Episode 6: Private Jets: Sanctions, SAF and the State of the Market (Richard Evans and Jonathan Maidwell)

Richard Evans: Hi, Jonathan. Thanks for having me.

Jonathan Maidwell: So just to give a bit of background on Richard: He’s a partner in Pillsbury’s LA office, his practice encompasses all aspects of asset finance, and he regularly works with ultra-high-net-worth individuals and lenders—not only on business jet transactions but also on other asset classes like yachts, automobiles, artwork, and in conjunction with our other practices. Pillsbury works closely with industry organisations to like NBAA, Corporate Jet Investor and Revolution Aero to cover the latest legal and business developments. Richard hosted CJI’s bank panel that was held online last year.

Evans: Thanks, Jonathan. Yes, my practice is mostly transactional. I help people and companies buy, sell, lease and finance aircraft. On the private jet side, we have the expertise to advise on everything from jet subscription contracts to multibillion-dollar fleet financings. We also cover all of the related areas which arise in relation to those transactions, including estates trusts & tax planning, executive benefits, regulatory and sanctions.

Maidwell: Let’s kick off with our first topic. While we’re all really sick of hearing about COVID by now, but it is helpful to quickly assess its impact on the business jets market over the course of the last two years.

Evans: Aside from the human cost of the pandemic and the effect on everyone’s daily lives, it was hugely disruptive for the economy and certain industries, with aviation being one of the hardest hit. However, 2020 and 2021, we saw a dramatic growth in the business jet market. I have spoken to brokers who have been in the industry for 30 years or more and they have not seen anything like it. There was a huge increase in demand for private jets during the lockdown, particularly when there were drastically limited options for travel on commercial airlines. There were also more new entrants to the market than ever before. This led to an increase in prices for new and used aircraft and the significant pressure of a shortage of pilots, maintenance providers and FBOs, who are still trying to keep up with demand.

Maidwell: Well, it’s certainly pleasing to hear positive signs from at least some parts of the aviation sector during the last year or so. What have people been looking to buy specifically—are we talking new or pre-owned, or both?

Evans: It’s been both, though there certainly have been more limitations on the new market than the used, as you can imagine. Until quite recently, there was a brief pause on new jet deals, meaning that for a while it was pre-owned jets only. But, for now at least, the market for new jets has bounced back, although lack of delivery slots has skewed the power balance in favor of sellers.

One regular feature of the transactions we work on is that they are heavily dependent on tax advice, which affects the structuring of the transaction and sometimes the timing of the transaction. The last quarter of the year sees a rush to deliver both new and used aircraft. The bonus depreciation rules in the U.S. mean that it is advantageous to take delivery towards the end of the year provided the buyer uses aircraft predominantly for business purposes in order to qualify

Maidwell: And how have people been funding their purchases?

Evans: We advise several banks in relation to the financing of similarly structured transactions. The banking landscape includes several banks with specialist aviation lending teams, including Citi, First Republic, Deutsche Bank, Credit Suisse and Bank of America. We also see banks like JPMorgan Chase, MUFG Union Bank, Wilmington Trust, UBS and BNYMellon provide financing to their customers on big asset purchases like aircraft. Given the widespread availability of cheap debt, buyers have naturally been using debt to finance their purchases. Similarly, current jet owners have been refinancing their assets in order to free up some capital for investment purposes. A dominant view in this area is that it is sensible to use debt to finance assets that go down in value and cash to finance assets that go up. So, lenders have to price their debt accordingly to make it attractive to buyers when measured against cash as the alternative option. There is arguably an exception to this if local exchange controls restrict the use of cash or in some circumstances we have seen recently, where liquidating large amounts of cash from sources like cryptocurrency would take too much time.

Maidwell: So in terms of making debt attractive, are interest rates the key to attracting borrower clients? The Fed just increased its base interest rate by 0.75%, which should see increased engagement from lenders in general given that they are now looking at higher returns. But how does this play out for relationship banks in the business jet sector?

Evans: Relationship banks in this sector are usually pretty accommodating to their borrower clients. From the customer perspective, they back themselves to make their capital work for them, with returns outweighing lenders’ interest rates.

Maidwell: Debt financing is not without its risks. Though. Is there anything to be said for excessive reliance on debt?

Evans: There is always a possible psychological barrier when it comes to debt financing, especially when looking back to the high interest rate environments of the past, but with cheap debt expected to remain available for the foreseeable future, people will continue to maximize the opportunities this brings about. If and when the interest landscape starts to shift, you can expect borrowers’ appetites to adjust accordingly.

