KAREN FLOERSCH TORONTO
Engine leasing is growing fast as airlines make use of the economics and flexibility on offer from an increasingly broad range of providers
Engine leasing may still be something of a niche market, but it has now started to take off. Over the past couple of years the number of engines on lease has soared and so have the variety of packages on offer from manufacturers and leasing companies. A surprisingly full array of products are now available, ranging from the traditional operating lease through to engine pools and power-by-hour arrangements. More competition has helped lower rates, but the underlying attraction for airline customers has been the promise of new levels of flexibility in supplementing their owned-engine fleet.
Since the majority of new engines are wrapped up in the same financing package as the aircraft they power, there is little need for a separate leasing arrangement. However, the requirement for spare engines is not always addressed at the time of a new aircraft acquisition. For all but the biggest fleets, it is hard to justify paying out $5-10 million for a spare simply to see it sit around idle for most of the time. Also, spare engines are rarely available with secondhand aircraft. Accordingly it is here that the lessors have focused their energies.
It is estimated that up to 20% of the spare engine population is now on some form of lease, a figure that has doubled from just a couple of years ago. Much of the demand is met by the engine manufacturers themselves. Although Pratt & Whitney has no dedicated engine leasing arm, most others have, including its two big rivals. Roll-Royce & Partners Finance has a portfolio of 195 engines, while General Electric Engine Leasing has 180. Then there are third party leasing companies with large mixed engine portfolios. The largest are Engine Lease Finance with 120 units and Willis Lease Finance with 112.
Simon Spalding, general manager-engine leasing for Rolls-Royce & Partners Finance, attributes the expansion in this market to "airlines becoming more open to the concept of spare engine leasing", their acceptance being largely driven by lower lease rentals in an increasingly competitive market.
Indeed, the customer base for engine leasing is broadening. Such a change is detected by Roger Welaraten, the senior vice-president for operations at Shannon Engine Support, an Irish subsidiary of engine maker CFM International. "Customers in the past were typically charter airlines or small carriers with five or six aircraft. Today, we are seeing more very large customers - such as British Airways, Air France, Lufthansa, Air China and China Southern - interested in engine leasing. These airlines probably already have spare engines but need the occasional top up," he says.
The range of leasing options on offer is also becoming more sophisticated, extending well beyond the standard three-year operating lease. Two trends appear to be driving this explosion of choice. First is the requirement for greater flexibility - the ability to acquire and pay for spare engines only when needed. Second, says Charles Willis, chairman at Willis Lease Finance, is giving airlines desire for "access to an integrated approach". Engine lessors are positioning themselves as total service providers, offering everything from leased engines to spares and repairs.
However, not all engine types are attractive lease prospects. What lessors are looking for is the profile of a successful and maturing engine development programme (see table right). Typical are the CFM56 types which power 3,500 aircraft within the Airbus A320 and Boeing 737 families. Given the mostly short-term nature of engine leasing, lessors require a deep, generic market in which to place products. Therefore, engines on niche aircraft are unlikely to be widely supported. Nor do all widebody engines make good lease candidates. Operators are fewer and the picture is complicated by the fact that widebodies often offer a choice of more than one engine type.
Life cycle may be a factor, too. If an operator starts to retire a particular aircraft type, the market will soften for the associated engines. A recent example is the retirement of the older Boeing 727, 737 and 747 types, which has had a negative impact on the value of many of the early P&W JT8D and JT9D powerplants.
New structures
Traditionally the market has centred on straightforward operating leases, providing the airline customer with short-term cover for an engine which is off the wing, perhaps in the maintenance shop. The length of lease would depend on how long the engine is likely to be out of commission. Around 90-120 days is fairly typical to cover repair and overhaul, although a lease could run to six months or more where maintenance is scheduled for a series of powerplants. The airline generally pays a monthly lease rental, plus a security deposit and utilisation fees.
Longer-term operating leases, usually running up to seven years, would mean lower monthly rentals and may suit a carrier which has a more regular requirement for a spare - perhaps its engines require three or four shop visits a year - or which operates out of remote areas.
To take the risk out of relying on leasing for such engine cover, some lessors now offer guarantees that an engine will be available when required. Christopher Cantwell, senior vice-president for sales and marketing at GE Engine Leasing, describes such guaranteed availability as an insurance product attached to a short-term operating lease. In addition to the daily rental payments and a per flight hour utilisation fee, the airline pays an access fee. The benefit, explains Cantwell, is in allowing an airline to plan its shop visits for multiple spare engines without the need for locking into a longer operating lease.
A variation on the theme is pool leasing. Shannon Engine Support, for example, operates lease pools for the CFM56-3, -5 and -7 types manufactured by its parent. The pool now has 35 customers, ranging from Air France to Virgin Express, with 350 aircraft. Welaraten explains that airlines pay an annual fee and commit to a multi-year contract - usually three years for the CFM56-3 and five years for the others. That guarantees a CFM engine whenever required. Additionally, the airline pays daily fees and maintenance when it utilises the engine and, depending on the customer's credit standing, may have to provide a security deposit too.
Besides the flexibility of being able to take an engine from the pool whenever needed, Welaraten adds that the airline customer knows that the engine it receives from the pool will be in good condition with all the right documentation. Another benefit, especially for airlines that are moving away from in-house maintenance, is that the lessor co-ordinates shop visits and manages engine removal rates. By contrast, in a classic operating lease, responsibility for managing the overhaul time typically rests with the lessee and maintenance servicer.
Power-by-hour is another flexible product with growing appeal. Here, the airline pays a fixed rate on a flight-hour basis to the lessor who is solely responsible for all maintenance and care of the engine. Like all short-term products, there is a price attached, but, on the plus side, the operator only has to pay when the engine is generating income and there are no surprise costs.
Given the higher risk of ownership associated with power-by-hour programmes, engine manufacturers typically offer these directly to their customer, rather than via third-party engine lessors. Rolls-Royce & Partners Finance says that power-by-hour programmes account for a growing portion of its portfolio, and a number of major flag carriers have signed for the Trent 700/800 engines offered on the Airbus A330 and Boeing 777. The old AlliedSignal business, now under the Honeywell name, offers a similar arrangement for ALF507 engines on the BAE Systems BAe 146s and Avro RJ.
Long-term finance
Long-term finance leases of 12 years or more would further cut the monthly rental rates, but they are not necessarily appropriate for all operators or engines. At the end of the finance lease the airline takes ownership of the asset. Therefore, it must determine not only if this engine type will be a core part of the fleet, but also whether it will be used on a regular basis. As with their equivalents aimed at aircraft, the engine finance lease can be highly structured and incorporate tax lease benefits. Due to the cost, time and complexity of structuring such a transaction, GE Engine Leasing's Cantwell says his company usually only offers this option for a package of engines. With a required minimum value of $50 million, these arrangements are usually best suited to larger carriers.
Rolls-Royce & Partners Finance places no minimum transaction size on the finance leases which it offers. Each deal is based on its own merits, although Spalding adds: "For smaller-sized transactions, the product will tend to appeal more to the middle-tier carrier, which is financially strong enough to utilise the tax benefits of ownership."
What is clear throughout is that this corner of the leasing market is now developing fast and with a package for just about anyone.
Source: Airline Business
