Investing in Aviation - Doric · Minimising Risk, Maximising Opportunity Shifting sands. The lessor market Mr 10% 10-20 aircraft Mid-life narrowbodies Chasing returns, not scale The

www.iba.aero Minimising Risk, Maximising Opportunity

Investing in Aviation

April 25th 2017

Phil [email protected]


The Aviation Growth Story

Air travel still doubling every 15 years

IATA still bullish

Developing market growth

Doubling of commercial fleet over 20 years. 40,000 aircraft delivered between 2016 and 2035 – five a day

Capital markets supporting financing demands

Why lease:

Latest tech Fuel efficiency Lower capex Flexibility Access the backlog Avoid residual risk


General Demand – Traffic

RPK – Up 9.6% for January 2017 v January 2016

Load Factors @ 80.2 % for January 2017 representing slight increase of 1.2% over January 2016

Freight traffic FTK up 6.9% for January 2017 compared to January 2016Source: IATA


Financing Structures

Source: Boeing


The Aircraft Operating Lease Sector

The Growth of the Sector.

Why airlines like leases – flexibility

Why investors like leases – typical returns

The changing face of the top 50 lessors

The new money

The variations in leasing entities from the mega lessors who order speculatively, the mid-band and the new entrants

The downside – what can go wrong?

How to mitigate risk


Why invest

Lots of reasons

Demand increasing

Stable cash flow

Regulation minimises corner-cutting

Capetown

Mobile and liquid (see opposite) assets

Predictable returns

But…be careful with

Credit risk: security, reserves, lease rate

The spec of your assets

Records

Maintenance

Operations

External influences


Getting In

Getting out

Target ROI

Staying in

The market is strong for investors

but returns are trickier to realise and risks need to be mitigated

Maturity – many more players

Competition – LRFs declining

Over-Supply? - narrow bodies just keep on coming

Volatility – uncertainty/regional pressures

Getting InAsset selection and valuationAsset purchaseFinancing arrangedCredits assessed

Staying InRisk mitigationGetting paidUtilisation and

maintenance

Getting OutRedelivery managementTransition options: sell,

part out, extendRemarketing


Shifting sands. The lessor market

Mr 10% 10-20 aircraft Mid-life narrowbodies Chasing returns, not scale

The new entrant Insurance, Pension, SWF or PE Asian focus last few years Disruptive in terms of margin, experience and

ambition

The top tier Listed Buying direct from OEMs Need to trade regularly Broad mix of operators and aircraft types

The mid market Consolidate or IPO Can be broad or niche Evolution A look at the ownership – buyers or sellers?


Getting In

Getting out

Target ROI

Staying in

Getting In


Staying InRisk mitigationGetting paidUtilisation and maintenance

Getting OutRedelivery managementTransition options: sell, part out, extend, P2FRemarketing


Where To Go and Not To Go

The good, the bad the ugly – jurisdictions, regions and countries – how to monitor risk.

The mix of risk and reward

Tier 1, Tier 2 and Tier 3 airlines; Qualitative analysis Quantitative analysis

FAA/EASA Banned lists

Changing circumstances – e.g. Brazil (GOL) Turkey (THY)

Use of registers

Cape Town Treaty


Appraised vs Trading values

Understandable frustration

Excusable reasons for lack of accuracy Crystal ball – 9/11, GFC Large carrier goes under

Inexcusable reasons for lack of accuracy Leaned on for value X Didn’t ask what it was for

Steps being to improve definitions We cannot put the genie back, but we can make it more clear what you are buying


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Age (years)

A320-200 Maintenance Value - 2016 Constant USD - V2500-A5, 2:1 (W.Europe)

Maintenance Value HL Level


Historic Performance – How accurate are appraisals – Boeing 737-800

The example used here is a Boeing 737-800 of 2006 YOB

To do this – IBA must look at its 10 year forecasts from 2006

Our 2006 records stated that the aircraft in 2016 would be worth US$ 25.50m with 2.5% annual inflation

IBA’s 2016 records show a MV of US$ 24m

Adapting for actual inflation gives a 10 year forecast of US$ 23.7m – a variation of 1.25%

Similar variations seen for A320 family / other high demand narrow-bodies to +/-4%

All performed according to ISTAT Definitions


Historic Performance – How accurate are appraisals – Airbus A330-300

The example used here is Airbus A330-300 of 2006 YOB

To do this – IBA must look at its 10 year forecasts from 2006

Our 2006 records stated that the aircraft in 2016 would be worth US$ 44.38m with 2.5% annual inflation

IBA’s 2016 records show MV of US$ 49.68m

Adapting for actual inflation gives a 10 year forecast of US$ 46m

Performed according to ISTAT Definitions


Trading - “Naked” aircraft versus “encumbered/with lease attached”

An economic analysis reveals the real value….

