Leasing Complexity

Maintenance gets more complicated when multiple airlines operate an aircraft over its service life. Given that almost 40% of the global airline fleet is leased rather than owned, the way leasing companies, airlines and to a lesser extent maintenance, repair and overhaul (MRO) providers structure contracts to ensure proper asset maintenance has become an increasingly complex and important part of the industry’s landscape.

The major points of inflection arise when the aircraft comes off lease from its first operator and transfers—when the aircraft is picked up by a second or subsequent airline. At these points, the negotiations and the number of contracts multiply to accomplish three basic things: completing all maintenance to ensure regulatory compliance; updating the aircraft to the leasing company’s specifications; and ensuring the aircraft meets the new operator’s specifications and regulatory compliance needs.

The primary relationship between lessors and airlines regarding maintenance seems, on the face of it, easy. “It’s simple—the lessee is responsible for all maintenance during the term of the lease and is responsible for all maintenance at return,” says Tony Diaz, CIT Aerospace’s executive VP, commercial airlines. “The maintenance terms don’t change over the lifecycle of the aircraft.” But behind that apparent simplicity lie a number of complicating factors.

Complicating Factors

In broad strokes, the airline is responsible for maintaining the aircraft to comply with the regulatory agency that has jurisdiction for the airline—the Federal Aviation Administration (FAA) or the European Aviation Safety Agency (EASA), for example. This includes implementing all airworthiness directives and other safety requirements. “If the airworthiness directive requires action, we require the operator to incorporate it at their own cost,” says Richard Poutier, senior VP for technical services at the International Lease Finance Corp. (ILFC).

Service bulletins typically are implemented at the operator’s discretion, however. If an airline decides to implement a service bulletin, the lessor only mandates that the same work done on the airline’s own aircraft be done on the leased aircraft in its fleet.

“Contracts demand that [the airline] can’t discriminate against our aircraft,” says Poutier.

Any routine maintenance required during the term of the lease is handled by the airline, including normal airframe and interior wear-and-tear. Lessors usually demand the aircraft is returned in as close to the same condition it was in at the beginning of the lease, says Diaz.

Complications multiply when the airline chooses to modify a leased aircraft. The major lessors approach this issue differently. Although most lessors do not require the right of approval for many modifications, including most interior changes, some modifications require the lessor to grant permission.

Some lessors put a dollar figure on modifications that require approval. If the cost of the modification is over $350,000 for a narrowbody aircraft or $500,000 for a widebody, ILFC usually requires approval. This threshold gives airlines the flexibility to do cabin reconfigurations under a certain amount. If the cost exceeds that threshold, ILFC needs to review the change. “We need to think about the future marketability of the asset,” says Poutier. Similarly, AerCap’s threshold for modifications begins at $100,000-$350,000, depending on the aircraft type, says spokeswoman Frauke Oberdieck.

CIT does not have a dollar amount that requires approval. “Our main concern is if the airline is making permanent changes to the aircraft,” says Diaz.

GE Capital Aviation Services (Gecas) requires approval for any permanent structural change regardless of the value of the modification, says Anton Tams, senior VP of technical services.

Modifications that add value to the aircraft are usually an easy sell to the lessor, executives say. Inflight entertainment systems, for example, and other modifications based on customer demand tend to be approved.

Support Strategies

Ongoing maintenance is fairly straightforward, but the issue of heavy maintenance is where the lease negotiations typically get more interesting. The typical lease term for a new narrowbody is between 5-7 years, or until the first D check. “We wouldn’t do a lease for anything less than the first structural check,” says ILFC’s Poutier. Subsequent leases can be for 3-7 years, depending on the aircraft and market demand.

This means that heavy maintenance visits may not occur during an airline’s lease term, so lessors collect maintenance reserves from airlines. Total maintenance costs for an aircraft are amortized over its 25-year lifecycle. The first lessee of an aircraft enjoys the “honeymoon period,” during which no structural or heavy maintenance is required. But the airline is responsible for paying its share of the reserves. “For every hour of utility, the airline pays into a reserve fund,” says Tams. Typically, lessors only reserve for heavy airframe maintenance, landing gear and engine maintenance.

