Asia Aviation Sector Aircraft Leasing: Asian Players Taking Flight

Transcription

1 38 number SECTOR BRIEFING DBS Asian Insights DBS Group Research April 2017 Asia Aviation Sector Aircraft Leasing: Asian Players Taking Flight

2 02 Asia Aviation Sector Aircraft Leasing: Asian Players Taking Flight Paul Yong CFA Equity Analyst DBS Group Research Singapore Research Team DBS Group Research Produced by: Asian Insights Office DBS Group Research Goh Chien Yen Jean Chua Geraldine Tan Martin Tacchi Editor-in-Chief Managing Editor Editor Art Director

3 Investment Summary Global Air Traffic on Long-Term Growth Path Aircraft Demand and Fleet Development Aircraft Financing Aircraft Leasing: Background Strategies Commonly Employed by Top Lessors Emergence of Aircraft Lessors in Asia Chinese Lessors to the Fore Japanese Lessors: Emerging Once More Other Non-Traditional Lessors Hong Kong s Tycoons Join the Party Potential Transactions in Aviation Leasing Spac Draw of Aircraft Leasing Valuations and Equity Picks Key Risk Factors Appendix Aircraft Leasing 101 What s Driving the Popularity of Aircraft Leasing? Critical Success Factors for Aircraft Lessors Drivers of Aircraft Value

4 04 Investment Summary Rising global air passenger traffic Growing middle class driving demand Robust demand for new aircraft According to the International Air Transport Association (IATA), global air passenger traffic rose 5.9% year-on-year in 2016 and is projected to grow 5.1% in Based on Boeing s estimates, global revenue passenger kilometres (RPKs) will almost triple by 2035 to reach 17,093 billion passenger-kilometres (p-km), which represents a compound annual growth rate (CAGR) of 4.8% for a 20-year growth period from 2015 to Looking ahead, the expanding middle class is expected to drive growth in global spending. The middle-class population is forecast to expand almost 73% from 2.8 billion in 2015 to 4.8 billion by Supported by firm global economic growth, a rising middle-class population, higher expected spending power, globalisation, and greater air connectivity, we expect trips undertaken per-capita (and thus propensity to travel) to remain on a steady uptrend over the long term, with strong growth driven by emerging markets such as China and India. Based on Boeing s estimates, the global fleet will more than double to 45,240 by 2035 to match increased aviation demand. Of the 22,510 in-service aircraft in 2015, 18,330 are slated to be retired from service while another 1,440 are expected to be converted to freighters to further extend their useful lives. This means that Boeing expects about 39,620 new aircraft to be delivered between 2015 and 2035, and would require financing of at least US$3 trillion in 2015 dollar terms. From less than 1% share in the 1970s, aircraft leasing has since grown its market share of the global fleet to over 40% and has held steady at around 42% in the last decade. Aircraft lessors play an important role in financing the substantial funding requirements for aircraft, and distributing aircraft capacity more efficiently globally. Asian lessors join the fray Buoyant deal activity Today, five of the 12 largest aircraft lessors hail from Asia, and a sixth is from Australia. Most of their growth were through the acquisition of another leasing company, and in the case of HNA Group s, two Avolon and CIT. Chinese lessors figure prominently among the top ten, including the largest player Avolon/CIT while Japanese lessor SMBC Aviation is also among the top five lessors globally. Asian lessors are being linked to all manner of activity in the sector, including 1) acquisition of aircraft portfolios such as AirAsia s leasing arm and Ansett Worldwide Aviation Services (AWAS), and 2) potential initial public offerings of lessors such as Minsheng Financial Leasing or the leasing arms of the Chinese banks, following the listing of CDB Financial

5 05 Leasing and BOC Aviation in Hong Kong. Meanwhile, even Hong Kong s tycoons such as Cheong Kong s Li Ka-shing and Chow Tai Fook s Dato Dr. Cheng Yu-tung have amassed aircraft-leasing assets in recent years, and are looking to grow their aircraft portfolios. Listed aircraft lessors are trading at an average of 8.9x (consensus) current earnings, declining to 7.7x forward earnings. BOC Aviation is the cheapest in terms of price-toearnings at 7.7x currently. Other than China Aircraft Leasing (CALC), which is trading at 1.9x current price-to-book value (P/B), against a projected current return-on-equity of over 22%, the rest of the Hong Kong-listed aircraft lessors are generally trading at around 1x current P/B. While on average the sector only offers a dividend yield of 2.5%, both CALC and BOC Aviation are offering higher than-average prospective dividend yields of over 6% and 3.8%, respectively. Our top pick is BOC Aviation (Buy, target price of HK$54.10) and we also recently initiated coverage on CALC with a Buy call and current target price of HK$12. Key risks The most common concern for investors seems to be that of aircraft oversupply. Our view is that given the duopoly in aircraft manufacturing, aircraft supply-demand should be balanced in the long term as it is in the interest of the original equipment manufacturers (OEMs) to promote such a situation. In the short term, we also see the aircraft supplydemand environment as relatively benign as 1) global load factors are near historic highs; 2) OEM production growth rate is matching expected demand growth; 3) order books are strong; and 4) aircraft storage/retirement are already at low rates. The next common concern interest-rate risk. A key feature or driver of an aircraft lessor s earnings is the net spread (the difference between average yield on aircraft portfolio and average cost of debt) that a lessor earns. In an environment of rising interest rates, investors may have reason to fret. Generally speaking, aircraft lessors are well aware of this risk and manage it via 1) natural hedging where fixed-rate leases are funded by fixedrate debt, and floating-rate leases are matched with floating-rate debt; 2) active interestrate hedging using derivatives such as caps and swaps; and 3) trading (sale) of aircraft in the portfolio.

