The roles engine leasing companies play in the aftermarket are shifting.
As OEMs and MROs partner to provide power-by-the hour solutions to carriers in search of engines—encompassing the maintenance to keep them running—traditional engine lease firms still have a role to play. The key is their ability to offer carriers cash via a sale and leaseback arrangement. To do that, lessors have to keep their own cost structures lean. That may mean nailing down maintenance and material costs at point-of-purchase, and more aggressively pooling parts.
“The trend is for [engine] OEMs to be winning more and more of the business,” says Joseph O'Brien, executive vice president of Shannon-based Engine Lease Finance Corp. “The dynamic in the market is [moving toward] more power-by-the-hour.”
But PBH pacts don't necessarily presage long-term loss of business, at least not in Abdol Moabery's estimation. “Typically what happens,” contends GA Telesis' president and CEO, is that power-by-the-hour is often a mere starting point in the evolution of an airline's engine maintenance philosophy. After a while, after they begin to understand the physical and fiscal parameters of their powerplants, they well might decide to migrate into a time and materials contract. And then, he contends, is when they seek out traditional engine leasing firms.
As maintenance efficiencies within a carrier become more manifest, the pull of the comprehensive services that OEMs and MROs offer lessens, and airlines gravitate towards leasing companies. At least that's the lessors' contention. To pave the way for new business, the engine lease firm must “pay a good number for the engine, then offer a very attractive lease factor,” says O'Brien.
That said, how else can lease firms counter OEM/MRO ascendance in the engine marketplace? Oliver Wyman partner Tim Hoyland characterizes the bond between OEMs and MROs as “pretty strong,” and believes the two are “working well” together. He thinks one tack engine lessors can employ to become more competitive is effectively using spares pools. “We still do not see as much pooling in North America as we have in Europe,” he says, but, “We're starting to see it—especially as airlines seek to reduce assets.”
Hoyland also believes leasing companies are going to have to get more aggressive at point-of-purchase, the point at which they acquire a powerplant. The reason: “You're not going to get a second chance to [nail down] the…maintenance costs.” If lessors don't do that then and there, if they lose that point-of-purchase opportunity to do “a very intelligent and aggressive PBH agreement…it's going to be very difficult for them to reduce their costs.”
The Oliver Wyman executive believes trying to nail maintenance costs in place after the buy is all but futile. If the lessor procures the engine and then leases it, when the lessor subsequently tries to purchase maintenance, “there [is] a lot less competition at that point in time.” That's why he argues leasing company must fix the maintenance expenditures up front—and that includes inventory and material costs. He says lessors should obtain guarantees, again at point of purchase, as to how much those costs will escalate—guarantees that allow their material costs to rise less rapidly than those of the airlines.
There's another key observation by the Oliver Wyman partner, and it concerns parts manufacturer approval (PMA). “What we're seeing in the high-tech PMA market is a rapid…reduction in high-tech PMA components,” says Hoyland. He terms the survey results “stunning.” Hoyland attributes the fall off in high-tech PMA product to regulatory changes. He asserts PMA manufacturers are simply unwilling to assume what he terms “massive” financial risk. That trend, should it continue, could have a telling impact on market dynamics.
The New Engine Nexus
Further influencing the direction engine leasing is headed is the advent of a new generation of engines about to come on the market. Far more fuel-efficient powerplants, notably's and Pratt & Whitney's PurePower (formerly referred to as the geared turbofan) are set to debut in the second half of this decade. They could be game-changers, not just for the airlines, but the leasing companies as well. Engine Lease Finance Corp.'s Joe O'Brien believes the new engines will exact a toll on “residual [engine] values.”
Along those lines, Moabery says a series of potent technological changes is leading to increased time-on-wing. The consequence? Powerplants will be leased “on a less frequent basis than they have [been] in the past.”
Will the trend be compounded by potentially even more reliable next-generation engines? “Not necessarily,” Moabury says. Aside from operational enhancements, engines “aren't getting any cheaper.” That means carriers will still need cash. It remains one of the most important drivers of sale-leasebacks. “I don't think [next-generation engines] will compound the issue,” he says. He contends the real market impact of the new powerplants will “define itself as the first generation of these [new] engines goes into operation.”
Paying for the Powerplant
About 40-50% of new engines are financed today on a sale and leaseback basis, says Roger Welaratne, senior vice president of marketing for Gecas' Asset Management Services Group. Welaratne says seven to eight years is the norm for a sale and leaseback, with five years at the low end of the range and a dozen years at the high end.
How a carrier finances an engine depends on how big it is. Moabery says for large airlines with anywhere from 30 to 50 spares, the best route might be an EETC (enhanced equipment trust certificate). “It's basically a bond,” he says, one secured against the specific asset of the engine pool. Because of enhancements such as protections against bankruptcy, they garner a lower interest rate, somewhere between 5-7%, depending on the airline and the engines. He says doing an EETC entails having an engine pool value of $70 million to $1 billion. “You can't do an EETC on a $7 million to $10 million engine, because its' just not big enough to get anyone excited.”
The recourse for smaller airlines which can't, he says, is to “come to a company like us, or a company like Willis, or ELFC and do a sale and leaseback.”
As for traditional banking participation in the financing process these days, O'Brien says banks haven't historically seen the need to be heavily involved in engine acquisitions. It's only in the last few years that some have become players. Even then, today's terms are decidedly different than they once were not too long ago.
Moabery says in years past carriers could borrow as much as 90% against the asset they were financing via the banks. Today, the best carriers can hope for is 50-70%, he says. That means on a $10 million engine an airline could once obtain as much as $9 million in financing. Now, it's almost half of that, which is one of the reasons “airlines are looking more and more to traditional leasing companies for spare engine financing,” says Welaratne. “The few banks that were in the aviation sector have to reduce [their] exposure” in this arena.
The result is a shortfall in financing, one tailor-made for a sale and leaseback. Even though the technique costs more in the long run, it produces short-term benefits. “Leasing is always more expensive in the long run,” says Moabery. But it also begets comparatively quick cash and helps manage the residual risk on the engine: a seven-year sale and leaseback equates to “zero risk of an asset write-down if the value of that engine is…more than the market is.”