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Private Equity and Hedge Fund Investments in Aircraft and Aircraft Leasing Airline Economics Growth Frontiers Dublin January 21, 2014

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Private Equity and Hedge Fund Investments in Aircraft and Aircraft Leasing Airline Economics Growth Frontiers Dublin January 21, 2014 Private Equity and Hedge Fund Investments in Aircraft and Aircraft Leasing Airline Economics Growth Frontiers Dublin January 21, 2014 Michael C. Mulitz Christopher Chaput Willys H. Schneider Daniel J. Hartnett Michael Gangemi Kaye Scholer LLP WNG Capital 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 Overview (cont’d) • Exit Strategies • Recent Transactions and New Participants in the Market • Important Issues for Aviation Finance in 2014 • Conclusions and Questions 3 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 Nimrod Air 1, 2 and 3 (LSE-listed) Emirates financing vehicles for A380 aircraft – German bond backed by an aircraft mortgage (NordLB) – Financial investors backing leasing businesses: • Cinven, CVC, GIC ,Oak Hill and Wells Fargo investment in Avolon • Carlyle investment in RPK Capital Management • Cerberus Capital investment in AerCap and buyback of 10 million shares from Cerberus • Oak Tree Capital Group sale of Jackson Square Aviation to Mitsubishi UFJ Financial Group • 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 – Emirates, Aviation Capital, LATAM and Ryanair issuance of bonds backed by Ex-Im Bank guaranty – Guggenheim Partners investment in AerCap aircraft portfolio – Wells Fargo investment in Avolon to start new Irish leasing company – Avolon $636 million ABS for Emerald Aviation Finance Limited to acquire 20 aircraft – Novus Aviation Capital, the Development Bank of Japan and Airbus partnership to create Tamweel Aviation Finance – Launch of Aeronautics Fund (hedge fund focused solely on acquiring jets for the part out market) – Helicopter investments – Milestone Aviation Group, Waypoint Leasing Ltd., Macquarie Group, GE 4 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 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 6 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 • Yield returns and effect of interest rates, lease rates and residual values and effect on transaction structure 7 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 8 Private Equity and Hedge Fund Investment Structural Issues (cont’d) • Sample Structures (See Diagrams) • Structure Driven By: – Tax Characteristics of Investors – Tax Treaty Availability – U.S./Non-U.S. Investors – Lessee/Aircraft Operator’s Jurisdiction – Aircraft Operation Locations 9 Sample Fund Structure 1 U.S. Taxable General Partner General Partner U.S. Tax-Exempt Non-U.S. Investors (Delaware LLC) (Cayman company) = Tax Corporation Investors Investors = Tax Partnership (or LLC LPs LPs LPs treated as a partnership) GP GP = Disregarded Entity Management Company Management Management Agreement Agreement Offshore U.S. Aviation Fund L.P. Aviation Fund L.P. Management Management (Delaware limited partnership) (Cayman exempted limited partnership) Agreement Agreement 100% 100% U.S. Source Blocker Non-U.S. Source Blocker (Delaware corporation) (Cayman corporation) LP LP LP LP General Partner General Partner (Delaware LLC) (Delaware LLC) GP ECI Non-ECI GP Master Fund Master Fund (Delaware limited partnership) (Delaware limited partnership) SPVs SPVs 10 Sample Fund Structure 2 = Tax Corporation = Tax Partnership (or LLC U.S. Tax-Exempt Non-U.S. treated as a partnership) Investors Investors Management = Disregarded Entity Company U.S. Taxable Management Management Investors Agreement Agreement U.S. Source Blocker Non-U.S. Source Blocker (Delaware corporation) (Cayman corporation) LP LP LP LP General Partner General Partner (Delaware LLC) (Delaware LLC) GP ECI Non-ECI GP Master Fund Master Fund (Delaware limited partnership) (Delaware limited partnership) SPVs SPVs 11 Tax Issues/General • Fund Structures to account for different classes of investors (U.S., non- U.S., U.S. tax-exempt) • 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 debt- financed aircraft), to avoid direct filing and tax payment 12 Tax Issues/General (cont’d) • Use of cross-border lease-in/lease-out structure under SVP’s owning aircraft to reduce/eliminate withholding tax on rental payments • Lessee use of aircraft and impact thereof on fund (potential tax liability and tax compliance issues) • Traded corporate fund in treaty jurisdiction can minimize income tax burden if real operations there • Sales tax/use tax/VAT tax on sales and operations of aircraft; varies among jurisdictions; some have exemptions; others do not 13 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); 50% bonus depreciation ended as of 12/31/13, subject to possible reinstatement (bills pending). 14 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 15 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) – 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
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