Private Equity and Hedge Fund Investments in Aircraft and Aircraft Leasing

Transcription

1 Private Equity and Hedge Fund Investments in Aircraft and Aircraft Leasing Airline Economics Growth Frontiers Dublin January 22, 2013 Michael C. Mulitz Willys H. Schneider Daniel J. Hartnett Kaye Scholer LLP Michael Gangemi WNG Capital LLC Christopher Chaput RPK Capital Management Group, LLC

2 Overview Introduction Brave New World New Sources of Capital for Aviation: Aircraft/Aircraft Finance/Aircraft Leasing What Do Traditional Private Equity and Hedge Fund Investors Expect from their Aviation Investments? Private Equity and Hedge Fund Investment Structural Issues How Do Private Equity and Hedge Funds Benefit the Aircraft Finance Market? Tax Issues 2

3 Overview (cont d) Exit Strategies Recent Transactions in the Market Important Issues for Aviation Finance in 2013 Conclusions and Questions 3

4 Brave New World New Sources of Capital for Aviation: Aircraft/Aircraft Finance/Aircraft Leasing Private Equity and Hedge Funds maintain an important position in the aviation leasing market and provide a significant source of equity, lending and leasing capital Transactions involve significant capital commitments Doric II (LSE-listed) Emirates financing vehicle for A380 aircraft German bond backed by an aircraft mortgage (NordLB) Financial investors backing leasing businesses: Cinven, CVC, GIC and Oak Hill investment in Avolon Carlyle investment in RPK Capital Management Cerberus Capital investment in AerCap and recent buyback of 10 million shares from Cerberus Oak Tree investment in Jackson Square Aviation and subsequent sale to Mitsubishi Corporation Terra Firma investment in AWAS Onex acquisition of 50% stake in BBAM and funding of Inception Aviation Apollo Global Management investment in Merx Aviation Finance LLC (aviation leasing ) Acquisition of RBS Aviation Capital by Sumitomo Mitsui Financial Group, now SMBC Aviation Emirates, Aviation Capital, Latam and Ryanair issuance of bonds backed by Ex-Im Bank guaranty Guggenheim Partners investment in AerCap aircraft portfolio Launch of Aeronautics Fund (hedge fund focused solely on acquiring jets for the part out market) Other funds in formation 4

5 Brave New World New Sources of Capital for Aviation: Aircraft/Aircraft Finance/Aircraft Leasing (cont d) Types of aviation assets for private equity and hedge funds: Aircraft and lease asset-backed securities (Guggenheim/AerCap securitization Class E Bonds for control of portfolio) Direct investment in aircraft and aircraft owning entities Equity investment in aircraft leasing firms or joint ventures Secured and unsecured privately placed notes Loans secured by aircraft or aircraft owning entities Co-investments with other investors/other funds in all of the above 5

6 6 Brave New World New Sources of Capital for Aviation: Aircraft/Aircraft Finance/Aircraft Leasing (cont d) Why are Private Equity and Hedge Funds attracted to this market? Significant amounts of capital can be put to work in aircraft related transactions Aircraft assets, while subject to business cycle and risks, have generally not been subject to as wide valuation fluctuations as other asset types, particularly newer aircraft Debt can be structured in the form of an asset-backed security, which qualifies as debt for tax, with no U.S. withholding tax on interest, allowing wide range of entities to invest and participate, even if underlying assets generate U.S. source income Aviation leasing assets provide current lease income and special tax benefits, unlike typical J Curve investment fund or venture capital return profiles Aviation assets are hard assets and in turbulent times, investors flock to hard assets Learning curve for establishment of relationships, technical expertise, documentation of operating leases and purchase transactions help protect the aviation investment and finance industry from complete market overrun and structurally provides a limit or governor on new competitors

7 What Do Traditional Private Equity and Hedge Fund Investors Expect from their Aviation Investments? Synergies across aircraft related investment platforms Opportunities based on market dislocations and lack of available financing Excess risk adjusted returns Inflation protection in an asset that resets financial terms on a regular basis Participation in global aviation market following and sometimes leading economic development 7

8 8 Private Equity and Hedge Fund Investment Structural Issues Investor Issues Participation in Advisory Boards Conflict Resolution Mechanics Investment Advisory Participation Corporate Governance/Acquisitions Manager/Authority, Compensation and Termination Relationship with GP/Ownership or Investor Roles Use of Separate, Special Purpose Entities for Purchase of Aircraft to Achieve Limited Liability Key Person Restrictions/Investment Criteria Restrictions ILPA Private Equity Principles Versions 1.0 and 2.0 Alignment of General Partner and Limited Partner Interests Governance Transparency

