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Market  Update – April 2016

Stuart Hatcher – CIO & VP ValuationsMike Yeomans – Senior Analyst

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Volatile Crude

• Oil volatility remains a concern• Airlines learned to manage through prolonged high pricing as

traffic demand was rising• Long term high pricing sparked interest in new engine options• Airlines still don’t believe low pricing will last beyond 2 years• New technology still remains valid, but given strong demand

for more capacity, current technology remains viable • Slowing down of demand for oil in developing countries –

better management of production required• Iran re-entrance will effect some change too• Middle East and Russian tensions will continue• End users in advanced economies continue to take advantage,

whilst strong USD hurts emerging market

Tough to manage

Manageable

Good Times

Source: FRED

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GDP

• GDP growth has remained steady although shift has moved away from the BRIC countries

• IMF predictions – China (6.3%),Russia (-1.0%), India (7.5%), Brazil (-3.5%), USA (2.6%), Euro area (1.7%), Japan (1.0%) –

• Advanced economies rising slowly, and slow rise in emerging economies – but not for China or countries dependent on China

• Emerging markets still account for 70% growth• How real is Chinese growth – shift to consumer

market or is a meltdown on the horizon? Traffic increase of 10.9% in China leans towards optimistic view

• GDP continues to drive traffic demand but prolonged consumer demand in the face of low oil/commodity pricing has shifted the gear

4.27%

1.83% 2.08%2.76%

4.15%3.59%

4.09% 3.94%

1.45%

‐2.06%

4.08%

2.85%2.26% 2.36% 2.49% 2.40%

5.90%

‐2.69%

‐0.33%

0.76%

13.62%

7.25%

5.65%

7.25%

1.69%

‐1.62%

8.21%

6.55% 6.13%5.60% 5.90%

6.50%

‐4.00%

‐2.00%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

GDP RPK

Source: IMF & IATA

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Traffic Relationship has shifted

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

25,000 35,000 45,000 55,000 65,000

RPK ‐

GDP X 10^9 US$ 2005

1985‐2015

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

25,000 35,000 45,000 55,000 65,000

RPK ‐

GDP X 10^9 US$

1985‐2009

How resilient is this shift – one‐way global consumer demand shift or bubble?

Source: IATA & IBA

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Business Confidence

• Conservative views compared to 2015• Firm confidence in Europe with

concerns for Brazil and China• US dipped below 100 – highlighting

issues with the strong USD• Confidence remains high for countries

like Sweden, Hungary, Turkey, Spain & Mexico – stronger airline demand apparent

94

95

96

97

98

99

100

101

102

103

Sloven

ia

Swed

en

Hungary

Turkey

Spain

Mexico

Japan

Russia

Germany

Belgium

Portugal

Nethe

rland

s

Italy

Austria

Australia

France

Poland UK

Czech Re

p.

Denm

ark

Indo

nesia

Switzerland

South Africa

United States

New

 Zealand

Estonia

Finland

Slovak Rep

.

India

China (PRC

)

Norway

Luxembo

urg

Greece

Korea

Chile

Brazil

Business Confidence

Jan‐16 Jan‐15Source: OECD

SH1

Slide 5

SH1 Stuart Hatcher, 10/02/2016

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Pax traffic remains steady

• Very strong start to the year with ~8% annual growth• Strongest start of the year since 2008….• Capacity increase remains cautious as seen by rising

load factors• In some regions, capacity is growing faster than traffic• Despite very high growth rate, Middle East Capacity is

rising quicker• Demand conditions look good ahead of peak season.

