Factors Influencing Operating Lease Economics

Transcription

1 Factors Influencing Operating Lease Economics Airline Economics: Growth Frontiers Dublin 2018 January 24,

2 COMPANY INTRODUCTION Alton Aviation Consultancy is a boutique consulting firm with deep domain expertise across the aviation value chain Aircraft Leasing & Financing Advisory Airlines Aviation & Aerospace Investors Business & General Aviation Aerospace Manufacturers & Supply Chain MRO & Aftermarket Airports Specialty Projects Agile. Global. Objective. 1

3 COMPANY INTRODUCTION Alton provides guidance and insight required to inform business strategies, allocate capital, prioritize resources, and manage risk Lessors, operators, lenders, and investors rely on Alton s professionals to provide independent, objective advisory support Market research & analysis Aircraft Leasing & Financing Advisory Investment strategy Commercial due diligence Maintenance and lease cash flow forecasting Appraisals/valuations 2

4 COMPANY INTRODUCTION Alton supports a global client base from offices in the U.S., China, Hong Kong, and Tokyo New York Beijing Hong Kong Tokyo 380 Lexington Avenue 17 th Floor New York, New York USA 8 Guanghua Dongli China Overseas Plaza South Tower, Floor 11, Suite A053 Chaoyang, Beijing China 136 Des Voeux Road Central Suite 903 Central Hong Kong Konan Minato-Ku Tokyo, Japan New.York@AltonAviation.com Beijing@AltonAviation.com Hong.Kong@AltonAviation.com Tokyo@AltonAviation.com In China, Alton Aviation Consultancy is known as 德世国际航空咨询 ( 北京 ) 有限公司, or De Shi. 3

5 TODAY S AGENDA Commercial Aircraft Market Environment Aircraft Operating Lease Cash Flows Drivers of Economics Summary & Conclusions 4

6 SECTION 1 COMMERCIAL AIRCRAFT MARKET ENVIRONMENT An Expanding Market for Aircraft Operating Leases 5

7 Aircraft Fleet Value (USD Billion) AIRCRAFT TRANSACTIONS IN REVIEW: VOLUMES AND TRENDS The commercial aircraft fleet is valued at more than $640 billion Worldwide Commercial Aircraft Fleet Value by Aircraft Type and Age $400 $350 $300 $250 $200 Turboprop Regional Jet Widebody Narrowbody $150 $100 $50 $0 < 5 years 5-10 years years years > 20 years Source: CAPA Fleet Database, December 2017, Alton Analysis 6

8 Aircraft Fleet Value (USD Billion) AIRCRAFT TRANSACTIONS IN REVIEW: VOLUMES AND TRENDS The value of the leased fleet totals nearly $300 billion, and is weighted toward younger aircraft $400 $350 $300 Worldwide Commercial Aircraft Fleet Value by Ownership and Aircraft Age Operator Lessor $250 $200 $150 $100 $50 $0 < 5 years 5-10 years years years > 20 years Source: CAPA Fleet Database, December 2017, Alton Analysis 7

9 Number of Leased Aircraft Percent of Aircraft Leased AIRCRAFT TRANSACTIONS IN REVIEW: VOLUMES AND TRENDS Aircraft leasing has evolved rapidly and accounts for 40% of the fleet today; it is attractive to lessees and lessors for a variety of reasons Aircraft Leasing Industry Growth, Attractiveness to Lessees Attractiveness to Lessors 10,000 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 Leased Aircraft % of Total Fleet 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Access to OEM Delivery Positions Fleet / Capacity Flexibility Residual Value Risk Avoidance Focus on Core Business Financial Flexibility / Liquidity Pre-Delivery Payment Financing Access to Lower Cost Capital Strong Long-Term Growth Outlook Capital Intensive Industry Opportunity for Long Contractual Cash Flows Dollar-Denominated Attractive and Relatively Stable Returns vs. Other Asset Classes Assets Capable of Being Repositioned Source: IATA December

10 Value ($ billion) Number of Aircraft AIRCRAFT TRANSACTIONS IN REVIEW: VOLUMES AND TRENDS Over the past 10 years, total aircraft transaction volumes have grown at an annual growth rate of approximately 7.5% Historical Aircraft Transactions, $180 $160 $140 Value ($ billion) Number of Aircraft 4,500 4,000 3,500 Participants include OEMs, airlines, lessors (and investors), and part-out companies $120 $100 $80 3,000 2,500 2,000 The average trading value is approximately $45 million per aircraft, across more than 4,000 units $60 $40 $20 1,500 1, Transactions may be segmented into those related with the OEM (primary), and those downstream (secondary) $0 0 Source: CAPA Fleet Database, Alton Analysis 9