6 06 Global Air Traffic on Long-Term Growth Path Rosy outlook for global aviation According to the International Air Transport Association (IATA), global air passenger traffic rose 5.9% year-on-year in 2016 and is projected to grow 5.1% in Based on Boeing s estimates, global revenue passenger kilometres (RPKs) will almost triple by 2035; reaching 17,093 billion passenger-kilometres (p-km) which represents a compound annual growth rate (CAGR) of 4.8% over a 20-year growth period from 2015 to Diagram 1 : World traffic flow forecast (RPKs in billions) for the next 20 years Source: Boeing, DBS Key drivers of air traffic demand: 1. Prevailing economic conditions, which dictate travel demand needs. 2. Improving inter- and intra-region route connectivity, helped by liberalisation of airspace and low-cost carriers. 3. Favourable demographic trends (i.e. population growth, rising middle-class population, and higher discretionary spending).

7 07 Diagram 2 : Drivers for air traffic and aircraft fleet growth Increased Demand for Fleet Source: Airbus, DBS Anticipating a world GDP growth rate of 2.9% per annum (p.a.) over the next two decades which should help spur trade flows, human capital movement, tourism, and ultimately, demand for global air travel, Boeing predicts air passenger traffic will grow at an average of 4.8% p.a. into This is supported by historical trends, where global air travel has consistently outpaced world GDP growth at 1.5x to 2x. Diagram 3: Breakdown of global annual GDP growth forecasts by region ( ) Source: Boeing, DBS Asia-Pacific to drive global growth Better connectivity, more mega hubs Between 2016 and 2035, global growth is expected to be largely driven by the Asia-Pacific region, which is poised to log an annual GDP growth rate of about 4.1%, far exceeding the global average of 2.9%. Following closely behind are the Middle East s estimated 3.8% and Africa s 3.7%. The gradual liberalisation of airspaces through open skies and bilateral air transport agreements, coupled with the expansion of low-cost carriers, have played a central role in driving inter- and intra-region air connectivity and the formation of new mega aviation hubs.

8 08 To illustrate, Shanghai Pudong Airport is now ranked the eighth busiest airport (by passengers) in 2016 from the 34th position in 2009 after passenger traffic more than doubled from nearly 32 million in 2009 to over 66 million in Over this period, the market shares of low-cost carriers in China also strengthened significantly from around 8% in December 2009 to more than 20% in December Airbus estimates that by 2035, the number of aviation mega-cities (which it defines as cities with more than 10,000 daily long-haul passengers) will rise to 93, from 55 in Banking on the middle class Looking ahead, global spending power will largely be driven by the growing middle-class population, which is forecast to expand by almost 73% from 2.8 billion in 2015 to 4.8 billion by Based on estimates by Airbus and Oxford Economics, the middle-class population will likely account for over 55% of the world s total population by 2035 the bulk of which should stem from emerging economies. Diagram 4 : Burgeoning middle-class population (in millions) between 2015 and 2035 *Households with yearly income between $20,000 and $150,000 at purchasing power parity (PPP) in constant 2014 prices Source: Airbus, Oxford Economics, DBS Strong growth in discretionary spending Based on estimates by Airbus and Oxford Economics, discretionary spending globally will rise from US$8 trillion to US$13.2 trillion by 2025, driven by higher spending in emerging economies. The share of discretionary spending by emerging economies is expected to expand from 39% in 2015 to 46% by 2025.

9 09 Diagram 5 : Discretionary spending in 2015 versus 2025 *Spending on recreational goods and services (2010 US$, PPP) Source: Airbus, Oxford Economics, DBS Diagram 6: Expect higher propensity to travel over the next 20 years Source: Airbus, Boeing

10 10 Thanks to firm global economic growth, rising middle-class population, higher expected spending power, globalisation, and greater air connectivity, we expect trips undertaken per capita (and thus propensity to travel) to remain on a steady uptrend over the long term. In 2015, average trips undertaken annually per capita in mature regions such as North America and Europe stood at 1.8 and 1.2, respectively, far above that observed in emerging economies such as China s 0.3 and less than 0.1 for India. Narrowing travel demand gap Airbus forecasts the travel demand gap between mature and emerging markets will narrow by 2035 on the back of rapid economic growth, with China set to see a multi-fold increase in air travel to 1.3 trips per capita. In absolute terms, given its population of over 1.37 billion, China s air travel market holds vast potential. Similarly, India is also poised to deliver significant trip-per-capita growth, albeit on a smaller scale. Diagram 7: Trips per capita for selected countries and regions (2015 versus 2035) China Source: Airbus, DBS Asia-Pacific leading global air traffic Home to approximately 4.4 billion people in 2015, Asia-Pacific accounts for almost 60% of the world s population but only represents around 30% of global RPK. Continued growth in China s domestic aviation sector could see the mainland overtake the United States as the single largest aviation market by Mostly driven by strong demand in China and traction in other fast-growing Asian economies (such as India), Airbus believes that air traffic in Asia-Pacific will grow at 5.7% CAGR, to represent 36% of global RPK by 2035.