9 Private Equity and Hedge Fund Investment Structural Issues (cont d) Sample Structures (See Diagrams) Tax Characteristics of Investors Tax Treaty Availability U.S./Non-U.S. Investors Participation in Multiple Funds, One Fund, Single Transactions, Multiple Transactions Lessee/Aircraft Operator s Jurisdiction Aircraft Operation Locations 9

10 Sample Fund Structure 1 = Tax Corporation = Tax Partnership (or LLC treated as a partnership) = Disregarded Entity U.S. Taxable Investors LPs GP General Partner (Delaware LLC) General Partner (Cayman company) Management Company GP U.S. Tax-Exempt Investors LPs Non-U.S. Investors LPs U.S. Aviation Fund L.P. (Delaware limited partnership) Management Agreement Management Agreement Management Agreement Management Agreement Offshore Aviation Fund L.P. (Cayman exempted limited partnership) 100% 100% U.S. Source Blocker (Delaware corporation) Non-U.S. Source Blocker (Cayman corporation) General Partner (Delaware LLC) GP LP LP ECI Master Fund (Delaware limited partnership) LP LP Non-ECI Master Fund (Delaware limited partnership) GP General Partner (Delaware LLC) SPVs SPVs 10

11 Sample Fund Structure 2 = Tax Corporation = Tax Partnership (or LLC treated as a partnership) = Disregarded Entity Management Company U.S. Tax-Exempt Investors Non-U.S. Investors U.S. Taxable Investors Management Agreement Management Agreement U.S. Source Blocker (Delaware corporation) Non-U.S. Source Blocker (Cayman corporation) General Partner (Delaware LLC) GP LP LP ECI Master Fund (Delaware limited partnership) LP LP Non-ECI Master Fund (Delaware limited partnership) GP General Partner (Delaware LLC) SPVs SPVs 11

12 Private Equity and Hedge Fund Investment Structural Issues (cont d) Lease-in/lease-out structures under special purpose entities may be able to be used to avoid non-u.s. withholding taxes Parallel non-u.s./offshore funds (Sample Structure 1) or ECI/non-ECI funds (Sample Structure 2) can shelter non-u.s. investors from necessity to file in the U.S. and can avoid U.S. income tax on most fund income if fund is not doing business in the U.S. Use of blocker enables U.S. tax-exempt investors, otherwise taxable on rental income (and sales income if have dealer sales or sales of debtfinanced aircraft), to avoid direct filing and tax payment 12

13 Private Equity and Hedge Fund Investment Structural Issues (cont d) U.S. fund must withhold on any non-u.s. investor s share of U.S.-source rental income (as effectively connected income ( ECI ) or FDAP income) Non-U.S. investors may be able to claim benefits under Section 883 with respect to exemption from tax on certain U.S.-source aircraft rental income 13

14 How Do Private Equity and Hedge Funds Benefit the Aircraft Finance Market? Aviation finance is very capital intensive Maturing of the aircraft leasing market, standardization of documentation for leasing and financing of aircraft Structural alternatives and methods of investment dedicated funds versus investments in operating/leasing companies Balance sheet commitments from large financial sponsors (Morgan Stanley, WestLB, etc.) need to be replaced, Private Equity and Hedge Funds are filling hole Several significant IPOs have occurred in recent years: AirCastle, AerCap, Air Lease Corporation, which Private Equity and Hedge Funds view as an important potential exit strategy 14

15 Tax Issues/General Fund Structures to account for different classes of investors (U.S., non- U.S., U.S. tax-exempt) Traded corporate fund in treaty jurisdiction can minimize income tax burden if real operations there Use of cross-border lease-in/lease-out structures to reduce/eliminate withholding tax on rental payments Lessee use of aircraft and impact thereof on fund (potential tax liability and tax compliance issues) Sales tax/use tax/vat tax on sales and operations of aircraft; varies among jurisdictions; some have exemptions; others do not 15

16 Tax Issues/General (cont d) Other U.S.-specific tax issues (if fund managed, and/or aircraft used, in United States) Income tax to non-u.s. investors dependent upon use of aircraft (rental income) or extent of participation of U.S. office (sales income) Tax benefits-depreciation (varies dependent upon where aircraft is used; if leased to non-u.s. or tax-exempt entity); bonus depreciation 16

17 Tax Issues/U.S. Federal Income Taxation of Aircraft Income Non-U.S. Persons: Interest income on aircraft secured debt may qualify for exemption from U.S. withholding tax as portfolio interest, unless fund is originating loan in the United States. If so, taxable on net basis as ECI Rental income may be treated as ECI, taxable on net basis and requiring tax return filing If not, rental income may be subject to U.S. withholding tax, depending upon use of the aircraft 17

