Banking Brief: Financial Services Insights

Secured loans require collateral, and lenders usually protect the collateral with certain provisions, like requiring insurance in a certain amount. This works well for collateral on common loans like real estate or automobiles. But, what about uncommon types of loans, like one for an agricultural aircraft? Is insurance enough?

Financing agricultural aircraft presents unique collateral risks. Agricultural aircraft (i.e., crop dusters) are valued well over $1 million. The lenders that finance them need to be sure that the collateral maintains its value as much as possible to avoid default due to the value dropping below the bank’s loan-to-value covenant. Insurance is necessary, but not always sufficient.

So, what can lenders do to keep value as high as possible? Two words: Engine programs.

How Engine Programs Mitigate Risk

On most aircraft, the engines are the most used and expensive components. Aviation is a highly-regulated industry, and the Federal Aviation Administration requires rigorous maintenance on all aircraft. Engines on propellor planes, for example, usually must be completely overhauled or replaced when the engines reach between 1,800 and 2,000 hours of use. Higher horsepower engines, like those used as crop dusters, cost between $200,000 and $600,000 to overhaul. Unless the owner has steadfastly saved for this expensive and mandatory maintenance event, the owner may not have the funds to overhaul the engine, making the bank’s collateral nearly worthless.

Engine programs are a way for the bank to insure the owner is able to overhaul crop duster’s engine without having to pay for such an expensive maintenance event at one time. There are companies that contract with owners to stabilize aircraft maintenance costs so that any maintenance event is completed on-time and by the best people. Such companies take regular monthly or annual payments and whenever a maintenance event occurs on an aircraft, the company pays for it and provides the right people to accomplish the task.

These companies have programs that only cover engine maintenance, but also have programs that cover any scheduled or unscheduled maintenance events for the entire aircraft. Such programs not only insure that expensive events such as engine overhauls are accomplished, but they also insure that owners do not “skimp” on other maintenance because it is all part of the cost of the program. 

Engine programs make it so that crop dusters are always maintained, which makes them retain their value. As a result, the lenders always have collateral that holds its worth for the duration of the loan.

Considerations for Lenders

Lenders should strongly consider requiring aircraft borrowers have their aircraft enrolled in a bank-approved engine program as part of the loan agreement. Such a requirement protects the bank by protecting the collateral. The borrower also benefits because enrollment in such a program maintains the airworthiness of their aircraft as well as the value of their property.