Capacity increasing, oil remains low, airport connections increasing, global air fare trend remains low & steady

Air Passenger Travel Growth & Business Confidence

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International Traffic

• Passenger traffic growth jumped to 9.1% in February• African carriers posted strongest percentage growth rate

for all regions in 2016 so far• Largest International market – Europe – rebounded since

Transaero problems, and strikes. Economy remains fragile• Second largest international market – Asia Pacific – 11%

growth. 7.3% increase in direct airport connections• Middle East – (3rd) – 11.3% growth – but LFs are trending

downwards• North America – weakest international growth – more focus

on domestic routes• Latin America – continuing to perform well – total opposite

from North American trend as domestic demand falls

International Passenger Traffic by Carrier’s registration

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Domestic Traffic

• Passenger traffic growth up at 7.9% in February• Only Chinese market result for February was lower than

January –CNY timing shifts• Whilst economic signals look poor for China, service

industry business growth continues to hold.• Once again, India remains on top. Fastest growing

economy and >20% YOY growth! • Japanese market remains modest• Some uptick in Australian demand• Domestic Russian & Brazilian market remains under

pressure. Both economies are dependent on energy – both economies contracting

• Russian carriers seem to have absorbed Transaero traffic, and brazil’s downward trend appears to have stopped

Domestic Passenger Growth by Country

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Fragile Freight Demand

• Early 2016 signs look lower than 2015, but average growth rates from 2015 to 2016 higher than 2014 – at 3.1% YOY

• World trade volume grew by 2.0% in 2015 – slower than GDP.

• Based on global export correlation, there is no surge in freight demand in near-term

Air Freight Growth v Global Export Orders

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Fragile Freight Demand

• Strong Feb 2015 signals over 2014, poor 2016 results in general

• Middle East leads the way, with only Latin America and Europe producing positive results

• Chance for results to stabilise by year end

International FTK Growth by Carrier Region

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Load Factors

• Airlines have been adding capacity cautiously, load factors remain strong

• Freight capacity has been increasing well beyond traffic demand.

• Low demand + low fuel costs!

• Passenger loads look robust but some signals indicate a possible slowdown on the horizon for international traffic

• Domestic load factors helped to boost factors with India and US markets leading the way with 83.2% - 85.4% respectively. China remains strong at 81.2%. All 3 up from 2014.

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Yields & Currency concerns

• As fuel costs have declined, downward pressure on yields have continued – global fares fell 12% in 2015

• Many operators have removed fuel surcharging despite hedging at higher levels remaining in place

• Fares expected to drop as hedge agreements unwind• Some operators have risen base fares, but it depends on

market environment• Stronger USD has significant impact on global fares.

Further squeezing non-US airlines that have costs in USD but fares in local currency

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Airline Costs Shifting

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What will Airlines do with all this cash?

• Airlines have shown “rational” behaviour since 2007 by cutting routes and parking older aircraft• Profits were achievable during prolonged high fuel cost period but margins were thin• New efficient aircraft were ordered to reduce DOCs/COCs as fuel was expected to remain high for good• With fuel low – what do airlines do?

• Buy more aircraft?• Open new routes?• Start a price war?• Cancel/defer new orders and buy older aircraft?• Buy out leased aircraft?• Pay dividends?• Buy shares in other airlines?• Stop leasing aircraft?

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Historical Net Orders – Airbus & Boeing

• Another strong year for orders• 3rd year in row and 7 out of 8 years for Airbus lead• Book to Bill @ 1.0 for Boeing, whilst Airbus is 1.5• Order volumes were down as expected – why?

• No point buying fuel efficient aircraft?• Have plenty on order already?• I’m going to remain focused on a rational

strategy?• Lets wait and see what happens to fuel?• Delivery is too far away?

• 2016 expected to be poor year for orders

0

200

400

600

800

1000

1200

1400

1600

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Net Orders ‐ Airbus & Boeing

Airbus Net Boeing Net

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Historical Deliveries – Airbus & Boeing

• Boeing retains the lead for deliveries, Airbus remain consistent with much lower volatility

• 2016 expected to remain similar – although Boeing declare slight drop

• We expect Airbus to deliver more in 2016 (680) as A350 ramps up

• We expect Boeing to deliver less in 2016 (740) –down 22 from 2015

• 777 and 747 lowering production rates• Airbus & Boeing both indicate production increases

for A320/737s• A320 – Rate 50 by 2017, 60 by 2019• 737 – Rate 52 by 2018, 57 by 2019

0

100

200

300

400

500

600

700

800

900

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Deliveries ‐ Airbus & Boeing

Airbus Deliveries Boeing Deliveries

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Current Backlog Spread

• Large lessor component but half what it should be –indicates 20% of fleet will be captured through SLBs

• Neo continues to outsell MAX

• Large unidentified orders that could be Chinese

• A320 backlog @ 11 years at current rate, 737 @ 8.5 years

• 777ceo backlog @ 2.2 years so production drop inevitable.