18 Tax Issues/U.S. Federal Income Taxation of Aircraft Income (cont d) Non-U.S. Persons - Aircraft Fund Rental Income: Flights that begin AND end in the U.S. If U.S. rental office, income is ECI If U.S. office is not involved, income is not ECI but subject to 30% withholding tax (subject to reduction pursuant to treaty) 18 Flights that begin OR end in the U.S. If U.S. rental office, 50% is ECI and 50% is not subject to U.S. tax If U.S. office is not involved, 50% is subject to 4% gross tax and 50% is not subject to U.S. tax Flights that begin AND end outside the U.S. Not subject to U.S. tax Non-U.S. corporation may be eligible for exemption from tax under Section 883 on rental income derived from flights that begin or end in the U.S. Need to fulfill certain tax residency and ownership tests

19 Tax Issues/U.S. Federal Income Taxation of Aircraft Income (cont d) Non-U.S. Persons Aircraft Fund Sales Income Gain on sales is not taxable to non-u.s. persons, unless: U.S. depreciation deductions were taken on the aircraft. In general, recapture of such deductions will be subject to U.S. tax (unless aircraft predominantly used outside of United States) A U.S. office is a material factor in the sales and regularly carries on sales activity, in which case gain is taxable as ECI If sold for use outside the U.S. and a non-u.s. office materially participates, then gain is not ECI If U.S. office is not a material factor or does not regularly carry on sales activity, whether gain is ECI depends on where title to the aircraft is transferred. Not ECI if sold outside the U.S. 19

20 Tax Issues/U.S. State and Local Taxes Even if not otherwise doing business, could be subject to U.S. state and U.S. local income taxes based on aircraft usage in a jurisdiction, in a particular state or subdivision thereof Typically lessee will indemnify Sales Tax Application varies by state. Generally depends upon where the aircraft is sold and/or used and not solely upon the residence of the buyer or seller Certain states have specific, aircraft-related exemptions 20

21 Exit Strategies Portfolio Sales Portfolio Liquidations/Part-out Liquidations Securitization of Portfolios Asset-Backed/Secured Notes M&A Transactions IPOs 21

22 Recent Transactions in the Market Prefunded bonds backed by Ex-Im Bank NordLB s aircraft covered bond (application of pfandbrief to aircraft) Doric s eighth A380 financed in the Capital Markets Launch of several new aviation funds in different market segments 22

23 Important Issues for 2013 Aviation Finance Industry Market challenge of finding sufficiently yieldy investments in an unusually low interest rate environment PE/Hedge Fund yield requirements effecting mid-life aircraft values: PE and Hedge Fund yield requirements remain in the high teens to mid-20 s Minimal debt is available to support acquisition of mid-life aircraft Mid-life aircraft lease rates are experiencing 30% to 40% declines, making debt service challenging Declining lease rates compared with engine and part values favor part-outs over forward leases to achieve yield requirements Mid-life aircraft values will continue to decline, mid-life part-outs will continue to increase There is a potential book value problem lurking below the surface of existing aircraft platform portfolios; and the potential write-offs or writedowns could be material 23

24 Important Issues for 2013 Aviation Finance Industry (cont d) Economic useful lives for many new aircraft may be shorter than the historical norms due to dumping of new deliveries and new technologies Maintenance of newer aircraft in emerging markets may present issues in the trading market Publicly traded leasing companies may have difficult disclosure obligations relating to the implications of all of the above, which may push an advantage in favor of the private firms Basel III implementation will increase the capital cost of risk-weighted assets and increase costs for loans Dodd-Frank implications on loans, assets and capital New ASU making export credit financing more expensive 24

25 Important Issues for 2013 Aviation Finance Industry (cont d) FATCA FFI agreements between foreign financial institutions ( FFIs ), including investment funds, and the IRS will begin to be entered into this year Withholding on U.S. source dividends and interest begins January 1, 2014 (and withholding on proceeds from sales of instruments producing such payments begins January 1, 2017) This withholding generally applies to income on all investments outstanding as of January 1, 2013, i.e., no more grandfathering (with limited exceptions) FFIs generally must have procedures for identifying U.S. holders in place by January 1, (Certain, later, deadlines apply for identification of accounts opened prior to 2014.) Agreements between the U.S. and various non-u.s. governments (some of which have already been signed and others of which are expected to be signed this year) will override statutory requirements for FFIs operating in jurisdictions that enter into such agreements ATRA Extension of 50% first year bonus depreciation if aircraft placed in service by end of this year (or, in certain cases, by end of next year) Increased tax rates on high income taxpayers 25

26 Conclusions and Questions 26