Maidwell: And what about the prevalence of first-time buyers—is that any indication as to the state of the market?

Evans: The involvement of inexperienced players in any market is often the indication of a market peak, and it’s no different here. In summary, if the past year was the party, then this may be the sign that the party is over. And of course, after every good party, there is a hangover...

In terms of the volume of deals and if we’re going to continue at the pace we have the past two years, sometimes that’s tempered by experienced voices in the market. Certain lenders will only advise their borrowers to complete a purchase if it’s right for them and is a sound investment decision for their lifestyle. In particular, certain lenders are keen to make their borrower clients aware of all angles of a deal, for example ongoing maintenance risk, and they certainly won’t advise their clients to buy an aircraft on the basis of tax-related reasons (such as bonus depreciation) alone. After all, the tax landscape can quickly shift as we all know.

Maidwell: Now we’re going to move on to our next topic for today: sanctions risk. Sanctions are of course notorious for their wide-ranging application and, given the nature of aircraft ownership, tax structures and political sensitivities amongst other things, it is not always straightforward to assess the sanctions risk profile of a proposed sale or purchase.

Evans: The war in Ukraine and the increased sanctions on Russia are so widespread that the potential for it to affect transactions in the U.S. or elsewhere is significant. It’s an asset that can move around—it’s international, it’s mobile, it can pass through various different hands on its way to the current buyer. One part of the analysis we provide clients is looking at the asset and the prior ownership to make sure the client is not acquiring an asset that is or was subject to sanctions. Thankfully, Pillsbury has very experienced regulatory and sanctions teams, which help out on those transactions.

Shifting away from the markets, we’re now going to take a look at a hot topic—arguably the hot topic for the aviation industry as whole: sustainability, and specifically Sustainable Aviation Fuel—or SAF as it’s commonly known. The broader impact of this was covered in our earlier podcast on ESG in Aviation Finance, but I wanted to look at how sustainability might also be front of mind for business jet owners and service providers. What are your thoughts on this?

Maidwell: First off, I think I should point out that, while it’s very important that the right kind of efforts are made to reduce CO2 emissions on a continuing basis, the aviation sector does seem to come under a disproportionate amount of criticism when compared to other sectors. After all, aviation only accounts for around 3% of all global emissions, and only for around 12% of all transport-related emissions. That said, we all need to play our part, and SAF is the key component in the aviation sector achieving its goals. Owners of private jets—be they high-net-worth individuals or companies—are arguably held to an even higher standard than the other players in the aviation industry in this context, and will therefore be at the front of the queue to evidence their green credentials by subscribing to and investing in SAF.

Evans: What are its goals, and is the sector on course to meet them?

Maidwell: The goal is to produce approximately 450 – 500m tonnes of SAF by 2050 in order to meet sector emissions targets. In terms of where we are in the timeline for the introduction of SAF, OEMs and operators are now moving on from the initial “education” phase—which primarily covered what SAF is and whether it’s safe to use—and attentions are now turning toward affordability and feasibility.

Evans: Does that mean we’re broadly on course to meet the 2050 production targets?

Maidwell: I think it’s fair to say that the target is difficult but achievable. It will require more than $500 billion of investment and the creation of 23 new production plants per year (on average) along the way, which sounds daunting, but as investment incentives increase and production efficiencies develop, we should start to see light at the end of the tunnel. It’s also worth noting that electric aircraft, which will ease the burden in terms of SAF production requirements, are expected to become commonplace by 2040.

Evans: Well it sounds like things are headed in the right direction.

Maidwell: Yes, and actually this fits with the wider picture of increasing awareness and criteria for sustainable investments. During the last two years, ultra-high-net-worth individuals have similarly started to shift their attentions towards ESG, philanthropy and ‘the greater good’. On the ESG side, they increasingly want to know that their investment portfolios are rated to ESG standard and that they otherwise meet sustainability criteria.

Maidwell: That’s all we have time for today. Many thanks to my guest Richard for his valuable insights.

Evans: Thanks, Jonathan. It was a pleasure to speak to you. and I look forward to catching up in person with some of our listeners at the Revolution Aero event in San Francisco in September.

Maidwell: Thanks again, Richard, and thanks to our listeners for joining us today. We hope you enjoyed it, and we hope you can join us again next time.