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ENGINE YEARBOOK 2003
Engine leasing and
maintenance
In drawing up an engine
lease contract, it is important
to consider maintenance
requirements, and to clearly
identify the relative
responsibilities of the lessor
and lessee. The EYB talks to
leading players in the market
about their various
approaches to this
sometimes thorny issue, and
hears the views of an
independent industry
observer.
"We have 15 employees who
do nothing but monitor our
assets around the world, to
determine whether those
assets are on-wing or are in a
repair shop."
— Charles Willis,CEO,Willis
Lease Finance Corporation
8 Engine Yearbook 2003
Rolls-Royce’s Trent 700 engine powered nearly 60 per cent of the A330s delivered in 2000 and 2001.
T ypically, a lease contract will not
specify the precise intervals at
which the engine must be
overhauled. “Rather, it will state that
the lessee must operate the engine in
accordance with its approved
maintenance programme,” says Phil
Seymour, managing director of the
International Bureau of Aviation. “The
complication is that each operator will
have a different view on how long the
engine can stay on-wing. Obviously, an
operator flying three-hour sector
lengths will have a different inspection
or overhaul profile to one that’s flying
45-minute sectors. So, the lessor has to
take a position based on the expected
utilisation of the engine. That position
will dictate the level of the maintenance
reserve, and whether or not the engine
is expected to come off-wing during the
lease term.”
The allocation of responsibility with
respect to maintenance will depend on
the nature of the lease. “If it’s a long-
term lease — of three to five years
duration, say — engine overhaul will
be managed by the lessee, as the
operator of the engine,” explains
Seymour. “Under those contracts, it’s
not usual for the lessor to take an active
interest. The lessor will of course be
kept aware of the workscope of the
engine, but the operator, in accordance
with non-discrimination clauses, is
merely expected to manage the engine
as it manages the rest of its fleet.”
Hence, the lessor will not request that
the engine is maintained after a certain
number of cycles, but will be anxious
to learn the operator’s general
maintenance policies, as part of the
general assessment it conducts before
the engine goes on lease.
Redelivery conditions
That assessment will also form the basis
of the set of delivery and return
conditions to be included in the lease.
“If the engine has just come out of the
shop after a full refurbishment — i.e.,
if that is the delivery condition — it’s
likely that that will also be the return
condition,” says Seymour. “In every
situation, there will normally be an
equality between the delivery and
return conditions.”
However, certain complications arise in
situations where the delivered engine
has already run up thousands of hours
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ENGINE YEARBOOK 2003
and is approaching its next shop visit.
“Theoretically, such an engine would
be returned in the same condition, but
obviously that’s a difficult thing to
achieve in practice. So, to bridge the
gap between delivery and return
conditions, there’s usually some form of
maintenance reserve, or compensation
for use. Suppose, for example, that an
engine is delivered fresh from an
overhaul visit, and that at the end of
the lease, it has run for only 9,000
hours. If that engine was capable of
running for 15,000 hours between
overhauls, it would be pretty
impractical to take it off and put it back
through the shop, purely to meet the
return conditions. So, what can happen
in those situations is that the
maintenance reserve is used to
compensate the lessor either by a
certain amount per hour, in the case of
refurbishment, or by a certain amount
per cycle, in the case of life-limited
parts.”
To avoid further complications, it is
necessary to incorporate a tight
definition of what constitutes the
engine in the lease contract. “That
definition could be anything from a
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bare engine, which is basically what the
engine manufacturer produces — just
the core and casings, without any other
accessories — right through to a quick
engine change (QEC), which is the
engine with all of the pneumatic,
hydraulic and electrical systems fitted,
plus all of the components, all of the
plumbing equipment, etc. It may even
include a nose cowl and thrust
reverser,” says Seymour. As a rule of
thumb, he adds, it’s usually the case
that “the longer the term [of the lease],
the barer the engine. If an airline was
leasing an engine for five years, it won’t
want to pay for all those pneumatic,
hydraulic and electrical systems to be
fitted on an engine that might be sitting
in the hangar, waiting to be used. But if
it needs an engine urgently, it will want
a QEC.”
In Seymour’s experience, “it is typically
the lessee’s responsibility to make sure
that the engine is in compliance with all
airworthiness directives [mandatory
service bulletins]. The negotiated point
is whether the lessor will make a
contribution towards the cost. That
might happen where the AD adds value
to the engine, a value which can be
amortised over a longer period than just
the lease term. There may be a formula
in the lease that provides a contribution
to the cost, divided by the length of the
term remaining, above a certain
threshold amount. That amount might
be $50,000, in which case any ADs
necessitating an investment of less than
$50,000 would be the responsibility of
the lessee.” Non-mandatory service
bulletins, on the other hand, are usually
incorporated by the lessee during the
shop visit, as part of the engine
management programme. It is of critical
importance that the lessor has access to
that engine management programme.”
