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Engine leasing, financing and investment
Airline EconomicsSchool
Hong Kong 2016***
Jon SharpPresident and CEO
Engine Lease Finance Corporation
Spare engine leasing
• Introduction
• Marketsize
• Businessmodels
• Shortandlongtermleasingconsiderations
• Economiclifecycle
• ImpactofOEMmarketinfluence
• Endoflifeexits
• Conclusions
121
Theworld’sleadingspareenginelessor
c.300engines$2.5bnportfoliovalue
130customers5jointventurepartners
Engine Lease Finance Corporation
This image cannot currently be displayed.
Company Structure
MitsubishiUFJLease&FinanceCompanyLimited(“MUL”)
ELFCSingaporePte. Ltd.
ELFLondonLimited
AviationLeaseFinanceLLC
EngineLeaseFinanceCorporation
SPCs&JVs
Market Overview – engine operating leases
123
• Howmanyaircraft?
• Whatnumbersleased?
• Howmanyspareenginesleased?
• Howmanyspareengines?
• Whatdollarvalue?
• Potentialmarket
EngineOperatingLeasingMarketSize– Analysismethodology
Market Overview – engine operating leases
124
ü Forecastc.2,450spareengineswillbedeliveredandplacedonoperatingleasebetween2016and2035
ü Totalvalue=$50bn(2015$)
ü Average=$2.5bnpanewengineoperatingleasemarket
ü OEMshare50%
ü Relativelysmallmarketremainsfornon-OEMlessors=$1.25bnpa
NewEngineOperatingLeasingMarketGrowth
125
1. Longtermoperatingleases
1. Saleandleaseback/Purchaseandlease
2. Third-partyengineandportfoliomanagementandremarketingservices
2. Short-termleases/AOGsupport1. Leasingofassetsreturnedfromoperatingleases
2. Greentimeburnoff/refurbish
3. Endoflifeexit1. Partout
2. Sellasis
Engine lessor business model
Eng
ine
Life
cyc
le
Segmentation and change in the spare engine leasing market
Long-termOperating lease
Second lease
Short term leaseand pooling
Greentime burn off and part-out,
EoL
Life-cycle
Long term v Short term spare engine leases
Long term• 5 – 10 years
• Normal operational risk = Lessee
• Negotiated contract
• Minimum return conditions
• Reserves a credit issue
• Rental a function of engine price and lessor cost of funds
• Planned transaction
• Credit/investment committee approval
• “Money”
Short term• 3 months +/-
• Normal operational risk = lessor(FOD, misuse excluded)
• Standard shortform
• As is
• Reserves retained by lessor
• Rental & Usage = Market rates
• Event driven
• Local approval only
• “Metal”
Engine and spare parts pricing structure –cause and effect
• OEMssellenginesataloss,relyuponrevenuesfromsparesales.
• Resultanthighsparespriceshascreated amarketforPMAandDER– butsmallpercentageofthemarket(2%- 3%),
• AndaboomintheUSMmarket– 60+companiesbreakingengines, refurbishingandsellingspares– $5bnp.a.
• OEMsproliferate thisbykeeping sparespriceshigh– whilstatthesamehavecountered inanumberofwaystoexcludePMA,DERandUSM.
130
New OEM parts escalation: LLPs
Q SV Costs are typically 70-80% material and the balance being labour & repair
Q Graph reflects LLP Parts Escalation§ Research shows LLP costs
(generally reflect top 50 line items)
§ => LLP escalation is a good indicator for material price inflation
Q Reviewed LLP increases since 2006 on 16 engine models from all OEM’s:§ Model Average Range 5.5% - 7.5%
p.a.§ Overall Average 6% p.a.
§ Material prices double every 11 years!
