Engine leasing, financing and investment Airline Economics School - PowerPoint PPT Presentation

Engine leasing, financing and investment Airline Economics School Hong Kong 2016 *** Jon Sharp President and CEO Engine Lease Finance Corporation

Spare engine leasing • Introduction • Market size • Business models • Short and long term leasing considerations • Economic life cycle • Impact of OEM market influence • End of life exits • Conclusions

Engine Lease Finance Corporation This image cannot currently be displayed. The world’s leading spare engine lessor c.300 engines $2.5bn portfolio value 130 customers 5 joint venture partners 121

Company Structure Mitsubishi UFJ Lease & Finance Company Limited (“MUL”) Engine Lease Finance Corporation Aviation Lease SPCs ELFC Singapore ELF London Finance & Pte. Ltd . Limited LLC JVs

Market Overview – engine operating leases Engine Operating Leasing Market Size – Analysis methodology • How many aircraft? • What numbers leased? • How many spare engines leased? • How many spare engines? • What dollar value? • Potential market 123

Market Overview – engine operating leases New Engine Operating Leasing Market Growth ü Forecast c. 2,450 spare engines will be delivered and placed on operating lease between 2016 and 2035 ü Total value = $50bn (2015 $) ü Average = $2.5bn pa new engine operating lease market ü OEM share 50% ü Relatively small market remains for non-OEM lessors = $1.25bn pa 124

Engine lessor business model 1. Long term operating leases 1. Sale and leaseback/Purchase and lease 2. Third-party engine and portfolio management and Engine Life cycle remarketing services 2. Short-term leases / AOG support 1. Leasing of assets returned from operating leases 2. Greentime burnoff/refurbish 3. End of life exit 1. Part out 2. Sell as is 125

Segmentation and change in the spare engine leasing market Life- cycle Long-term Short term lease Operating lease and pooling Second lease Greentime burn off and part-out, EoL

Long term v Short term spare engine leases Long term Short term • 5 – 10 years • 3 months +/- • Normal operational risk = Lessee • Normal operational risk = lessor (FOD, misuse excluded) • Negotiated contract • Standard shortform • Minimum return conditions • As is • Reserves a credit issue • Reserves retained by lessor • Rental a function of engine price and • Rental & Usage = Market rates lessor cost of funds • Planned transaction • Event driven • Credit/investment committee approval • Local approval only • “Money” • “Metal”

Historical Residual Value Model (0% Inflation) 12 8

Engine and spare parts pricing structure – cause and effect • OEMs sell engines at a loss, rely upon revenues from spare sales. • Resultant high spares prices has created a market for PMA and DER – but small percentage of the market (2% - 3%), • And a boom in the USM market – 60+ companies breaking engines, refurbishing and selling spares – $5bnp.a. • OEMs proliferate this by keeping spares prices high – whilst at the same have countered in a number of ways to exclude PMA, DER and USM.

New OEM parts escalation: LLPs LLP Escalation Factor LLP Escalation Factor LLP Escalation Factor LLP Escalation Factor Q SV Costs are typically 70-80% material and 200.00 190.00 200.00 the balance being labour & repair 280.00 190.00 Q Graph reflects LLP Parts Escalation 190.00 180.00 260.00 § Research shows LLP costs 180.00 180.00 170.00 240.00 (generally reflect top 50 line items) 170.00 170.00 160.00 § => LLP escalation is a good indicator 220.00 160.00 160.00 for material price inflation 150.00 200.00 150.00 150.00 Q Reviewed LLP increases since 2006 on 16 engine models from all OEM’s: 140.00 140.00 180.00 140.00 § Model Average Range 5.5% - 7.5% 130.00 130.00 130.00 160.00 p.a. 120.00 120.00 120.00 140.00 § Overall Average 6% p.a. 110.00 110.00 110.00 § Material prices double every 11 years! 120.00 100.00 100.00 2006 2006 2008 2008 2010 2010 2012 2012 2014 2014 2016 2016 100.00 100.00 CFM56-5B CFM56-5B CFM56-7B CFM56-7B V2500-A5 V2500-A5 2006 2008 2010 2012 2014 2016 2000 2005 2010 2015 CFM56-5B CFM56-5B CFM56-7B CFM56-7B V2500-A5 V2500-A5 T772 T772 CF6-80E CF6-80E PW4-100 PW4-100 13 0