11 11 Diagram 8 : Global air traffic to grow at 4.5% CAGR into 2035 Regions % of 2015 World s RPK % of 2035 World s RPK 20-year CAGR Asia-Pacific 30% 36% 5.7% Europe 25% 22% 3.5% North America 24% 19% 2.9% Middle East 9% 11% 5.7% Latin America 5% 5% 4.8% CIS 4% 4% 4.1% Africa 3% 3% 4.5% Global Average 4.5% Source: Airbus, DBS Ranked the second- and third-largest aviation markets by RPK in 2015, the European and North American regions represented 25% and 24% of global RPK, respectively. With 20- year growth expected to steady at 3.5% CAGR for Europe and 2.9% for North America (both below the global average of 4.5%), Airbus estimates that their global shares will taper slightly to 22% and 19% respectively, by Leveraging its geographical advantage and the gulf carriers rapid expansion, Airbus expects the Middle East to deliver 20-year traffic growth at 5.7% CAGR, to grow its share of global RPK from 9% in 2015 to 11% by But emerging and developing economies are the ones to watch. Air-traffic growth in emerging and developing economies - representing nearly 86% of the global population, or 6.2 billion people - is expected to surpass that in advanced economies as (1) the former s living standards improve, (2) more air travel infrastructure is put in place, and (3) as new routes (especially between secondary cities) are formed. China s domestic aviation sector could overtake the US as the single largest aviation market by 2030

12 12 Diagram 9: Emerging/developing economies RPK growth prospects Economies Countries & Region Population (2015) Emerging/ Developing Advanced Asia China India Middle East Africa CIS Latin America Eastern Europe Western Europe North America Japan 6.2bn 1.0bn RPK CAGR c.5.6% c.3.7% Source: Airbus, DBS

13 13 Aircraft Demand and Fleet Development Boeing estimates there were approximately 22,510 passenger aircraft in service globally in Of which, North America had the largest fleet share of about 31% or 6,910 aircraft. The second-largest fleet was found in Asia-Pacific with 6,350 aircraft, which represented about 28% of the global fleet. Europe, with about 4,610 aircraft and a 20% share, ranked third. Diagram 10: Average passenger fleet age by region (as at 8 August 2016) Age - Source: Boeing, DBS According to the fleet database from the Centre for Aviation (CAPA), the North America region is currently home to some of the world s oldest passenger fleet, with an average fleet age of about 18 years. Meanwhile, the youngest stems from Latin America, with average fleet age of about 9.1 years. While fleet age is viewed as a lagging indicator, it can still provide insight into varying demand trends across regions and direction with regard to fleet renewal.

14 14 Diagram 11: Global fleet growth ( F) Source: CAPA, DBS Similarly, Boeing forecasts traffic (RPK) growth of 4.8% CAGR between 2015 and 2035, and believes that global passenger fleet should grow at 3.6% CAGR to satisfy this growing demand for air travel. Asia-Pacific to log largest fleet growth Given the Asia-Pacific region s strengthening economy, improving air transport connectivity, and with over 100 million new passengers set to enter the air travel market each year, it is poised to see the largest fleet growth (at 5% CAGR) among peers. Meanwhile, the Middle East is expected to expand its fleet by 4.8% per year, in line with expected RPK growth of 5.9% CAGR, and Latin America by 4.4%. As such, fleet growth in advanced markets such as Europe and North America will likely be outpaced by that of emerging and developing markets. Diagram 13: Fleet growth rate by region between 2016 and 2035 Source: Boeing, DBS

15 15 More than double Based on Boeing s estimates, global fleet will more than double to 45,240 to match increased aviation demand. Of the 22,510 in-service aircraft in 2015, 18,330 are slated to be retired from service while another 1,440 are expected to be converted to freighters to extend their useful lives and are likely to be narrow-body aircraft. Boeing also expects about 39,620 new aircraft deliveries to be made between 2015 and Diagram 14: Global fleet could double by 2035 Source: Boeing, DBS Asia to account for the bulk Of the 39,620 new aircraft deliveries expected into 2035, Asia will likely account for around 38% or 15,130 aircraft. This is followed by the North American (21%) and European (19%) regions which account for 8,330 and 7,570 aircraft, respectively. We see this as largely in line with their respective future air traffic demand needs, and as they seek to replace ageing fleet with newer technologies which are often more fuel-efficient to optimise operating costs. Diagram 15 : Global new deliveries by region Source: Boeing, DBS

16 16 Broadly speaking, there are three distinct aircraft types: 1. Wide-body: Typically larger commercial aircraft with twin aisles typically with medium to long range and can have passenger capacity from 160 to upwards of 480. Such aircraft can have 2-4 engines and be rated transatlantic or transcontinental. At list prices, a wide-body such as a B787-8 cost about US$224.6 million. 2. Narrow-body: They are smaller aircraft with a single aisle configuration with a passenger capacity of up to 200 and mainly ply short- to medium-haul routes. At list prices, a narrow-body B cost about US$80.6 million. 3. Regional jets: Regional jets can be defined as a set of narrow-bodies typically with passenger capacity up to 100 and are mostly used for connecting regional hubs and with a shorter range. These can include turboprops aircraft. The popularity of narrow-bodies Of the new aircraft to be delivered by 2035, approximately 71% (or 28,140 hulls) will be narrow-bodies, while 23% (9,100 aircraft) will be wide-bodies. The remaining 2,380 are regional jets. The popularity of narrow-bodies among carriers is largely attributable to: 1. Cost efficiency: Narrow-bodies tends to come with shorter, lighter engines which are typically more fuel efficient. 2. Route flexibility: Narrow-bodies provide carriers especially those who are also looking to operate new complementary short-haul routes, with wider redeployment opportunities. Additionally, as these routes typically involve smaller hubs with lower passenger traffic, carriers run a lower risk of unfilled seats. Diagram 16: Breakdown of global deliveries by aircraft type - - Source: Boeing, DBS

