June 2010 – www.avitrader.com

SPARE ENGINE LEASING

Availability, Low Risk, Peace of Mind

MRO Success in High-Tech Singapore

IATA: Future looks bright for airline industry

COVER STORY

AviTrader MRO – June 2010

COVER STORY

In the past, airlines owned their own spare en-gines, and many still do. But over the last two decades, operators have increasingly turned to leasing as the most cost-effective way of ac-cessing spare engines, and as the business has grown, so have the variety and scope of pro-grams available to them.

As recently as 20 years ago, only around 1 per cent of spare engines were leased. By the turn of the cen-tury, that number had grown to 10 per cent and now stands at close to 25 per cent of the total spare engine population.

Current estimates suggest there are between 1,100 and 1,300 leased spare engines in the market, with a total combined value of around $8 billion – although with no central database tracking when engines are installed, removed or decommissioned, it is difficult to know exactly how many spares there are in the market.

With the leased spare engine population forecast to double in the next 15 years to over 40 per cent – some estimates even go as high as 60 per cent – of all spa-res, its overall value, boosted by the addition of new generation engines, could break through the $20 bil-lion barrier.

Why such dramatic growth in the market? According to Jon Sharp, president and CEO of Engine Leasing Finance Corporation (ELFC), the sheer cost of new generation aircraft engines is making leasing more at-tractive. ‘The GE90 engine built for the Boeing 777 costs $32.5 million. 20 years ago when I started in the business, that’s what you’d pay for a new aircraft.’

Cash-rich airlines like Singapore Airlines and Emirates can raise money fairly easily to buy their own engi-nes, but investors are not as comfortable with smaller companies and start-ups. But even the top airlines will struggle to finance engines, particularly with banks ta-king a much more conservative approach to aviation lending in the wake of the global downturn.

The global commercial airline business reported record profits of close to $13 billion in 2007 – and record net losses of more than $15 billion a year later, according to figures from IATA. Two years of record orders follow-ed by a massive downturn in 2008 led to a scenario of too many engines and an awful lot of planes parked in the desert.

The downturn wasn’t all bad news for the leasing companies, however. Moving engines off the books in-creases an airline’s profitability, and a long-term lease is considered an ‘off-balance-sheet’ method of finan-cing an airline’s portfolio of spare engines. As one se-nior executive at a prominent national carrier said: ‘Our aircraft are strategic assets, but our engines are not.’

Nevertheless, spare engine availability is a key factor in every airline’s first and foremost priority – staying in the air. Spare engines need to be available imme-

diately, at every airport the airline serves and at the lowest possible cost. The traditional model of owning spare engines has changed to a growing preference for leasing as new business models have been adopted, calling for a greater focus on investment in core activi-ties and improving cash flow.

Spare engine leasingAvailability – risk = peace of mind

Scheduled engine maintenance, foreign object damage, faults, campaigns and other unscheduled engine removals– all are among the reasons that airlines need to access spare engines to keep their fleets in the air.

Rolls-Royce engine undergoing pre-lease servicing Courtesy of RRPF

‘The GE90 engine built for the Boeing 777 costs $32.5 million. 20 years ago when I started in the business, that’s what you’d pay for a new aircraft.’ Jon Sharp, President and CEO, ELFC

COVER STORY

AviTrader MRO – June 2010

Companies offering engine leasing coming in a variety of shapes and forms, with leasing packages determin-ed largely by the airlines’ financial considerations. Air-lines prefer low-risk spare engine provision, and will pay a premium to secure an availability guarantee or to join an engine pool. Long-term or operational leases and purchase-leaseback programs are the most cost-effective – but only if the lessee achieved 70-per-cent utilization.

Short-term leases are costlier but necessary for unplan-ned shop visits and emergencies, as well as for airlines with small fleets. In the end, most airlines cover their spare engine needs with a combination of long-term and short-term leases to reduce operational and finan-cial risk.

Let’s take a look at the various solutions available to airlines, from leasing pools and independent lessors to financier-backed leasing firms and the OEMs and MROs that have extended their services to offer spare engine coverage as well.

Leasing options

The engine leasing pool

Rising demand for leased engines has spawned an in-creasing array of options for airlines to cover their spa-re engine needs. US-based Willis Lease is the leading independent lessor in the business, having launched over 30 years ago when engine leasing was virtually unheard of. The company pioneered the model of co-

operative engine sharing pools, launching its Chinese program in 2003 and its North American pool three years later.

While the company does not offer a 100-per-cent availability guarantee, Wil-lis noted that because of ‘our close relationships and candid information sharing amongst pool members, the Willis pools have never failed to provide engines when requested’.

The North American pro-gram supports a combined fleet of over 700 B737 Next Generation aircraft, and its charter members include American Airlines, Southwest Airlines and WestJet, which have since been joined by Delta, Air-Tran, Alaska Airlines and EnerJet. The China program provides support to over 300 Boeing 737 Next Gene-ration aircraft, with members such as Air China, China Eastern Airlines, Shanghai Airlines, Shenzhen Airlines and Shandong Airlines. Together, the two pools sup-port over 1,000 aircraft.

‘Our pools allow members to work together to re-evaluate their spare engine acquisition plans and to re-deploy capital, to achieve better utilization of expensive assets and to gain access to a wider pool of spare engines than they otherwise would have by working alone,’ said company founder Willis.