11 Value ($ billion) AIRCRAFT TRANSACTIONS IN REVIEW: VOLUMES AND TRENDS As the operating leasing industry has grown, the trades of aircraft in the secondary market with attached leases have expanded as well $45 $40 $35 $30 $25 $20 $15 $10 $5 $0 Historical Secondary Transactions 1 Outright Lease Attached Average Annual Transaction Volume 1, Sale Leaseback (New) Lessor Trade w/ Lease Sale Leaseback (Used) Airline Trade / Outright Lessor to Airline / Outright Lease Attached Outright Lessor Trade / Outright Airline to Lessor / Outright Lessor to Part Out Airline to Part Out $0 $10 $20 Value ($ billion) Source: CAPA Fleet Database 1/ Transactions from the OEM are excluded 10

12 SECTION 2 AIRCRAFT OPERATING LEASE CASH FLOWS An Overview 11

13 OPERATING LEASE ECONOMICS Aircraft operating lease economics are influenced by a large number of inter-related cash flows Aircraft Operating Lease Cash Flow Sources Acquisition Lease Rentals & Security Deposits Maintenance Cash Flows Financing Costs Transition Costs Residual Sales Proceeds Servicing & Performance Fees 12

14 USD, Millions OPERATING LEASE ECONOMICS The drivers of operating lease economics may best be assessed by evaluating each cash flow source CASE STUDY ASSUMPTIONS New Aircraft First Lease: 9 Year Term 0.80% Lease Rate Factor End of Lease to Full-Life Senior & Junior Financing to Term Second Lease: 5 Year Term, 0.95% Lease Rate Factor Maintenance Reserves Single Tranche Refinancing $40 $30 $20 $10 $0 ($10) ($20) ($30) ($40) ($50) ($60) Case Study Cash Flow Projections FIRST LEASE SECOND LEASE Servicing Residual Transition Financing Maintenance Rentals & Deposits Acquisition Aircraft Age 13

15 USD, Millions AIRCRAFT OPERATING LEASE ECONOMICS: AN OVERVIEW The factors influencing purchase price depend on the lessor s acquisition channel $10 $0 ($10) ($20) Cash Flow: Acquisition From OEM: Lessor Direct Order Basic list price Price adjustments for specification, BFE/SFE, etc. Airframe and engine manufacturer credits Escalation provisions ($30) ($40) ($50) ($60) Aircraft Age CASE STUDY ASSUMPTIONS Acquisition Price: $50 million From Airline: Lessor Sale-Leaseback Lessee s acquisition pricing from OEM; SLB objectives Negotiated lease provisions (term, rents, maintenance, etc.) Lessor s capital costs / return hurdles, industry environment, competitive landscape Risk profile (lessee credit, jurisdiction, etc.) From Other Lessor: Trade Seller s acquisition pricing, trading objectives Contracted lease provisions (term, rents, maintenance, etc.) Buyer s capital costs / return hurdles, industry environment, competitive landscape 14

16 USD, Millions AIRCRAFT OPERATING LEASE ECONOMICS: AN OVERVIEW Lease rentals are similarly dependent on the sourcing channel; security deposits are typically 1-3 months of rent $6 $5 $4 $3 $2 $1 $0 ($1) ($2) Cash Flow: Lease Rentals & Deposits Security Deposits Aircraft Age CASE STUDY ASSUMPTIONS Lease Rentals Lease Schedule: 9 year initial lease, 3 months downtime, 5 year second lease Fixed 0.8% of Purchase Price for Initial Lease, and 0.95% of Half-Life BV for Second Security Deposit: 2 months of initial lease rent; 3 months of second lease rent Placement from Lessor s Order Book: Industry environment; competitive landscape when placed Lease provisions (term, maintenance, security, etc.) Risk profile & exposures (lessee credit, jurisdiction, etc.) Interest rates changes between signing and delivery Lessor Sale-Leaseback Lessee s sale-leaseback objectives Risk profile (lessee credit, jurisdiction, etc.) Lease provisions (term, maintenance provisions, security, etc.) Lessor s capital costs & spread requirements Industry environment; competitive landscape when signed Changes in interest rates from signature to delivery From Other Lessor: Trade Contracted lease rental rates 15