• A330ceo enough production for nearly 2 years –same point as the A330neo expected EIS

• Lessor spread widened for Airbus

• Both OEMs below book to bill 1.0 ratio for widebody aircraft

lessor airline other unknown totalA320ceo 210 625 2 227 1064A320neo 966 3021 5 479 4471A330ceo 25 123 7 27 182A330neo 55 115 0 0 170

A350 70 673 1 2 746A380 23 104 0 13 140

1349 4661 15 748 677320% 69% 0% 11% 100%

Lessors airline other unknown total737 MAX 590 1824 6 652 3072

737 180 833 50 282 1345747 0 18 1 0 19767 0 76 0 0 76777 27 166 2 23 218

777X 0 296 0 10 306787 138 579 5 51 773

935 3792 64 1018 580916% 65% 1% 18% 100%

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2015 orders

80%71%

79%

20%29%

21%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2013 2014 2015

Identified Gross Orders % Split

Airline Lessor

847

397

189

143

95

329

8

9

0

200

400

600

800

1000

1200

Airbus Boeing

Airbus/Boeing Split

Airline Lessor Unidentified Government/ Private

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Who has yet to Order?

0 50 100 150 200 250 300 350 400 450 500

American AirlinesChina Eastern Airlines

China Southern AirlineseasyJet

LATAM AirlinesjetBlue AirwaysUnited Airlines

LufthansaBritish Airways

Air FranceDelta Air Lines

Air ChinaIndiGo

Turkish AirlinesVueling

Sichuan AirlinesAeroflot‐Russian Airlines

AirAsiaAlitalia

Spirit AirlinesAvianca

Shenzhen AirlinesAir CanadaAir IndiaWizz Air

Backlog Fleet

A320 family Operators Fleet BacklogAmerican Airlines 360 145China Eastern Airlines 241 0China Southern Airlines 234 0easyJet 220 181LATAM Airlines 217 82jetBlue Airways 156 91United Airlines 153 0Lufthansa 145 136British Airways 130 35Air France 127 3Delta Air Lines 126 45Air China 125 0IndiGo 101 430Turkish Airlines 99 104Vueling 99 63Sichuan Airlines 98 0Aeroflot-Russian Airlines 95 0AirAsia 80 309Alitalia 79 0Spirit Airlines 79 87Avianca 77 133Shenzhen Airlines 77 0Air Canada 75 0Air India 74 0Wizz Air 66 146

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Who has yet to Order?

B737 family Operators Fleet BacklogSouthwest Airlines 577 254Ryanair 328 248United Airlines 311 141American Airlines 266 138China Southern Airlines 159 25Air China 139 0Delta Air Lines 135 68GOL Transportes Aereos 135 72Hainan Airlines 127 9Xiamen Airlines 123 28Alaska Airlines 122 67WestJet 113 71Lion Air 107 243Shandong Airlines 88 0Shenzhen Airlines 88 0Turkish Airlines 87 94SAS 85 0Garuda Indonesia 81 50Virgin Australia 77 45COPA Airlines 76 72China Eastern Airlines 73 33Jet Airways 70 75Qantas 67 0Shanghai Airlines 65 0Norwegian Airlines 63 135

Some still have to place orders, others are planning on big growth!!