17 17 Replacement needs, tighter regulations Travel demand aside, replacement needs and emergence of new regulations may also drive demand for newer aircraft. As compared to older models, newer aircraft offer the advantages of: (i) Lower operating costs, especially improved fuel burn (the best way to hedge fuel cost exposure) and lower maintenance costs; (ii) improved payload and range capability (important for opening new markets) and despatch reliability; (iii) advanced cockpits and cabins (weight savings either reduce costs or offer greater revenue potential from increased seat density. Often, older aircraft are uneconomic to refurbish); and (iv) availability (the option to upgrade an older aircraft is driven by available supply of new aircraft). The airline industry is also subject to regulations, particularly on the safety and operational axes. The latter may impact fleet strategy and aircraft values. Another form of regulation which can potentially impact aircraft liquidity is aircraft importation age restrictions, which are used in certain countries to prevent the import of aircraft older than a certain age (typically ten, 15 or 20 years). According to aviation consultant Ascend, such regulations can be found in approximately 44 countries today, but only half of these are currently in effect. We estimate that the order backlog of passenger aircraft from Airbus and Boeing totalled 9,676 as at 6 February 2017.At present production/delivery rates, this is equivalent to approximately ten years worth of deliveries and represents about 54% of the current installed fleet. Emerging markets contributing the lion s share With the exception of Africa, emerging and developing markets such as Asia-Pacific and the Middle East, generally have higher backlog-to-current fleet ratios relative to their mature counterparts (Europe and North America). While order backlogs in North America and Europe only represent 36% and 42% of their respective fleet, the respectively, they absolute aircraft or order remains substantial at 1,501 and 1,978 aircraft respectively. With majority of the order backlog already firmly committed towards airline s fleet growth plans and replacement needs, both Airbus and Boeing have announced plans to lift production rates for the Airbus A320 and Boeing 727 families of aircraft to capitalise on the strong demand for passenger jets. Separately, based on CAPA s fleet data, we also estimate that around 27.5% or 2,660 of the current order backlog actually accrue to lessors. Expected to be delivered through 2025, we believe the firm backlog of nearly 10,000 aircraft from Airbus and Boeing alone, demonstrates the robust long-term demand for new commercial jet airliners. Replacement needs and emergence of new regulations also drive demand for newer aircraft

18 18 Diagram 17: Order backlog (as disclosed by customers) as at 6 February 2017* Region Africa Asia-Pacific Europe Latin America Middle East North America Order Backlog 190 4,006 1, ,282 1,501 % Share 2% 41% 20% 7% 13% 16% Current Fleet 587 6,240 4,708 1,130 1,127 4,114 Backlog as % of Current Fleet 32% 64% 42% 64% 114% 36% *for Airbus and Boeing passenger aircraft only Source: CAPA, DBS Airbus and Boeing s firm backlog of nearly 10,000 aircraft demonstrates robust long-term demand for new commercial jet airliners

19 19 Aircraft Financing Based on the 39,620 new fleet deliveries number between 2016 and 2035 as estimated by Boeing, the total value of aircraft based on list prices would be worth at least US$5.96 trillion in 2015 dollar terms, but closer to US$3 trillion in reality. Diagram 18: Percentage of aircraft type by delivery value (2015 versus 2035) Source: Boeing, DBS Asia to bear bulk of fleet delivery costs In the next two decades ( ), in line with the expected fleet expansion and deliveries, Asia will bear the bulk (approximately 40%) of actual fleet delivery costs, which is typically at a discount to list price and estimated overall costs is around US$1.195 trillion. Europe is expected to have a 19% share or about US$570 billion of actual fleet value, while the North American market will contribute a further 17%, which represents an actual fleet value of approximately US$524 billion. According to Boeing, Latin America, Africa, and the Commonwealth of Independent States (CIS) will likely account for around US$178 billion (6%), US$86 billion (3%), and US$72 billion (2%) of actual fleet delivery costs, respectively. We believe that this is mainly a result of reflection of their preference/demand for secondary purchases of older aircraft (usually from developed markets), as opposed to outright purchases of newer models.

20 20 Diagram 19: Aircraft delivery value by region from (List prices) Source: Boeing, DBS Growing need for aircraft financing To support the strong demand for newer technologies and fuel-efficient aircraft going forward, we anticipate that the aviation industry would require even larger amounts of funding above and beyond that in 2015, which Boeing estimates to be in excess of US$100 billion p.a. According to their projections, annual aircraft financing required for new deliveries alone will likely reach US$172 billion by 2020, which represents a CAGR of 5.9% between 2015 and Diagram 20: Growth of aircraft financing needs ( F) USD (bn) Source: Boeing, DBS

21 21 Of the US$127 billion in new aircraft financing estimated for 2016, a majority (87%) will be attributable to capital markets, bank debt, and cash. Capital markets will likely serve as the single largest source of financing, satisfying about 36% of new aircraft financing needs. Bank debt and cash will likely represent 27% and 24%, respectively. Meanwhile, export credit provided by export-import banks and tax equity should account for the remaining 13% for new aircraft financing. Given ample liquidity in commercial markets, the popularity of export credit as a source of financing has diminished over time, but remains a key source of financing in emerging markets. Diagram 21: Sources of aircraft financing sources in 2016F Source: Boeing, DBS Capital markets aircraft lessors preferred choice Capital markets play a huge role in aircraft financing. The largest users have been aircraft lessors, who have the financial sophistication and experience. In 2015, aircraft leasing companies tapped the capital markets frequently and accounted for a 45% share of capital market financing. The second-largest user of the capital markets for aircraft financing has been the US airlines as it is a cheaper source of financing than traditional commercial loans. Non-US airlines form the other bulk of the main user of capital markets.