17 USD, Millions AIRCRAFT OPERATING LEASE ECONOMICS: AN OVERVIEW Maintenance cash flows depend on the aircraft and its operation, the leasing provisions, and the financing stipulations $6 $5 $4 $3 $2 $1 $0 Cash Flow: Maintenance Aircraft Age CASE STUDY ASSUMPTIONS Aircraft/Operation: Standard Narrowbody, MPD Program, Monthly Utilization of 300FH/187FC for first, 249FH/133FC for second lease End-of-lease payment to full-life for initial lease, maintenance reserves for second lease Partially trapped reserves Aircraft / Operation: Aircraft Utilization Maintenance Program & Intervals Work Scopes & Costs Leases: Return Conditions End of Lease Payments One-Way or Two-Way To Full-Life, Half-Life, or Delivery Maintenance Reserves Basic Rates & Escalation Lessor Contribution / Top-Up Provisions Financings: Reserve traps 16

18 USD, Millions AIRCRAFT OPERATING LEASE ECONOMICS: AN OVERVIEW A wide range of financing products and structures are available to lessors, significantly impacting leasing economics $40 $35 $30 $25 $20 $15 $10 $5 $0 ($5) ($10) Cash Flow: Financing Costs Financing: Interest Financing: Principal Senior Loan Outstanding Junior Loan Outstanding Refinance Loan Outstanding Aircraft Age CASE STUDY ASSUMPTIONS 3.5%: 60% LTV to Purchase Price, 1% Upfront Fee, No Balloon, to First Lease Term 6%: 75% LTV to Purchase Price, 1% Upfront Fee, Full Balloon, to First Lease Term 6%: 65% LTV to Half-Life CMV, 1% Upfront Fee, No Balloon, to Second Lease Term $40 $35 $30 $25 $20 $15 $10 $5 $0 ($5) ($10) Secured Commercial Bank Debt Senior / Junior Tranches Amortization / Balloons Pricing Loan-to-Value Fixed/Floating Tenure Export Credit Agency Supported Financing Secured Term Loans and Warehouse Financings Asset Backed Securitizations Unsecured Notes 17

19 USD, Millions AIRCRAFT OPERATING LEASE ECONOMICS: AN OVERVIEW Transition costs are dependent on the (1) existing aircraft configuration and return conditions, and (2) the delivery conditions of the next lease $0.1 $0.0 ($0.1) ($0.2) ($0.3) ($0.4) ($0.5) ($0.6) ($0.7) ($0.8) Cash Flow: Transition Costs Aircraft Age CASE STUDY ASSUMPTIONS $0.75M transition cost after initial lease $0.50M transition cost after second lease A range of transition-related expenses may be incurred: Maintenance Bridging maintenance programs Airworthiness directive compliance Reconfiguration Interior seats, galleys, lavatories, in-flight entertainment, soft goods Upgrades Engine thrust Operating weights Transition costs are not independent of future lease rentals Lessors typically have multiple options to place the aircraft, with different delivery conditions, ranging from expensive new cabin interiors with IFE systems to as is 18

20 USD, Millions AIRCRAFT OPERATING LEASE ECONOMICS: AN OVERVIEW Ultimately, a lessor s economics are dependent upon the proceeds generated by a sale of the aircraft $25 $20 $15 $10 $5 $0 ($5) Cash Flow: Residual Aircraft Age CASE STUDY ASSUMPTIONS Sale at end of second lease Maintenance adjusted future base value $20.5M half-life base value less $2.6M maintenance Unadjusted for conservatism Realized Proceeds Depend on Market Environment Aircraft Supply and Demand (general) Aircraft Supply and Demand (model-specific) Asset Age, Specification, Maintenance Status, Records, Pedigree Sales Campaign Strategies & Effectiveness Valuation Approach: Top Down: Reference Value & Adjustments for Maintenance Bottom Up: Green-Time Value of Major Components + Part-Out Value Lease Encumbered Value: Sale to Buyer with Lease Attached 19