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Orderbook Positive & Negatives

• Pro:• Current traffic growth will sustain current backlog

for growth not replacement• If traffic is sustainable, older aircraft will be around

for some time• Can identify heavy A320/B737 users that have still

yet to order sufficient aircraft• Many operators have yet to decide on a widebody

replacement strategy too

• Con:• RPK growth slows back to traditional levels• Production increase pushes excess supply into the

market • New aircraft sufficient for replacement and growth

pushing older types back onto lessors • Deferments likely• Lease terms likely to shrink along with economic

life• Some weakness in order book – Russian &

Brazilian carriers

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Hedging

• Fuel prices have remained low since 4Q 2014

• Global yields have dropped already by 4-6% of a global saving of $70Bn in fuel costs, the real number will be closer to $35Bn – also factoring the strong USD against some currencies

• United, Southwest, Delta, Lufthansa, Ryanair – all hedged based on longer term high fuel costs and are losing out. Ryanair are expected to unwind shortly.

• AA, Emirates, Etihad, Air China, China Southern, China Eastern all unhedged

• Asiana, Air Asia, JAL, ANA and Cathay have between 10%-50% hedged

• Regional fare pricing expected to remain competitive to maintain market share - this will be reflected in yields and airline results

• Carriers such as Emirates will continue to take international market share as they can reduce fares due to the low fuel price

• Falling yields indicate that fares are dropping ahead of fuel globally as other costs aren’t rising disproportionally

• Some will undoubtedly try to unwind their hedges but providing fares remain relatively stable and within reason for hedged airlines to react to, then some will ride out the storm

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Single Aisle Market

• Slower orders for 2016 as backlogs reach new high

• Oil reaching new low may shift short-term focus away from new orders

• Fewer lessor orders with more bias towards operators that haven’t bought yet

• Deals driven by discounts not necessarily long-term optimisation – more conversions within the family

• Expect greater push from Boeing to equalise the neo/MAX variance

• Used aircraft values rising for <10 year olds – off or on-lease – from a low base position

• Older types trading but often priced too high for part-out

• Lease rates factors falling aided by new entrants entering the market

• Availability of 737NGs and A320s falling

• How does neo/MAX value increase stand in low oil price environment?

• Technology risk remains a potential problem

Trends

• Sale & Leasebacks

• Sales with leases attached

• Lease Rate Factors

• OEM pricing

• Lease Term Lengths

• Extension opportunities

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Regional View – North America• Unprecedented Airline performance – very high Q4 results (Q4 net profit & op, margin)

• AA $1.3bn 16% - 142 Airbus on order, 162 Boeing on order• US Airways – 22 Airbus on order, • Delta $926m 17% - 100 Airbus on order, 82 Boeing on order• United $924m 13% - 35 Airbus on order, 170 Boeing on order• Southwest $591m 20% - 249 Boeing on order• JetBlue $190m 21% - 90 Airbus on order• Alaska $186m 21% - 62 Boeing on order• Hawaiian $49m 16% - 22 Airbus on order• Allegiant $57m 30% - no new orders• Air Canada - 84 Boeing on order• WestJet $49m 12% - 70 Boeing on order• Frontier $29m 24% – 96 Airbus on order• Virgin America $54m 14% - 33 Airbus on order, • Spirit $74m 23% - 86 Airbus on order• Region accounts for 18% of Boeing backlog (1,535), 10% Airbus backlog (626)• For US carriers, strong domestic growth but expect some international weakening

if USD remains strong. Canada suffering weakened Q4 – but still decent

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Regional View ‐ Europe

• 1,112 Boeing on backlog, 1,192 Airbus

• Migration & general political discontent

• UK planning EU referendum

• Wide currency variances against USD

• Ryanair – 9% margin – still paying too much for fuel – still attacking easyJet with lower fares.

• Terrorism threat continues

• LCC Wizz (7%) growing fast but still faces wider regional demand swings

• Europe looking more to Iran with new routes likely to open

• Lufthansa took the first A320neo

• IAG now encompassing Aer Lingus

• Aeroflot moving in on Transaero

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Regional View – Asia Pacific

• Mixed results

• India doing well – IndiGo & Spicejet announcing good results – with margins of 20%/17% - Jet Airways managed 9%

• Korea having problems with weakening traffic and some expensive aircraft to pay for – margins closer to 5% for Korean Air and 1% for Asiana

• Australia remains weak but some profit expected for Virgin

• JAL doing well with 15% margin, ANA 7% - but they are upbeat!