100.00
120.00
140.00
160.00
180.00
200.00
220.00
240.00
260.00
280.00
2000 2005 2010 2015
LLP Escalation Factor
CFM56-5B CFM56-7B V2500-A5
100.00
110.00
120.00
130.00
140.00
150.00
160.00
170.00
180.00
190.00
2006 2008 2010 2012 2014 2016
LLP Escalation Factor
CFM56-5B CFM56-7B V2500-A5
100.00
110.00
120.00
130.00
140.00
150.00
160.00
170.00
180.00
190.00
200.00
2006 2008 2010 2012 2014 2016
LLP Escalation Factor
CFM56-5B CFM56-7B V2500-A5T772 CF6-80E PW4-100
100.00
110.00
120.00
130.00
140.00
150.00
160.00
170.00
180.00
190.00
200.00
2006 2008 2010 2012 2014 2016
LLP Escalation Factor
CFM56-5B CFM56-7B V2500-A5T772 CF6-80E PW4-100
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”
131
OEM Control – Multiple Counters
Q In 1995 Engine OEM’s had 15% of a $6.25bn MRO marketQ In 2005 - 45% of a $12.5bn MRO marketQ In 2015 - 55%+ of a $25bn MRO marketQ In 2025 OEM will have ??? of an estimated $37bn MRO market
132
OEMs dominate MRO market(Source: ICF International)
• Chart includes:-– airline orders only (no lessors) – only orders where engine
selection has been made– Firm orders only (no options)
• Very long term agreements 10 – 20 years.
13
OEM Flight Hour Maintenance Agreements contracted at point of engine sale
0
200
400
600
800
1,000
1,200
1,400
1,600
B737MAX(LEAP-X)
A320LEAP-X A320PW1000
AirlineOrdersasofJuly2016
EngineOnly
Engine+Maint.
17%33%
70%
A320 PW1100
Non-OEM lessors’ problems with integrated packages
• Lackofsecurity- noreserves
• Restrictiononportabilityoffund
• Questionableadequacyoffund
• Inflexibilityofworkscope
• Extralegalandmanagementcosts
• Restrictionofendoflifeexits
Somebanksfindenginesadifficultassettofundforthesereasons.
Somelessorsarerefusingtoinvestinaircraftpoweredbycertainmanufacturer’s
types.
OEMsdoing‘something’aboutit
134
OEMs dominate engine leasing market
135
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
End of life solutions vitally important
• Theleasingcommunityemploysmanydifferent businessmodels.
• All thosebusinessmodelshavetwocommonelements–
• Buytherightassetattherightprice(andleaseitmakingmoneyover
money)and
• Ultimately,monetarisetheassetattheoptimumtimeinitslifecycle.
• Decisionsandconstantlymade:refurbishorsell?Itisamarketjudgement.
• Ultimately,Lessorsselltheirendoflifeassets(engines) toMROsorparts
companies.
136
Challenges regarding traditional end of life solutions
• OEMsintroducingschemessuchas‘TRUEngine’ /‘Pure-V’ retrospectively.
• BuyersofEoLengines(andpartsfromthem)selltoOEMcontrolledMROs.
• TheydemandBacktoBirthtracecertifyingno‘influencingparts’.
• EfforttotraceBtoBiscostlyevenifpossible,schememayhavebeenintroducedmanyyearsafter theassetwasacquired.
• Lessor’sassetthereforehaslostvalueoratworstisunsaleable.
• Morecrucialwithearlierbreakingofaircraft.
137
“TheErosionofChoice”.
• OEMsdominanceoftheaftermarket–– Engineleasing– MRO– Partssupply
• Airlinesandlessorsarefacing“The ErosionofChoice”.
• IATAisonthecaseofpotentialanticompetitivebehaviourandnowtheEUCommissionerforCompetitionisinvestigatingatIATA’srequest.
• Independent serviceprovidersmustformpartofthesolution.
Some conclusions
1. Theengine leasemarketisrobustbutsmallinscale.
2.Theshorttermandlongtermengineleasemarketsareverydifferent propositions:-1. Theyhavedifferentmarketdynamics.2. Theyhavetobemanagedseparately.
3.Leasingofengines andaircrafthavedifferent dynamics.
4.Businessmodelsforenginesneedmoreemphasisonmanagementof‘metal’ thanoncreditorfinance.
5.TheOEMshavedrivenradicalmarketchange, airlines’choiceshavebeeneroded,butIndependents doprovideasolutiontomaintainairlines’choice.