21 USD, Millions AIRCRAFT OPERATING LEASE ECONOMICS: AN OVERVIEW Finally, asset and investment managers earn fees for their services $0.2 $0.0 ($0.2) ($0.4) ($0.6) ($0.8) ($1.0) ($1.2) Cash Flow: Fees Servicing Fees Aircraft Age CASE STUDY ASSUMPTIONS Servicing Fees: 2% of Acquisitions, Rent, and Dispositions Management Fees: None Performance Fees: None Servicing Fees % of Acquisition % of Rent (Billed/Collected) % of Disposition Management Fees % of Equity / Capital Deployed Performance Fees Hurdle Rate Carried Interest 20

22 USD, Millions AIRCRAFT OPERATING LEASE ECONOMICS: AN OVERVIEW The leasing transaction will generate an expected unlevered (all cash) internal rate of return, and equity internal rate of return Unlevered (All Cash) & Equity Cash Flow Comparison $30 $20 $10 $0 ($10) ($20) ($30) ($40) ($50) ($60) Unlevered Cash Flows Equity Cash Flows Measurement IRR Unlevered (All Cash) 7.7% Equity 10.8% Aircraft Age 21

23 Acquisition Lease Rentals Security Deposits Maintenance Transition Costs Residual Servicing Fees Acquisition Lease Rentals Security Deposits Maintenance Principal Interest Transition Costs Residual Servicing Fees USD, Millions USD, Millions OPERATING LEASE ECONOMICS Operating leasing returns are driven by buying assets at the right price, maximizing rentals and residuals, and financing at low costs Acquisition Lease Rentals & Security Deposits Maintenance Cash Flows Financing Costs Transition Costs Residual Sales Proceeds Servicing & Performance Fees $40 $30 $20 $10 $0 ($10) ($20) ($30) ($40) ($50) ($60) NPV of Unlevered (All-Cash) Cash 7.7% $40 $30 $20 $10 $0 ($10) ($20) ($30) ($40) ($50) ($60) NPV of Levered Cash 10.8% 22

24 SECTION 3 DRIVERS OF ECONOMICS An Assessment of Sensitivity 23

25 SENSITIVITY: ACQUISITION PRICE Holding all else equal, equity returns demonstrate a high degree of sensitivity to acquisition price Acquisition 20% Equity IRR vs. Acquisition Price Lease Rentals & Security Deposits Maintenance Cash Flows Financing Costs Transition Costs Residual Sales Proceeds Servicing & Performance Fees 15% 10% 14.7% 12.7% 10.8% 9.2% 7.6% 5% 0% -10%, $45.0M -5%, $47.5M Base, $50.0M +5%, $52.5M +10%, $55.0M 24

26 SENSITIVITY: INITIAL LEASE RATE Equity returns also move significantly with changes in initial lease rate factors Acquisition 20% Equity IRR vs. Lease Rate (Factor) of Initial Lease Lease Rentals & Security Deposits Maintenance Cash Flows Financing Costs Transition Costs Residual Sales Proceeds 15% 10% 13.3% 12.0% 10.8% 9.7% 8.6% Servicing & Performance Fees 5% 0% +10%, 0.88%, $440,000 +5%, 0.84%, $420,000 Base, 0.80%, $400,000-5%, 0.76%, $380,000-10%, 0.72%, $360,000 25

27 SENSITIVITY: INITIAL LEASE TERM All else equal, the duration of the initial lease term has a meaningful impact on equity returns Acquisition Lease Rentals & Security Deposits 20% Equity IRR vs. Term of Initial Lease Maintenance Cash Flows Financing Costs Transition Costs Residual Sales Proceeds 15% 10% 12.3% 10.8% 9.5% Servicing & Performance Fees 5% 0% 12 Years Base, 9 Years 6 Years 26

28 SENSITIVITY: DOWNTIME To the equity investor at lease inception, sensitivity to the downtime between leases is limited Acquisition Lease Rentals & Security Deposits Maintenance Cash Flows Financing Costs Transition Costs Residual Sales Proceeds Servicing & Performance Fees 20% 15% 10% Equity IRR vs. Downtime Between Leases 11.1% 10.8% 10.6% 5% 0% 1 Month Base, 3 Months 5 Months 27