• Chinese traffic rose >10%. Domestic demand is soaring – but airline stocks remain volatile with big swings

• Strong competition between Singapore, Cathay, Philippines, Garuda

• Malaysia Airlines still trying to sort its issues out

• Traffic is there, but economies are adapting, currency exchange has posed problems and strong rivalries

• 1256 Boeing on order, 1942 Airbus on order!!!

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Regional View – Latin America

• GDP outlook very bad• Doesn’t look good for Brazil• Rocky times ahead for GOL, as Brazil suffers• Zika, poor growth, crumbling Real, Olympics!• Government changes ahead• Mexico operators showing demand uplift• Colombia showing tourism growth helping Avianca• 418 Airbus on backlog, 248 Boeing

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Regional View ‐ Africa

• Wide issues• South African economy weakening• Kenya Airlines trying to sort its finances by selling

young expensive aircraft• Emirates big player on its doorstep draining traffic• Too many areas still no-go zones• Egypt facing additional terrorism concerns as are

French territories and Algeria• Pockets of growth – Rwanda, Morocco, • Nigeria suffers with low oil price• Ethiopia leading• Boeing backlog 71 – Airbus 47

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Regional View – Middle East

• Once again Middle East provides focus

• Emirates, Qatar, Etihad push hard and show largest international growth

• Saudi Arabia on edge of austerity measures – Saudi Aramco

• Oman growing its regional stretch too but the economy is tightening

• Iran orders Airbus and ATR, Boeing now allowed to go in

• Syria and Iraq are no-go areas

• Massive migration issue of biblical proportions

• Tensions strong within the region – with divisions everywhere

• Boeing 560 on order, Airbus 413 – expect more orders

• A380 & 777 hub

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Airline Strategies

• What we have learnt from the high fuel market is that airlines with older aircraft can make a profit

• There were far fewer bankruptcies than expected as capacity was managed instead

• New aircraft aren’t needed in low fuel price environment and therefore legacy carriers will continue to buy mature aircraft rather than new ones and everyone will balance the cost of new ‘v’ extending or buying mature. EasyJet, IndiGo, BA, Air France, Lufthansa – all are looking at buying mature assets – Ryanair may just keep hold of its older owned fleet

• Large new orders have become the most expensive hedge! If fuel remains low and provided airlines can buy, lease or extend good mature assets, then we may expect to see some deferments

• However, if traffic continues to grow at the same rate, then orders are largely there for growth not replacement and the usedmarket simply cant supply that much capacity into the market

• Secondary market values will continue to strengthen provided traffic growth does.

• What will make an aircraft attractive will depend on the airframe, interior and engine condition.

• Leases will be extended more often either because they need the capacity and/or they don’t want to pay the compensation to the lessor, but also the interior reconfiguration cost goes away (for both sides!)

• Second-hand sales will benefit those with good aircraft with plenty of life remaining on the airframe and serviceable engines

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Lessor Activity

• Established lessors finding it difficult to compete in open bid situations• Too much cheap money chasing limited product • Lease rate factors down to 0.6%, full-life returns are being relaxed• Lease extensions very common but at much lower rates and weaker terms• All lessors trying to grow but also illustrate they can trade too• Lessors becoming more prudent with setting reserve levels where they can • M&A activity is warming up• Impairments on widebodies?• Good time to sell

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2016 view

• Low oil continues to stimulate growth in developed economies – expected to rise slightly with greater management of supply and demand

• Emerging markets growing but oil is too low• Strong USD will hurt US exports and non-US

airlines with USD DOCs• Interest rates will remain low with slow rises ahead• Likewise, inflation – especially in Europe will

remain due to low oil pricing/cheap commodity pricing

• UK referendum in 2016 on EU wouldn’t be good• Traffic will remain strong for 2016 within US and

Europe• China remains on watch

• Possible further impairments for lessors and banks on 777

• Lessor M&A deals throughout the year• Iran could offer plenty of new opportunities and

most lessors have already been down there?!