22 22 Diagram 22: Users of capital market for aircraft financing Source: Boeing, DBS The largest players that provide commercial lending are led by China and Japan, who have been extremely active and aggressive in the space. China accounts for almost 29% of commercial lending for aircraft financing. Japan is the second-largest lender at 15% globally. Diagram 23: Commercial bank debt by country for 2016F Source: Boeing, DBS

23 23 Airlines are growing to meet the continued aviation transport demand globally, particularly new players such as the low cost carriers (LCCs) and start-up airlines in Asia. However, new aircraft are expensive and ties up large part of a carrier s balance sheet as its fleet expands. Hence, aircraft leasing companies will continue to support and play a big part in financing new commercial aircraft deliveries through direct purchases and purchase-and-leaseback agreements as they assist airlines in growing their fleet. Aircraft leasing companies use a wide range of financing tools such as asset-backed securities, debt capital markets, unsecured borrowings, etc. From the time series, it is evident that lessors are tapping more and more of the capital market from 36% of all lessor deliveries in 2012 to 53% in Diagram 24: Share of funding for aircraft lessor deliveries Source: Boeing, Company filings, DBS Aircraft leasing companies play a big part in financing new commercial aircraft deliveries, assisting airlines in growing their fleet

24 24 Aircraft Leasing: Background Aircraft leasing started almost five decades ago in the 1960s, just as commercial aviation was taking off. In 1968, airframe maker McDonnell Douglas was the first to introduce a vendor aircraft finance business solution to support its aircraft sales in an attempt to compete with its rivals. This eventually led to the founding of modern day aircraft lessors Guinness Peat Aviation (GPA) in 1975 in Ireland and International Lease Finance Corporation (ILFC) in 1973.GPA and ILFC were eventually respectively taken over by General Electric Capital Aviation Services (GECAS) and AerCap, who are currently the world s top two lessors. From less than a 1% share in the 1970s, aircraft leasing has since grown its market share of the global fleet to over 40% and has held steady at around 42% in the last decade while the global fleet continued to grow. (For more on the basics of aircraft leasing, please refer to the appendix.) Diagram 25: Top global aircraft lessors (>100 seats) While there are over 160 operating lessors globally, the sector is dominated by players with 50 or more aircraft in their portfolios. Among these, AerCap and GECAS dwarf their peers with over a thousand aircraft each, while the next closest player would be the Avolon/CIT Group (acquisition in-progress) with around 600 aircraft. Of the top 12 lessors currently, four are from China, whereas there were none just ten years ago. Lessor In-service On order Total AerCap 1, ,535 GECAS 1, ,459 HNA/Avolon/CIT Air Lease Corp SMBC Aviation Capital BOC Aviation ICBC Leasing BBAM LLC Aviation Capital Group AWAS Macquarie AirFinance CDB Leasing Source: Bloomberg Intelligence, DBS

25 25 Core markets for aircraft leasing Currently, there are nearly 800 airlines in about 160 countries operating almost 20,000 passenger jets of 100+ seats and their freighter equivalent. According to data from CAPA, the global airline fleet is currently dominated by the Asia-Pacific region with a 34% market share as at 7 February Europe follows with 26% and North America with 23%. A breakdown of the global leased fleet shows similar trends, with Europe and Asia-Pacific holding higher shares of around 30% each, and a lower share in North America of less than 20% which indicates that the core aircraft operating lease markets are in Asia- Pacific and Europe, while the tax regime in North America encourages profitable airlines to own aircraft on their balance sheet. Based on Air Finance data, the largest lessees by number of aircraft are from the European and Asia-Pacific regions. The single largest carrier lease is American Airline that accounts for almost 430 aircraft. Coming up in second is Air-France KLM as well as the International Airline Group (IAG), which includes British Airways, Aer Lingus, Iberia, Vueling airline brands under its umbrella. Diagram 26: Breakdown of global fleet as at 7 February 2017 Source: Ascend, DBS From Asia-Pacific, the Chinese airlines dominate the lessee space. China Southern leads with 195 aircraft on lease, followed by Air China with 168 aircraft, Garuda Indonesia with 158 aircraft, China Eastern with 157 aircraft, and lastly, Jet Airways from India.

26 26 Diagram 27 : Top lessees by fleet (January 2016) Source: Air Finance, DBS From less than a 1% share in the 1970s, aircraft leasing has since grown its market share of the global fleet to over 40%

27 27 Strategies Commonly Employed by Top Lessors Narrow-bodies generally preferred Based on CAPA s fleet database, we infer that nearly 60% of the global in-service passenger fleet owned by lessors as at 7 February 2017 are narrow-bodies. Offering better cost-efficiency and route-flexibility relative to wide-body aircraft, narrow-bodies are highly sought-after by airlines, particularly in Asia where LCCs have been rapidly gaining market share as they continue to drive regional connectivity through fleet expansion and the launch of new short to-mid-haul routes. Given the above, it is unsurprising that narrow-bodies are able to tap a bigger market and are thus generally more liquid, which helps support secondary market values and are often easier placed out than wide-body types. Evolution of widebodies could change things But evolution of wide-body jets could help lift proportion of wide-bodies from 13% currently. Helped by technological shifts, new-generation wide-body aircraft, such as Boeing s 787 Dreamliner as well as Airbus A350 and A330neo, offer improved cost economics, performance, and operational flexibility than previous generations (such as the Boeing 747 and Airbus A340) and at a fraction of the cost. With the ability to conform to a wide range of carriers business models, these newgeneration wide-body types could play a bigger role in lessors portfolios going forward. Diagram 28: Global in-service leased fleet by type (as at 7 February 2017) - - Source: CAPA, DBS Bank

28 28 We estimate that the top ten players hold well over 40% of the global leased narrow-body fleet. Among the top ten, data from CAPA as at 7 February 2017 also suggests that the narrow-body space is mostly dominated by long-standing industry leaders, GECAS and AerCap. With a fleet of 905 and 730 narrow-body aircraft in their respective portfolios, GECAS and AerCap s current scale in the narrow-body leasing market significantly eclipses that of their next closest rivals. Diagram 29 : Top 10 lessors for narrow-bodies by fleet size (as at 7 February 2017)* *excludes Avolon/CIT merger data Source: CAPA, DBS Bank Similar to trends in the global narrow-body leasing market, both AerCap and GECAS also appear to dominate the wide-body leasing market, with estimated market share of 14.9% and 5.9%, respectively. Meanwhile the top ten players jointly hold about 40% of the global leased wide-body fleet, with Aercap having a larger proportion of wide-body aircraft in their portfolio relative to other top-tier lessors.