OEM Control – Multiple Counters OEM’s have used a multi faceted approach to achieve a dominant aftermarket position:- 1.Increase in OEM owned MRO supply 2.Proliferation of flight hour agreements 3.Reduction in repair availability and restrictions on performing repairs 4.Effective elimination in use of PMA & DER in gas-path 5.Continuous enhancements, modifications and upgrades 6.Control of new parts prices and increased presence in used serviceable material market 7.Discounting of value for Non OEM maintained engines e.g. “TruEngine” and “Pure-V” 1 3 1

OEMs dominate MRO market (Source: ICF International) Q In 1995 Engine OEM’s had 15% of a $6.25bn MRO market Q In 2005 - 45% of a $12.5bn MRO market Q In 2015 - 55%+ of a $25bn MRO market Q In 2025 OEM will have ??? of an estimated $37bn MRO market 1 3 2

OEM Flight Hour Maintenance Agreements contracted at point of engine sale Airline Orders as of July 2016 • Chart includes:- – airline orders only (no lessors) 1,600 – only orders where engine 1,400 selection has been made 1,200 – Firm orders only (no options) 1,000 • Very long term agreements 10 – 20 800 years. Engine Only 600 Engine + 70% 400 Maint. 200 33% 17% 0 B737MAX (LEAP- A320 LEAP-X A320 PW1000 A320 PW1100 X) 1 3

Non-OEM lessors’ problems with integrated packages • Lack of security - no reserves • Restriction on portability of fund • Questionable adequacy of fund • Inflexibility of workscope • Extra legal and management costs • Restriction of end of life exits Some banks find engines a difficult asset to fund for these reasons. Some lessors are refusing to invest in aircraft powered by certain manufacturer’s types. OEMs doing ‘something’ about it 134

OEMs dominate engine leasing market Ranking of leading engine leasing companies by engines (owned and managed) Engine lessor # Engines est. Comment GEEL 450 OEM – includes MCPH RRPF 400 OEM – includes Total Care Engine Lease Finance 300 Financial institution SES 240 OEM Pooling WLFC 250 Independent Sumisho 35 Financial institution New entrants 2012-16 50 Various 135

End of life solutions vitally important • The leasing community employs many different business models. • All those business models have two common elements – Buy the right asset at the right price (and lease it making money over • money) and Ultimately, monetarise the asset at the optimum time in its life cycle. • • Decisions and constantly made: refurbish or sell? It is a market judgement. • Ultimately, Lessors sell their end of life assets (engines) to MROs or parts companies. 136

Challenges regarding traditional end of life solutions • OEMs introducing schemes such as ‘TRUEngine’ /‘Pure-V’ retrospectively. • Buyers of EoL engines (and parts from them) sell to OEM controlled MROs. • They demand Back to Birth trace certifying no ‘influencing parts’. • Effort to trace B to B is costly even if possible, scheme may have been introduced many years after the asset was acquired. • Lessor’s asset therefore has lost value or at worst is unsaleable. • More crucial with earlier breaking of aircraft. 137

“The Erosion of Choice”. • OEMs dominance of the aftermarket – – Engine leasing – MRO – Parts supply • Airlines and lessors are facing “The Erosion of Choice”. • IATA is on the case of potential anti competitive behaviour and now the EU Commissioner for Competition is investigating at IATA’s request. • Independent service providers must form part of the solution.

Some conclusions 1. The engine lease market is robust but small in scale. 2.The short term and long term engine lease markets are very different propositions:- 1. They have different market dynamics. 2. They have to be managed separately. 3.Leasing of engines and aircraft have different dynamics. 4.Business models for engines need more emphasis on management of ‘metal’ than on credit or finance. 5.The OEMs have driven radical market change, airlines’ choices have been eroded, but Independents do provide a solution to maintain airlines’ choice.

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