So how is the maintenance reserve
calculated? “It will usually be a
function of the typical cost of
refurbishment, divided by the typical
number of hours between
refurbishments. Now, there can of
course be arguments over what is
‘typical’, since operating profiles vary
widely between lessees. Ideally, lessors
would like to be paid a monthly amount
based on engine utilisation the previous
month, but obviously, the larger
Engine Yearbook 2003
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ENGINE YEARBOOK 2003

carriers won’t want to pay a monthly

amount, preferring to sort it out at the
end of the lease. Hence, there is a
compensation for use mechanism at the
end of the lease, instead of ongoing
monthly maintenance reserves.”
There can be other points of negotiation
as well, one of which is the inflation
rate to be assumed in the lease. “In
some cases, the reserve will increase by
a fixed rate per annum — three per
cent, say — while in others, the
increase will be linked to the US
consumer price index, which may or
may not be relevant to trends in the
cost of overhauls. Some leases will
simply say that there will be
discussions between the lessor and
lessee at the end of the term to mutually
agree the appropriate compensation.
Those clauses, being very woolly, can
give rise to disputes.”
Any lease will, of course, define the
situations that constitute default.
“There are some obvious ones,” notes
Seymour, “such as if the lessor does not
pay, or is not insured, or misuses the International Aero Engines’ V2500 engine is flown by 80 customers worldwide.
engine in some way. There could be
‘cross default’ clauses, whereby default cycle. So, if the aircraft’s doing four-
on an aircraft lease can lead to hour sectors, you’re charging $50 per
repossession of an engine. There are flight hour. If it then moves to one-hour
legal formulae to cover that.” sectors, that needs to be adjusted to
$200 per cycle. That’s why you must
Engine monitoring always be aware of changes in the
To accomplish monitoring of the engine engine’s utilisation.”
in service, the lessor needs to receive Based in San Francisco, US,
periodic utilisation reports for the independent engine leasing specialist
lessee. “The lessor should always know Willis Lease Finance Corporation
what’s happening to the engine month (WLFC) is highly vigilant when it comes
by month,” says Seymour. “After all, it to technical monitoring of its assets.
could be fitted to one aircraft that’s “We have 15 employees who do nothing
operating four-hour sector lengths, then but monitor our assets around the
switched to another that’s operating world, to determine whether those
one-hour sectors. It’s important to be assets are on wing or are in a repair
aware of such changes, because the shop,” explains CEO Charles Willis.
maintenance reserve will have been “Your customer has got to have faith in
calculated from the expected utilisation your product. As far as I know, there’s
and hour-to-cycle ratio. no one that has as large an in-house
“Engine lives are determined by the operation as we do for technical
number of cycles between leases. Every monitoring of the asset. Many of our
time an engine goes to take-off power, competitors sub-contract that work to
it’s at its most stressed condition. Cost external providers. Having 15
of overhaul therefore varies bankrolled employees dedicated that
dramatically by sector length, rather function involves a significant
than flight hours. If an overhaul costs investment, and presents a major
$1 million, to pick an easy number, and barrier to entry to potential new
you assume 5,000 cycles between competitors.” An additional barrier to
overhaul, your reserve rate is $200 per entry is the extraordinarily high value

Engine Yearbook 2003 11

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ENGINE YEARBOOK 2003
The Trent 800 engine has a market share of over 40 per cent on the B777.
of the assets which the lessor must hold
on its balance sheet. This, notes Willis,
can run to billions of dollars.
Lessees are required to report back to
WLFC on a monthly basis. “They
basically tell us what they’re doing and
how they’re doing it, and keep us
posted on any ADs or SBs they’ve
complied with,” says Willis. “If they’ve
got any maintenance events coming up,
they’ve got to submit the workscope to
us for ‘approval’, for want of a better
word. In some cases, we can help to
improve the engine by investing in
additional maintenance work — work
which the lessee may not be required to
do, but which will ensure that we
always have a top-of-the-line engine
available.”
Long and short term leases
Willis notes that, in the months
following September 11, longer-term
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leases increased in popularity, where
previously there had been a strong
trend towards short-term arrangements.
“I think a lot of carriers see a benefit in
the pricing (of longer term leases).
Interest rates are low, and generally
speaking, rates are favourable right
now. A lessor will tend, if it has a spare
engine available, to put it out at a
slightly lower rate if the lease runs to
five or seven years. So, the mid- to
longer-term leases, which had been
declining, are starting to firm up.” In
overall volume terms, Willis observes
that the engine leasing market has not
been as badly affected by the downturn
as the aircraft leasing business. As for
the engine types currently on lease in
the market, he notes that the number of
Stage 2 engines on lease has declined
“for obvious reasons”, while CFM56
engines continue to grow in popularity,
with the lease markets for such engines
as the CF6-80 and PW4000 remaining
generally stable.