29 29 Diagram 30: Top 10 lessors for wide-bodies by fleet size (as at 7 February 2017)* *excludes Avolon/CIT merger data Source: CAPA, DBS Bank Aircraft lessors generally acquire aircraft through a) ordering and purchasing new aircraft directly from manufacturers, b) purchase and lease-back transactions with its airline customers, or c) acquiring aircraft from other lessors or even the entire portfolio/platform. Based on data from CAPA, we estimate that the average fleet age of the top ten aircraft lessors (by in-service narrow- and wide-body fleet size as at February ) is approximately 7.4 years. Diagram 31: Average fleet age of top 10 aircraft lessors (as at 7 February 2017)* * includes in-service narrow-body and wide-body fleet only Source: CAPA, DBS Bank

30 30 Managing fleet age against risks Lessors with older planes tend to enjoy higher yields, and vice versa. In the event of overcrowding in the secondary market, however, lessors with an ageing fleet could be faced with higher residual-value risks, which may put pressure on their credit rating and financing costs. As such, a strong risk-management framework is necessary to help balance the benefits of an older fleet against possible longer-term risks. Operating Models While the actual operating model pursued tends to differ among the tier-1 lessors, their underlying business strategy may be broadly classified under either of the following categories: - 1. Young fleet: Under this strategy, lessors typically manage newer aircraft that are still in the first aircraft life-cycle and are thus less subject to residual value risk and substantial maintenance capex needs. Lessors employing this strategy include ICBC Leasing, Avolon, BOC Aviation, and Air Lease, which have average fleet ages between 3.8 and 5.1 years. 2. Yield-focused: Lessors such as Aircastle and AWAS operate in a niche space which is more agnostic (on a relative basis) to fleet age and instead, is focused on extracting yield and further value from their fleet. 3. All-rounders: Armed with specialty knowledge and extensive technical expertise, lessors such as GECAS and AerCap are well able to manage aircraft across ages and life-cycles. Their higher fleet ages of 11.3 years and 11.6 years, respectively, are reflective of this strategy.

31 31 Diagram 32: Comparison of key metrics of selected aircraft leasing companies As at end 2015 (US$m) AerCap Air Lease Air Castle FLY Leasing CALC BOC Aviation Total assets 43,914 12,355 6,570 3,417 3,090 12,474 Aircraft net book value 32,219 10,813 5,867 2, ,476 ROE (%) 13.8% 11.0% 6.9% 13.0% 19.5% 15.1% Owned fleet Aircraft on order n.a Weighted average age (years) Average lease remaining (years) Cost of debt funding (%) % 3.70% 5.20% 5.40% 4.10% 2.00% Debt to equity (x) Number of aircraft lessees Number of countries Manufacturer bias (existing fleet) Geographic concentration (by NBV) Largest three customers Airbus (53%) Airbus (40%) Boeing (56%) Boeing (57%) Airbus (92%) Airbus (51%) Europe (35%),AP (32%) American Airlines (11%), Aeroflot Russian Airlines (~7%) Virgin Atlantic Airways (~6%) Asia (47%), Europe (34%) Diversified client base Asia (42%), Europe(28%) S. African Airways (~7%) Thai Airways (~7%) Martinair (~6%) Europe (41%), Asia (31%) Diversified client base Asia (100%) Asia (54%), Europe (23%) China Eastern (17%) Chengdu Airlines (15%) China Southern (14%) Cathay Pacific (~7%) Iberia (~6%) Qantas(~6%) Source: Company filings

32 32 Emergence of Aircraft Lessors in Asia Inorganic growth a key driver While aircraft leasing has traditionally been dominated by American or European firms, Asian lessors have been catching up in a big way beginning with the founding of Changjiang Leasing and ORIX Aviation in Today, five of the 12 largest aircraft lessors hail from Asia, and a sixth is from Australia. Most of these have prominently grown through the acquisition of another leasing company, sometimes two. Approximately a year after HNA Group completed the acquisition of Avolon and merged it with its own aircraft-leasing arm Hong Kong Aviation Capital, it sealed a deal in October 2016 to acquire CIT s aircraft-leasing arm forming the world s third-largest lessor. In 2012, SMBC Aviation acquired RBS Aviation Capital, and BOC Aviation was formed following the Bank of China s acquisition of Singapore Aircraft Leasing Enterprise from Singapore Airlines (and other investors) in Organic growth has also helped Meanwhile, Asian lessors have also grown organically from deliveries from OEM manufacturers, primarily Airbus and Boeing. As it stands, Avolon/CIT, SMBC, CDB Leasing, BOC Aviation, and ICBC Leasing all have order books of over 100 aircraft, which should help drive double-digit growth in their portfolios in the coming years. And this does not take into account the purchase and leasebacks of aircraft they will enter into. All this implies that the largest Asian lessors will continue to grow at a pace that is above industry average. Diagram 33: Top global aircraft lessors (>100 seats) November 2016 Lessor In-service On order Total AerCap 1, ,535 GECAS 1, ,459 HNA/Avolon/CIT Air Lease Corp SMBC Aviation Capital BOC Aviation ICBC Leasing BBAM LLC Aviation Capital Group AWAS Macquarie AirFinance *As at June 2016 Source: Bloomberg Intelligence, DBS