29 SENSITIVITY: SECOND LEASE RATE To the equity investor at lease inception, sensitivity to the follow-on lease rate is moderate Acquisition Lease Rentals & Security Deposits Maintenance Cash Flows Financing Costs Transition Costs Residual Sales Proceeds Servicing & Performance Fees 20% 15% 10% 5% Equity IRR vs. Lease Rate (Factor) of Second Lease 11.6% 11.2% 10.8% 10.4% 10.0% 0% +20%, 1.15%, $320, %, 1.05%, $295,000 Base, 0.95%, $270,000-10%, 0.85%, $245,000-20%, 0.75%, $220,000 28

30 SENSITIVITY: MAINTENANCE Lease and financing provisions related to maintenance can have meaningful impact on returns Acquisition 20% Equity IRR vs. Maintenance Provisions Lease Rentals & Security Deposits Maintenance Cash Flows Financing Costs Transition Costs Residual Sales Proceeds 15% 10% 12.4% 10.8% 7.0% Servicing & Performance Fees 5% 0% #1: MR, Partial Trap #2: MR, Partial Trap Base #1: EOL to Full-Life #2: MR, Partial Trap #1: EOL to Half-Life #2: MR, Partial Trap 29

31 SENSITIVITY: LEVERAGE The amount of leverage has a large impact on equity returns Acquisition 20% Equity IRR vs. Financing Leverage Lease Rentals & Security Deposits Maintenance Cash Flows 15% 12.9% Financing Costs Transition Costs 10% 11.3% 10.8% 10.4% 9.4% Residual Sales Proceeds Servicing & Performance Fees 5% 0% Senior: 70% Junior: 85% Senior: 65% Junior: 80% Base Senior: 60% Junior: 75% Senior: 60% Junior: 70% Senior: 55% Junior: -- 30

32 SENSITIVITY: FINANCING COSTS The cost of financing is an important determinant of equity returns Acquisition 20% Equity IRR vs. Financing Costs Lease Rentals & Security Deposits Maintenance Cash Flows Financing Costs Transition Costs 15% 10% 12.1% 11.5% 10.8% 10.2% 9.5% Residual Sales Proceeds Servicing & Performance Fees 5% 0% -100 bps -50 bps Base #1: 3.5%, 6.0% #2: 6.0% + 50 bps +100 bps 31

33 SENSITIVITY: RESIDUAL VALUE The residual value of the aircraft in this case after the second lease is an important driver as well Acquisition 20% Equity IRR vs. Half-Life Residual Value Lease Rentals & Security Deposits Maintenance Cash Flows Financing Costs Transition Costs Residual Sales Proceeds 15% 10% 12.5% 11.7% 10.8% 9.8% 8.6% Servicing & Performance Fees 5% 0% +50% +25% Base (25%) (50%) 32

34 SENSITIVITY: CUMULATIVE DOWNSIDE ASSUMPTIONS +20% Acquisition Price Suboptimal performance in many areas would generate negative returns (even absent a default) Base vs. Non-Defaulting Downside Equity IRRs 72 Month Lease 5 Months Downtime (10%) Initial LR (20%) Second LR Initial: 55% 4.5% Second: 65% 7.0% Half-Life 50% 33

35 AIRCRAFT OPERATING LEASE ECONOMICS: AN OVERVIEW Defaults and restructurings occur; the impact can range from minor to significant, depending on lease and market-related factors Variables Affecting Cash Flows Lease Rental Income Maintenance Cash Flows Transition Costs Residual Value Security 1. Restructuring, Early Return, or Repossession 2. Timing of Default 3. Contractual vs. Market Return 4. Maintenance Provisions in Lease 5. Condition of Aircraft and Return 6. Interior Configuration, Modification Standard 7. Security Deposits, Letters of Credit High Impact Medium Impact 34

36 SECTION 4 SUMMARY & CONCLUSIONS 35

37 SUMMARY & CONCLUSIONS Summary & Conclusions Aircraft leasing is attractive to lessees and lessors for a variety of reasons; it has grown rapidly to more than $300 billion in assets, and accounts for 40% of the fleet today Aircraft trades with attached leases now dominate the market Our case study uncovered the simplicity of the business: Buy assets at the right price Maximize rentals (including avoiding defaults) Maximize residuals Finance at low costs Sophisticated models may be developed to assess economics in different circumstances Investments will never perform as modeled; benefits may be derived from diversification: Acquisition channels Aircraft types/models Airline credits and geographies Lease expiry profiles Investment cycles 36

38 John J. Mowry ALTONAVIATION.COM NEW YORK HONG KONG BEIJING TOKYO 37