Then there are further considerations:

Lease income, security deposits. Lessor contributions Other lease terms – extension/purchase option Delivery/Redelivery Conditions Maintenance Reserves and compensation for use Cost of finance


Getting In

Getting out

Target ROI

Staying in

Staying In





Ongoing AM and monitoring…..the WWWWWWH guide

The Asset and its Technical Condition

Who? – IBA tech team – usually one senior surveyor. Lessee tech team – records and physical.

Which? – for portfolios there is sometimes a sampling process – e.g 4 aircraft on lease, choose which one is on maintenance.

Why? Asset value, building rapport, ensuring compliance. Lease v Regulatory can create different approaches – monitor the differences

Where? – ideally at main base where records are held and aircraft inspection ideally during extended downtime or heavy maintenance.

When? – per the lease clause – usually annual rights for lessor

What can change? See next slide

How? – finance and lease management aware - via lessee technical team contacts. Security passes.

Lease

Reserves vs compensation

Ambiguity

AD cost share

Return conditions

Credit

IBA Score

Track record

Deferrals & route changes

Management

team

Asset

Values

Residuals

End of life options

Market shift

Technical

Maintenance costs

Utilisation

Technical Due Diligence

Asset Inspections

Jurisdiction

PESTEL

analysis

Capetown

Courts

Arrests

Transition

Scheduled v unscheduled

Reconfig costs

Reserves or cash

Liquidity of asset


What can change?

Utilisation

Maintenance Program

Flight Ops

Components

Modifications

Damage

The inspection provides the opportunity to assess thevariables associated with the use of the asset and to assess if there is anything that may impact the valueand future use (remarketability) of the asset:

1. Utilisation: per initial expectation? Any changes?2. Maintenance Program: these can develop from OEM

of from lessee – check variations.3. Flight Operations – any changes to operating weights,

de-rate, performance and procedures?4. Changes to components, including engines. Title?

MRO influence5. Modifications: Configuration, Source documents.6. Damage: Per OEM, who/how performed, per lease,

insurance, repeat inspections.


Asset Management During the Lease

Use of CMS – Client’s and IBA’s access.

Monitoring and analysing Lessee input – utilisation reports, operator mod. requests,damage rts, certificate and insurance renewals.eporAre the aircraft flying?

Mid–term Aircraft/Records Inspections at appropriate frequencies.

General Monitoring – ADs, Regulatory Changes, etc.

Maintenance Reserves – reserve invoicing and fund balances, workscopes,drawdown approvals.Packaged to build a comprehensive “moving picture”.


Warning Signs

Late Payment of rentals or reserves

Financial reporting, business plans

Press articles/peer networks, other lessors/financiers concerns

Key staff changes, route cancellations

Supplier payment issues

Economic/regulatory changes

Order deferrals

SO......WATCH FOR THE SIGNSINTEGRATE THE COMMERCIAL AND TECHNICAL ASPECTS

BUILD THAT MOVING PICTURE


Risk monitoring, easy in hindsight

Look at operator and macro environment as well as the asset itself.

Financial reporting, business plans

Route changes and cancellations

Records & maintenance issues

Political, economic & regulatory changes

Key staff changes

Order deferrals

Staff and suppliers not getting paid

Desktop: Trade, Business, Stats like these to my right

Peer networks

Data: Fleet, Utilisation, Routes and Usage

Spotters

Fleet Info


Getting In

Getting out

Target ROI

Staying in

Getting Out





The Transition Management Minefield

Top 10 contributors to transition challenges

Poor contract drafting around redelivery conditions. Lesser inspection rights and disputes processes

Lack of lessee planning and early engagement with lessor

Inadequate focus on assets during operations

Lessee operational demands consuming redelivery resource

Decentralised, missing or incorrectly completed records

Underestimation of the total workload

Discovery of additional work required during maintenance input

Lack of lessor appetite for returning aircraft

Engines failing borescopes – carry out precautionary borescope much earlier

Underestimating lead times and lessor expectations.