33 33 Diagram 34: Timeline The emergence of the Asian players Source: AirFinance, CALC, DBS

34 34 Chinese Lessors to the Fore After the China Banking Regulatory Commission (CBRC) relaxed regulations on aircraft leasing in 2007, many financial institutions, led by China s big banks such as Industrial and Commercial Bank of China (ICBC), China Construction Bank (CCB), China Development Bank (CDB), Minsheng, China Merchants Bank (CMB), and Bank of Communications, started building up their aircraft-leasing arms and developing their own capabilities and scale in this segment. Diagram 35: Top Chinese aircraft lessors (In no particular order) CDB Leasing ICBC Financial Leasing BOC Aviation CALC Minsheng Financial Leasing CMB Financial Leasing Bank of Communications Financial Leasing CCB Financial Leasing ABC Financial Leasing AVIC Leasing Avolon/CIT (HNA Group) Source: Airfinance, DBS Fast-growing domestic aviation pie Going international According to Boeing, China will take delivery of nearly 6,000 new jets worth US$780 billion between 2015 and 2035, as its domestic market is projected to be the world s largest by Chinese lessors have been growing their share of the domestic aircraftleasing business aggressively through acquisitions from other aircraft leasing companies as well as through purchases and leasebacks from Chinese airlines. By 2018, according to industry consultant Ascend, Chinese lessors will capture 55% of the aircraft-leasing market, from 38% in 2013, and nearly zero a decade ago. It is estimated that Chinese lessors now handle 80% or more of new domestic leasing transactions in China. In 2013, China s central government spoke of their desire for local lessors to expand outside their domestic market, given the huge potential growth in aviation traffic in the next decades. Prior to this, only a handful of Chinese lessors, namely BOC Aviation, CDB Leasing, ICBC Leasing, and Hong Kong Aviation Capital had significant operations outside China. We have since then seen Chinese lessors participate more actively in the international markets, and many of them are now actively linked to transactions outside China.

35 35 Bank-backed Most of China s top aircraft lessors are supported by the country s top banks. Examples of these are: China Development Bank (CDB) Leasing (Listed in the Hong Kong Stock Exchange in July 2016) Industrial and Commercial Bank of China (ICBC) Financial Leasing Minsheng Financial Leasing China Merchants Bank (CMB) Financial Leasing Bank of Communications Financial Leasing China Construction Bank (CCB) Financial Leasing Bank of China (BOC) Aviation (Listed in the Hong Kong Stock Exchange in June 2016) Agricultural Bank of China (ABC) Leasing We profile some of China s top, and up-and-coming aircraft lessors: HNA Group: In January 2016, HNA Group, via its subsidiary Bohai Leasing, completed the acquisition of Avolon then a top ten aircraft lessor globally and merged its existing aircraftleasing arm Hong Kong Aviation Capital under Avolon to form a top eight aircraft lessor. This was sensationally followed by an agreement reached in October 2016 by Avolon to acquire the aircraft-leasing business of CIT Group for US$10 billion which will form a combined business that will have an owned, managed and committed fleet of 910 aircraft valued at over US$43 billion, placing the combined entity well ahead of SMBC Aviation and Air Lease as the third-largest aircraft leasing business in the world. We expect that Avalon, having achieved its medium-term target in less than a year after it was bought by Bohai Leasing, will continue to be active in acquisitions and transactions as it seeks to narrow the gap between itself and the two big boys, GECAS and AerCap, and to perhaps one day even surpass them. BOC Aviation: Bank of China acquired Singapore Aircraft Leasing Enterprise (SALE) from Singapore Airlines and other shareholders in 2006, and subsequently became known as BOC Aviation. Since then, BOC Aviation with Bank of China s support, has grown to be among the top aircraft leasing companies globally and was a top-5 player globally when it successfully completed its initial public offering (IPO) in HK in June 2016.

36 36 Having been nudged out of the top five by Avolon s acquisition of CIT, prospects for BOC Aviation remains bright as it is looking to leverage on new equity raised from its IPO to more aggressively growth its business. ICBC Leasing: The leasing arm of China s ICBC Bank, ICBC Leasing is one of China s largest aircraft lessors with an owned, managed and committed aircraft portfolio of over 400 aircraft. The portfolio is primarily made up of Boeing and Airbus aircraft, with a spattering of Embraer and Bombardier planes. According to its website, ICBC Leasing has 48 airline customers in South America, Europe, Africa, the Middle East, and Asia. With over 100 aircraft on order, ICBC Leasing is well positioned to continue growing and remain one of the country s and world s top lessors. CDB Leasing: The leasing arm of the China Development Bank, CDBFL focuses on aircraft and infrastructure leasing mainly in China. As at end June 2016, CDB Leasing had a portfolio of 184 owned aircraft, 11 managed aircraft and 214 committed aircraft. This consisted mainly of narrow-body aircraft, such as the A320 family and B , and wide-body aircraft including the A330 and B777. CDB Leasing had 41 airline clients in 22 countries. With committed aircraft that is well over its current owned portfolio, CDB Leasing is positioned to grow firmly in the years ahead. China Aircraft Leasing: Established in 2006, China Aircraft Leasing (CALC) had grown its fleet to 81 aircraft by end 2016, leased to 16 airline customers in Asia and Europe. With a firm order book for 92 aircraft from Airbus and potential for more from pop-ups and purchase & lease-backs, CALC is well poised to grow its fleet to at least 173 by CALC has also been growing its earnings through the sale of its finance lease receivables to recycle its capital and grow its business, and also has a 49% stake in an aircraft disassembly business based in Harbin that is slated for commencement in This could help push CALC to become a true full value chain aircraft solutions provider. Ping An International Financial Leasing: Ping An International Financial leasing company was founded in 2012 is a wholly owned subsidiary of Ping An Insurance Group which is China s largest non-state owned company. It has made sizeable orders and has been active in the secondary markets for purchase-and-leaseback deals to build up its portfolio, and has also been linked with M&A deals in the sector.