Rolls-Royce & Partners Finance (RR&PF)
— which, as a joint venture between
Rolls-Royce and GATX, specialises in
leasing Rolls-Royce engines — offers in
addition to its engine pooling product
“two basic engine lease contracts”, says
general manager Mark Arundell.
“Firstly, there’s the longer-term
operating lease, where the lessee
assumes 100 per cent of the
maintenance risk on the engine. Then
there is the emergency lease, where an
engine is required to support a shop
visit. An emergency lease can run to 40,
60 or 90 days. Under those short-term
contracts, we as the lessor take the
maintenance risk associated with the
engine.
“Basically, we provide those emergency
lease engines at premium rates and with
a premium maintenance reserve, to
account for the additional maintenance
risk we are taking and the much shorter
lease term. The lessee can then hand the
engine back when they have finished
with it. If the engine goes
unserviceable, and it’s not due to any
fault on the lessee’s part, then the lessee
can simply hand it back.
“The longer-term lease is obviously
more complicated. But if we hand over
an engine that’s halfway through its
maintenance cycle, we’ll probably give
Engine Yearbook 2003
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the lessee a credit to account for time
burnt off the engine. The lessee can
then apply that credit to contribute to
the cost of maintenance carried out on
the engine whilst it is in the shop,
against the engine management
programme that we’ve approved.
Obviously, we don’t dictate where the
lessee sends the engine for
maintenance, provided that it is a JAA
or FAA approved station. We try and
make our leases as attractive as possible
to a wide lessee base.” To accomplish
monitoring of leased engines in service,
Rolls-Royce typically appoints a
representative to liaise with the airline.
According to Mark Garrett, vice
president of marketing for Trent and
V2500 engines, RR&PF imposes
stringent redelivery conditions on
lessees. “While the lease needs to be
flexible enough to attract operators, we
obviously have to ensure that we get
the engine back in a marketable
condition. With respect to the
definition of the engine that you’re
leasing, we’re lucky in that we’re co-
owned by Rolls-Royce, and therefore
have access to what are called the
‘engine contract specifications’ for the
various engine types. Those specify
every nut and bolt on the engine. It’s
good to have that precise definition of
what it is that you leased to the airline;
not only does it keep inventory
discrepancies to a minimum at
redelivery, but it is critical, if an
operator goes bust, to be able to
demonstrate to a judge, administrator or
maybe even an aircraft lessor or
financier, precisely what you own —
otherwise, your engine might be
returned as a bag of bolts. Engine
stands, IDGs, and all the other engine
components are obviously very
expensive. You need them back, and
you don’t want to sour a relationship by
having the lessee think it’s being
accused of stealing equipment when the
post-lease inventory checks are carried
out.”
John Abbott of GE Engine Leasing
agrees that thorough contracts are
critical. “The key issue is thoroughness
and precision of the definitions within
the lease contract. When we provide
the engine in the first place, they
should not be surprised — or at least,
Engine Yearbook 2003
ENGINE YEARBOOK 2003
only surprised positively — with what
they get. Similarly, we don’t want any
surprises when we get the engine back
at the end of the lease.”
Market developments
Commenting on trends in the leasing
market over the past two years, Abbot
makes a distinction between trends in
the demand for spare engines, and
trends in engine financing. “The
demand for spare engines is, of course,
driven by the amount of overhaul
maintenance activity, which clearly
declined late in 2001 and early in 2002.
People parked aircraft, reduced the The CFM56-5A is one of the options open to
overall size of their fleets, and deferred operators of A320 family aircraft.
certain maintenance events. So there
was a noticeable decline in demand for
spare engines. However, in our short-
term rentals business, we’ve seen, since
May 2002, a resurgence in demand for
rental engines to support overhaul
activity. That’s consistent with our
expectations. We were hoping to see
demand improve with the hotter
summer season, and it has.
“On the financing side, the picture’s a
little different. Financial distress in the "Long-term investors are still
airline industry has increased the thinking that this is a good
airlines’ desire to monetise their assets, market to be in."
and airlines have in many cases looked
to engines as a source of liquidity. This — Mark Arundell,general
has brought increased demand for sale manager,Rolls Royce
and leaseback engines, and we’ve Partners & Finance
participated strongly in that market.
There’s been, I would say, less new
activity in that area than we expected
early in 2002. Discussions are starting
to take place, but there’s not much
urgency about closing deals.” A
possible reason for this is that
companies are wary of selling into a
market where prices are depressed, and
are seeking to wait out what may be a
trough in engine values.
Still, conditions in the market are
definitely improving. Says Willis:
“Business is coming back to its pre-
September 11 level, albeit incrementally
rather than exponentially. Long-term,
it’s definitely possible for us to grow at
20 to 30 per cent annum, through
strategic alliances.”
This accords with Arundell’s
assessment: “Long-term investors are
still thinking that this is a good market
to be in.” ■
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