Leasing activity for aircraft, engines, and major components appears to be on the rise. For example, for engines, the leasing market is now at $14-15 billion, with new leases of $2.5 billion coming on line each year, and an estimate that as much as 50% of spare engines globally are funded by operating leases¹. For aircraft, over a third of the world’s airline fleet is now leased^2, and is expected to rise to 50% by 2015³. Distributors and MRO’s should take notice of these trends because the terms of the leases often give specific instructions and limitations regarding the parts used during the course of expected maintenance, and in some cases, the choices of MRO’s. Given these developments, I thought I’d take time to impart some introductory information on the practice.

By the way, are there any freshman college courses that still use the “101” for the course numbers?

Lessor: The firm with the asset that is being leased to an airline/operator.

Lessee: The firm operating the leased asset

Why Lease?

The need for increased levels of reliability and fuel efficiency has pushed technological innovation for aviation products to new heights. Technological risk, which in the past was reason for lengthy and more cautious product rollouts, has been greatly mitigated by the overwhelming need for fuel efficiency and reliability. All this has pushed prices to dizzying levels. Consider that a new GE90 engine for a 777 will cost close to $35 million, and the same new aircraft in the range of $300 Million. To buy will usually require substantial cash outlays, and consider that some banks have taken steps to reduce their exposure to the aviation industry, limiting in some cases, financing those buys. For any operator that is cash-challenged, wants to maintain a level of cash reserves, or liquidity, leasing would then seem increasingly attractive. A short list of additional reasons to lease may include:

• The operator only has need of the asset for short term, seasonal or temporary use. E.g., the airline’s fleet of aircraft or engines are entering a cycle when heavy checks are due, and therefor will not be available for revenue operation; lease to make up the difference.

• For an operating lease (discussed later), the asset does not appear on the lessee’s balance sheet.

• The airline needs cash: The airline sells its owned aircraft or engines to a leasing firm, receives the cash, then gets the aircraft leased back which remain in service.

• A “Wet Lease”, sometimes is a way for an operator to circumvent restrictions it may have on flying into certain countries. The restrictions may be imposed by political or NAA sources. In other words, if an airline is restricted from flying in certain countries, a Wet Lease may be a way to get your products or customers there. Commonly called ACMI, the lessee is leasing the Aircraft, Crew, Maintenance, and Insurance is provided. Most wet leases are not for this reason, however.

• When dramatic economic changes occur either to the airline or in the operating environment, the leased assets can simply be returned under the terms of the agreement.

• For lessors, there is the expectation that an otherwise idle asset will be generating steady income.

How?

There is literally a myriad of different leasing options, agreements, terms and conditions, with their own pro’s and con’s. For the purpose of this blog, I’ll just keep it simple, and please keep in mind there are variations for all of this.

WET LEASE:

• Commonly called ACMI, the lessee is leasing the Aircraft, Crew, Maintenance, and Insurance is provided.

• The period can go from one month to usually one to two years.

• The Lessee has to provide all fuel, landing/handling/parking/storage fees, crew expenses including meals and transportation as well as visa fees, import duties where applicable, as well as local taxes. Furthermore, the Lessee has to provide passenger/luggage and cargo insurance and in some cases need to cover the costs for War Risk.

• BTW, the term “Wet” at one time meant, and still in some agreements means, that fuel is provided.

DRY LEASE:

This is the lease of the basic aircraft without insurances, crew, maintenance etc. Usually a dry lease is the instrument of choice by leasing companies and banks. A dry lease requires the Lessee to put the aircraft on his own AOC (Airline Operating Certificate) and provide aircraft registration. There are generally two types of dry leases, an Operating Lease and a Finance Lease.

Operating Lease:

• Generally a lease term that is short compared to the economic life of the aircraft being leased. An operating lease is commonly used to acquire aircraft for a term of 2-7 years.

• With an operating lease the aircraft doesn't appear on the Lessee’s balance sheet.

• Operating Leasing has grown from 3% of the world fleet in 1980 to 35% today, and is expected to rise to 50% in the next decade³.

Finance Lease: also known as a capital lease, is defined when one of the following conditions are met:

• At the end of the lease term the Lessee has the option to purchase the aircraft at an agreed price.

• The lease payments are more than 90% of the market value of the aircraft.

• The term of the lease is over 75% of the aircraft's usable life.

With a finance lease the aircraft appears on the Lessee's balance sheet, because it is viewed as a purchase.

Leasing’s impact on Distributors and MRO’s:

Since the Lessor’s own the asset, there is an expected strong need to enter into agreements which in their eyes maintains and protects the value of the asset; that’s its future marketability is not compromised during the lease. Consider the following in many cases:

• The lessor will require that the lessee maintain cash reserves to cover the cost of certain scheduled maintenance checks, and further that those checks be performed by MRO’s defined by the lessor.

• The lessor wants the asset to be maintained in strict Configuration Control. This may mean that alternative PMA parts or DER repairs are not allowed or are closely controlled.

• Replacement parts used in maintenance may be required to be in new or overhauled condition rather than Repaired, or Inspected.

• There may be restrictions on exchanges and control of Life Limited Parts

For Distributors and MRO’s, if leasing is increasing, who then is the relationship with? Who is the customer? The Lessor, the airline, both? How about the OEM’s? Nearly every OEM has its own financing and leasing organizations. In other words, there are both independent and OEM lessors. In the face of increasing leasing activity, Distributors and MRO’s should consider diversifying their customer base to include these lessors.

Lease Returns

Based on feedback I’ve had from my aviation friends, it is a rare lease return that will not involve some form of contesting. Teams from the lessor and lessee will be formed to examine every iota of the agreement for compliance. Areas that typically require further resolution include:

• Were all the AD’s and required Service Bulletins closed out?

• The status of remaining time or cycles for Life Limited Parts.

• Were any major scheduled maintenance checks about to become due?

• Were any parts or assemblies modified to non-standard configurations as defined by the agreement?

• Anticipated life remaining of Tires and Brakes

• Are there any installed leased or pooled parts that must be returned to, for example, to a Pooling group?

In settling the particulars of the lease return which often has to be negotiated, Distributors and MRO’s will often find themselves in the settled solutions, e.g., in resultant exchanged parts and MRO activity.

I hope you’ve found this blog (course number LeasingEco101) informative. Please leave a comment on this blog site. We’d particularly like to hear from Distributors and MRO’s involved in leasing activity.

Over ‘n out

Roy “Royboy” Resto

Aim Solutions Consulting

www.AIMSolutionsConsulting.com

¹ “Leasing Options for Sourcing Spare Engines”. Aircraft Commerce. Issue No. 90, October November 2013.

² http://www.economist.com/node/21543195

³ Laurence Vigeant-Langlois, PHD. ”Overview of the Aircraft Leasing Industry”. Presentation to the Air Transportation Systems Engineering class, George Mason University. CIT Group.