Pros and Cons of the options if you don’t have a new lessee

Part Out Happening sooner OEM engine programs

Convert Interesting, growing market Amazon driving change

Extend Easiest option Lower rent typical Heavy check triggered

Sell Residual value Naked can be tough


Demand: where are we? Orders: Airbus A320 & Boeing 737 CFM

Source: IBA. iQ

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2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Gross Orders

NG MAX NEO CEO Oil


Historic Narrow-body Production Levels

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1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Delivery Profile

737 CL 737NG CEO NEO


The Airbus A320 vs Boeing 737 MAX – Latest

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2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016/7

Cumulative NEO/MAX orders – Source: IBA. iQ

MAX NEO


The Airbus A320 vs Boeing 737 MAX – Latest

Airbus is ahead with the NEO in terms of cumulative orders, regardless of the fact that the NEO was launched 7-8 months earlier.

In terms of firm orders Airbus have circa 5,000 NEO while Boeing have about 3,500 MAX Both the A319NEO and 737 MAX 7 have hardly set the sales stats on fire with sub 100 units each to date The A320NEO and MAX 8 are very closely matched with the NEO slightly ahead. The A321NEO is doing very well while sales of the MAX 9 are a little slow – No figures supplied as it is difficult to

determine which MAX orders are actually confirmed as the Dash 9 Will Boeing do a MAX 10 ? Looking almost inevitable. 66 inch stretch (meaning it will still be slightly smaller than

A321). The 737 MAX 9 is a goer and it has now rolled out of factory Basically – both NEO & MAX very successful when looked at on a programme basis Boeing 737 MAX 8 should enter service with Norwegian / Lion Air circa June this year, WN circa September A321-Neo should enter service later this year too…


Passenger Aircraft – Lease Rates – Airbus A320-200

Source: IBA. iQ

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A320 Lease Rates - Constant Age

Age - 0 Age - 5 Age - 10 Age - 15 3m Libor


Passenger Aircraft – Lease Rates – Boeing 737-800

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737-800 Lease Rates - Constant Age

Age - 0 Age - 5 Age - 10 Age - 15 3m Libor Source: IBA Jet DataSource: IBA. iQ


Passenger Aircraft – Values – Airbus A320-200

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A320 Market Values - Constant Age

Age - 0 Age - 5 Age - 10 Age - 15 Source: IBA. iQ


Passenger Aircraft – Values – Boeing 737-800

$10.00

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737-800 Market Values - Constant Age

Age - 0 Age - 5 Age - 10 Age - 15

Source: IBA Jet Data Source: IBA. iQ


Trading Volumes – Narrowbodies

Considering new operating leases, secondary sales and sale leasebacks, trading volumes for 2016 appeared to be close to levels encountered for 2015 – although majority of most liquid aircraft are down so far Once again, we expect the top 3 families that trade under those scenarios to remain the same. In terms of % of trades performed this year:

A320 family = 22.9% ≡ 3.7% of the in service fleet

737NG = 14.2% (16.0% in 2015) ≡ 2.7% of the in service fleet

737 classics = 8.8% (8.5% in 2015) ≡ 7.5% of the in service fleetA320 family trading is at same level as for 737classics & 737NG The top 3 specific models are the same as in 2015:

A320-200 = 12.5% of trades

737-800 = 10.9% of trades

A321-200 = 6.3% of trades

Secondary trading 2016 v 2015

Volume CMV

– A320-200 ▼ ▲

– 737-800 ▼ ▲

– A321-200 ▲ ▲

– A319-100 ▲ ▲

– 737-700 ▼ ▲


Trading Volumes - Widebodies

Widebody trading is down from 2015 – but not far from long-term trend

767s = 4.1% of 2016 trades ≡ 10.2 % of the in service fleet

A330s = 2.6% of 2016 trades ≡ 4.6% of the in service fleet

777s = 2.0% of 2016 trades ≡ 3.2% of the in service fleet

4 engined aircraft overall remain down on previous year

Secondary trading 2016 v 2015

Volume CMV

– 767-300ER ▲ ◄

– A330-200 ▼ ▼

– A330-300 ▼ ▼

– 787-9 ▲ ▲

– 777-300ER ▲ ▼

– 777-200ER ▲ ▼

– A350-900 ▲ ▲

– 737-900ER ▼ ▲

– 787-8 ▼ ▲

– A380-800 ▼ ▲ (new)

– A340-500/600 ▼ ▼


Wide – Body Market – Take Away Comments

Stronger performers• New generation twins - Boeing 787-8/-9, Airbus A350-900

Strong appetite for sale and leasebacks, good credit lessees, wide operator base, leading edge technology and still in early in the product cycle. Residual value performance is expected to be good.