37 37 Diagram 36: Selected Chinese aircraft lessor activities ( ) Timeline February 2015 July 2015 July 2015 July 2015 September 2015 June 2016 July 2016 October 2016 Activities Commencement of trading for Rongzhong International Financial leasing CALC s US$94 million Hong Kong IPO - Asia s first publicly traded aircraft lessor Newly set up Ping An International Financial Leasing aviation business Two new lessors entered the market Hong Kong Financial Group Bridge Partners opened an aviation division Astro Aircraft Leasing launched Bohai Leasing; a subsidiary of HNA Group acquired Avolon (the world s third largest aircraft lessor at that point of time) BOC Aviation, an arm of Bank of China, started trading on the Hong Kong Stock Exchange with a US$1.1 billion IPO China Development Bank Leasing (CDB) Hong Kong s US$800 million IPO Avolon agrees to acquire CIT s aircraft leasing business for US$10 billion Source: Company filings, DBS

38 38 Japanese Lessors: Emerging Once More The Japanese were one of the earliest players in aircraft leasing, with the establishment of Showa Leasing in In the 1980s, the Japanese were a major source of aviation financing. While Japanese banks have always figured strongly in domestic aviation financing, they have re-emerged in recent years in the global aviation market, as they seek higher returns and lower risk than traditional corporate lending. With the purchase of RBS Aviation Capital by Sumitomo Mitsui Financial Group (SMBC Aviation) and Mitsubishi UFJ s acquisition of Jackson Square Aviation, Japanese lessors have once more returned to the fore. Japanese financing structure The Japanese have been prominent in aircraft leasing since the 2000s, helped by their very own Japanese operating lease with call option (JOLCO) or Japanese operating lease (JOLs). A JOLCO is an operating lease fully or partially funded by a Japanese-domiciled source of funds. Under this structure, Japanese investors would plough back profit into financing aircraft purchases in exchange for tax benefits and depreciation-allowances claims It typically takes the form of an SPV with equity provided by Japanese equity investors (typically 20-30%) and the remainder financed by debt. JOLs or JOLCOs are essentially like conventional operating or finance leases but the depreciation benefits that allow Japanese investors to decrease the taxable part of their funds end up being shared by lessor and lessee (in the form of lower lease rates). Since JOLs or JOLCOs are also available to foreign lessees, the availability and benefits offered by JOLs and JOLCOs have helped Japanese lessors become significant players in the aircraft-leasing space. Diagram 37: Top Japanese lessors SMBC Aviation Capital ORIX Aviation Jackson Square Aviation MC Aviation Partners Century Tokyo Leasing Corporation Showa Leasing Mitsui Bussan Aerospace Source: Airfinance Journal, DBS

39 39 Profiles of selected top aircraft lessors in Japan: SMBC Aviation Capital (SMBC): It was established as a result of a US$7.3-billion acquisition of Royal Bank of Scotland s aircraft-leasing business by leading Japanese institution Sumitomo Mitsui Banking Corporation. SMBC Aviation Capital is based in Dublin, Ireland. It is today among the world s top five aircraft-leasing companies, with 669 owned, managed, and committed aircraft in its portfolio as at the end of September ORIX Aviation: Founded in 1991 as part of ORIX Corporation, a Japanese financial conglomerate with businesses in asset lending rentals, property leasing, insurance, and investment management. It has presence in 30+ countries, with 60+ lessees. Jackson Square Aviation: A San Francisco-based lessor which was acquired for about US$1.3 billion in 2013 by Mitsubishi UFJ Lease & Finance (MUL), one of the largest leasing companies in Japan by assets. MC Aviation Partners (MCAP): Founded in 2008 as the wholly-owned leasing-andtrading arm of Mitsubishi Corporation, and currently owns and manages a fleet of over 100 aircraft. Century Tokyo Leasing Corporation (TC Lease): The company was established in 2009 via a merger of Century Leasing System, Inc. and Tokyo Leasing Co., Ltd. Showa Leasing: Founded in Tokyo in 1969 as a general leasing company, Showa is Asia s first aircraft leasing firm. It was subsequently acquired by the Shinsei Bank Group in 2005 and is now the financial and operating leasing arm of Shinsei Bank. Other Non-Traditional Lessors The first airline-lessor was run by the now-defunct Ansett Australia, which established its leasing arm Ansett Worldwide Aviation Services in It was later sold to Morgan Stanley Dean Witter in 2000 for US$600 million and rebranded in 2004 as AWAS one of the top ten aviation lessors by fleet size. Similarly, Singapore Airlines also set up a leasing arm known as Singapore Aircraft Leasing Enterprise (SALE) jointly with Boullioun Aviation Service (in 1993) which was sold to Bank of China in 2006 for US$965 million; SALE has become one of the world s largest aircraft-leasing companies. We have seen in recent years a number of airlines setting up their own leasing arms which, in addition to leasing to their own affiliated airlines, also lease to third-party airlines. The more prominent names include Indonesia s Lion Air, Malaysia s AirAsia, and Norway s Norwegian Air Shuttle. We believe there are three main reasons for this phenomenon: