects to take this issue on without professional assistance needs to ensure these items are identified and addressed. The title company (as good as many are) simply do not provide that assistance unless they are asked to do so and it is up to the banker to ask the right questions and obtain the right documentation before closing the loan.
I have worked with several banking clients as a Closing Agent ensuring that all paperwork is in order and ownership will transfer successfully BEFORE funds are disbursed. This ensures that there are no issues with document filing/recording and that everything is in place prior to closing. When required, checks are in place regarding the International Registry as well. It sounds simple but ensuring the appropriate items have been properly addressed early in the process makes the closing much easier and hassle free.
The aircraft cannot be sold for the value shown in the appraisal report. When taking physical possession of the aircraft and records, banks at some point hire me to appraise the aircraft and provide them with an opinion of value. The aircraft is usually then turned over to a broker to sell and I typically get a telephone call some weeks later stating that an offer has come in at a value well below the appraised value or the broker cannot obtain whatever value was in the appraisal. The question is – What “value” does the bank really need to identify and focus on?
At the time of the initial financing and throughout the course of the loan, the aircraft’s Market Value is the number most banks focus on and the one provided. The Market Value identifies what a knowledgeable and willing buyer and seller would agree upon under normal market conditions with neither party being forced to act. However, when disposing of the asset, the Liquidation Value becomes more important (possibly the Scrap Value in some cases) and the bank needs to ensure the correct value is requested and stated in the report (the Liquidation Value can be requested at the time of the initial loan as well). The Liquidation Value presumes that all efforts are made to sell the aircraft within X days (X is a number provided by the bank). The number of days the bank chooses to liquidate the asset should be selected with some thought and reasoning. Many aircraft, if priced correctly, will sell within about 90 – 120 days. In this market however, some aircraft can take well over a year to sell. If the bank sets the “Days to Liquidate” at 30 (for example) then they will take a significant loss as the timeframe will tend to be unrealistically short for that specific make and model and the bank will almost have to give it away to dispose of the asset in that timeframe. On the other hand, a timeframe closer to the “average number of days on market” will bring something closer to Market Value.
In some cases, brokers may tend to be “less than enthusiastic” in their marketing efforts for the subject aircraft or buyers may be “bottom fishing”. Keep in mind that the subject aircraft may have missing records and/or missing equipment so it is not in pristine condition even though these attributes are captured in the appraised value. As a result, brokers may put their marketing efforts toward aircraft that are more likely to sell quicker. The Liquidation Value presumes that “all reasonable efforts” are being made to market and sell the aircraft. My point is that the broker may be listing the aircraft only on their website (and nowhere else) or the buyer may be aware (though the selling broker or other means) that the aircraft has been repossessed by the bank and they can get a “deal”. In cases where the broker is having difficulty disposing of the asset, the bank may be better served by allowing the aircraft to be sold at public auction because of the broker’s efforts. Regardless, knowing the aircraft’s Liquidation Value can help the bank understand what to expect and what to reject when offers are presented. It removes the guesswork and makes the entire process more professional and fact oriented. Also note that the Liquidation Value is not identified in ANY publication and can only be obtained by using a trained professional. Wholesale Value is NOT Liquidation Value.
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.
Plane Data, Inc.