Average performers – cautious future outlook• Boeing 777-300ER, Airbus A380-800

Aircraft are entering the later stages of their product cycles, high fleet concentration within certain carriers and the secondary market is untested for these models. High transition costs and potentially limited second-hand market compared with fleet size may place pressure on secondary market trading values.

Older twin engine WB - Market softening• Airbus A330-200/-300, Boeing 777-200ER, Boeing 767-300ER

Aircraft are either late in the product cycle (A330s) or out of production (B777 & 767). Whilst there are placement opportunities, the market is in oversupply for these types, storage and availability are high and values and lease rates, particularly of older examples, are under pressure. Part-out is a likely eventuality for mature examples.

Weakest performers – transactions likely to be at distressed levels, limited demand• Airbus A340-300/-500/-600, Boeing 777-200, Boeing 747-400, Boeing 747-8I

Airbus A340s and Boeing 747-400 are all out of production. The later A340 variants achieved poor market uptake, likewise the Boeing 747-8I has struggled in its passenger form with only three carriers and circa 30 aircraft in service. Prospect for future placements is weak with narrow/narrowing operator bases. Secondary market value and lease rate expectations are weak.

Source: IBA. iQ


Wide – Body Market Source: IBA. iQ

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A330-200 A330-300 A340-300 A340-500 A340-600 A350-900 B747-400 B767-300ER B777-200ER B777-300ER B787-8 B787-9Fleet size Parked Available


Wide – Body Market – Transactions Source: IBA. iQ

A330-200 A330-300 A340-300 A340-500 A340-600 A350-900 B747-400B767-300ER

B777-200ER

B777-300ER

B787-8 B787-9

Sold with lease 12 5 3 0 0 0 0 2 0 0 1 0

Sold off lease 12 1 17 3 1 0 14 58 11 5 0 0

Sale leaseback 1 14 0 0 0 5 0 0 0 7 13 17

Operating Lease 27 24 4 2 0 11 8 21 9 18 0 17

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Wide – Body Market – Monthly Lease Rentals (idealised market)

Aircraft Year 2017 2012 2007 2002

Low 1,850 1,050 600 -

High 2,250 1,380 850 -

Low 1,100 700 - -

High 1,250 800 - -

Low 630 480 350 245

High 830 665 510 370

Low 680 520 375 250

High 900 720 545 370

Low 1,000 - - -

High 1,300 - - -

Low 920 760 - -

High 1,050 860 - -

Low 1,000 - - -

High 1,200 - - -

Low 1,150 930 750 -

High 1,450 1,145 880 -

Boeing 787-9

Boeing 777-300ER

Airbus A380-800

Boeing 747-8I

Airbus A330-200

Airbus A330-300

Airbus A350-900

Boeing 787-8

Source: IBA. iQ


NB Market – The Disconnect in Lease Rates

2006 A320-200

Value then $45,600,000

Lease rate then $395,000

LRF 0.87%

2016 / 2017 A320 NEO

Value now $47,950,000

Lease Rate now $350,000

LRF 0.73%

Source: IBA. iQ


NB Market – The Disconnect in Lease Rates

2006 Boeing 737-800

Value then $46,200,000

Lease rate then $400,000

LRF 0.87%

2017 Boieng 737 MAX 8

Value now $50,500,000

Lease Rate now $360,000

LRF 0.71%

Source: IBA. iQ


WB Market – The Disconnect in Lease Rates

2006 A330-300

Value then 103,000,000

Lease rate then 830,000

LRF 0.81%

2016 / 2017 Boeing 787-9

Value now 137,000,000

Lease Rate now 960,000

LRF 0.70%

Source: IBA. iQ

Documents

Investing in Aviation - Doric · Minimising Risk, Maximising Opportunity Shifting sands. The lessor market Mr 10% 10-20 aircraft Mid-life narrowbodies Chasing returns, not scale The