In other words, if the D check occurs two years into the second lessee’s term, that airline will have paid reserves toward the two years it used the aircraft. If the first airline’s lease term was five years, it paid five years’ worth of amortized maintenance reserves toward the structural check. “We have to protect against future maintenance costs,” says Poutier. “We can’t afford to grant all of the honeymoon period to the first lessee.”

Maintenance reserve costs vary based on the type of aircraft and where it is in its lifecycle. During contract talks, the lessor and airline negotiate the cost of the reserves for the term of the lease. “If an airline leases an aircraft at midlife, rectification costs are higher, while a new airplane is often under warranty and therefore can cost less in reserves,” says Robert Ditchey, an aviation industry consultant. Reserves also can vary depending on where the aircraft is on its maintenance cycle.

Another variable in the cost of maintenance reserves is the financial condition of the leasing airline, says Ditchey. “Reserves get higher depending on the financial wherewithal of the airline and whether the lessor thinks it is a good risk for maintenance costs,” he says.

O&M contacted several airlines—U.S.-based, international, network carriers, low-cost carriers and regionals—for this story, but all declined to comment, citing the financial sensitivity and confidentiality of lease negotiations.

During lease negotiations, the payment of reserves can be complicated if an airline has contracted with the engine OEM for maintenance, in so-called “power by the hour” agreements. Lessors say the contracts for each power-by-the-hour engine can be a one-off. These agreements can be handled in two ways, says AerCap’s Oberdieck. In the first, the lessee may pay the lessor a lump sum at the end of the lease term for use of the engine. In the second, the lessor assumes the power-by-the-hour agreement and continues it even after the aircraft comes off lease, says Oberdieck.

From the lessors’ standpoint, the advantage of such agreements is certainty. The lessor always knows the engine is being maintained by the OEM to its standards. “It allows us not to worry about the asset,” says ILFC’s Poutier.

The disadvantage for the lessors is the payment of reserves. Poutier infers that power-by-the-hour agreements essentially cut off a maintenance-related cash stream for lessors. The intent of a maintenance reserve is that it ensures that the lessor always has the cash to fund maintenance, and with power-by-the-hour agreements, the fund is diminished, says Poutier. “We think airlines have an advantage using the tried-and-true reserve system,” says CIT’s Diaz.

MROs’ Role

MROs typically do not get involved in power-by-the-hour agreements. Additionally, the payment and collection of reserves is immaterial, as MROs are not involved in the lease negotiations, although the lessor must approve an MRO for maintaining its aircraft.

“The MRO is not an equal party in the leasing discussion,” says Ditchey. “But the leasing company is obligated to know whether the MRO is up to snuff, because if the maintenance is not done correctly, the lessor can be legally liable.”

MROs contract directly with the operator of the airline for all maintenance, and therefore whether the funds come from the lessor’s reserve or from the airline directly does not matter, says John Eichten, Timco Aviation Services’ senior VP of sales.

Where the MRO does get involved is at the return and transfer of the aircraft. When an aircraft comes off lease, the first lessee may contract with an MRO for modifications required by the lessor to bring it back to its original condition. The lessor then may separately contract with the MRO to carry out modifications for regulatory compliance, which are particularly important when the aircraft is moving from one jurisdiction to another. And the next lessee may then contract with the MRO to bring the aircraft up to its own fleet’s standards, says Jack Arehart, AAR Corp.’s VP for sales and marketing.

For these transactions to occur smoothly, MRO executives stress the importance of clearly defined work scopes and contracts. “Contract administration becomes very important,” says Arehart. “We only serve one master at a time.”

This is true even when work is being done on an aircraft and it makes sense for the other parties—the lessor and the next lessee, for example—to piggyback on the work being done, but MROs must ensure that the contracts are clear on who is paying for which portion of the work.

“The key is to have clear lines drawn in the sand between every party involved,” says Philip Fields, Aviation Technical Services’ VP of business development. “If an area of an aircraft is open and it makes sense to do maintenance there at the same time, we do a new work scope, finish it and move onto the next event.”

A further complication is that lessors usually do not have a large inventory of spares, so the MRO may contract with the airlines during transfer for parts. “We tell the leasing company that the aircraft needs certain products, which airlines usually will have a spare for,” says Arehart.

Ultimately, MROs try to keep these situations to a minimum for clarity. “The guy who’s paying the bills is the guy we listen to,” Arehart says.