While the company does not offer a 100-per-cent avai-lability guarantee, Willis noted that because of ‘our close relationships and candid information sharing amongst pool members, the Willis pools have never failed to provide engines when requested’.

Members are strongly supportive of the sharing ar-rangement. Bill Caravello, Product Manager - En-gine Leasing at Delta Airlines, said that the Willis pool ‘has been a great benefit to Delta. Willis has continually provided engines when needed. They are extremely knowledgeable and a pleasure to do busi-ness with.’

Willis Lease is not part of another financial institu-tion, unlike other lessors which are backed or even owned by banks, so while the company’s funding costs may be higher, it has greater freedom of opera-tion than its competitors, which often have strict co-venants imposed on them by their financier partners.

Nor is it linked to or owned by an OEM, like many of its rivals – giving it a more diversified asset base. The company’s current portfolio, which represents a market share of around 11 per cent, comprises 180 owned and managed engines from all major OEMs, with an estimated value of at least $1.1 billion.

Guaranteed Availability

While a number of companies offer 100-per-cent avai-lability, the Guaranteed Availability or GAF program of-fered by Shannon Engine Support (SES), a wholly-owned subsidiary of engine manufacturer CFM, is the best known.

Described by SES as ‘an insurance-type product de-vised to protect airlines against the risk of an AOG’, the program requires clients to pay an annual access fee based on the technical details of their fleet in ex-change for a guarantee of availability for one or more engines at pre-agreed terms and conditions. Engines are made available within 24 hours of the customer request.

While the GAF product is unique to SES, Susan Kea-ting, SVP Sales at SES, is quick to point out that ‘SES has developed expertise across a wide range of en-gine leasing solutions over the past 20 years. Today, our expertise is as much in longer-term operating lease solutions; engine sale and exchange programs; asset management services and shorter-term ad hoc lease solutions.’

Willis:Portfolio: 180 owned and managed Market value: $1.1 billionTypes: All major OEMs

‘Because of our close relationships and candid information sharing amongst pool members, the Willis pools have never failed to provide engines when requested.’ Charles Willis, Willis Lease Finance Corporation

Aeroturbine spare prepped for leasing. Courtesy of Aeroturbine

Charles WillisPresident and CEO, Willis Lease

Shannon Engine Support:Portfolio: 260+Type: CFM56Clients: 150+ airlines/lessors/MROsAvailability guarantee: Yes

AviTrader MRO – June 2010

COVER STORY

from OEM-related programs, because they ‘want inde-pendence. The bigger OEMs are divesting from non-core activities and moving increasingly towards their own products.’

GA Telesis is part-owned by Bank of America Merrill Lynch, the world’s largest brokerage, and offers a wide range of jet engines. ‘We cover virtually all commercial engines,’ said Moabery, adding that the company’s portfolio of 50 engines includes the range of CFMI and V25000 engines, as well as Rolls-Royce, GE and

SES is unique in that is supports only one engine type, the CFM56 product line. ‘By focusing on one asset type, our customers benefit from our in-depth product knowledge and real expertise in this area’ says Keating. The company manages a portfolio of over 260 CFM56 engines from pools in 11 cities on 3 continents, inclu-ding 3 pools in China and 5 in Europe.

‘Cradle to Grave’ Services

Yet another model available to airlines is the compre-hensive ‘cradle to grave’ service offered by companies like the US-based Aeroturbine and GA Telesis.

AeroTurbine is a global supply-chain solutions com-pany, with services including engine/component lea-sing, engine/component material sales, engine ma-nagement and engine exchanges. The firm has been owned since 2006 by the Netherlands-based AerCap Group, a global aviation company with total assets of $8 billion and $3.6 billion of lease assets under purchase contract.

The AeroTurbine engine lease portfolio includes en-gines from all the most common engines in service to-day; including CFM56, CF6, CF34, PW2000, PW4000, V2500 and JT8D-200.

AeroTurbine offers a portfolio of over 80 engines for immediate sale, lease or exchange, located across the

world ready for immediate deployment through flexible programs tailored to each individual client.

The company’s AeroTurbine Flexible Engine Care So-lutions service provides the financial and operational advantages of engine overhaul through the company’s engine management group, engine exchange with an immediately available serviceable engine or an imme-diately available engine lease flexible terms and condi-tions – comprising, in the words of company president and CEO Michael King, a ‘powerful cost-saving tool. Speed and flexibility equal success for airlines, MROs and lessors in today’s complex economic conditions.”

“We see ourselves as offering an ‘out-of-the-box’ way of thinking, as opposed to a typical lease company that says: ‘sign here, pay this and we’ll see you when the lea-se is over’. We have a close relationship with our clients and custom tailor each solution to meet their needs.’

AeroTurbine’s purchase-leaseback program provides much needed capital and an exit strategy for airlines. Purchase-leaseback gives them the opportunity to have cash now with no effect on the operational require-ments of the airline.

AeroTurbine has withstood the financial downturn of the last two years well, reporting solid growth through-out, according to King, because of its “close-to-the-

customer business model and its creative solutions to drive cost savings and operational efficiency in the aerospace industry”.

Also a provider of ‘crade-to-grave’ services through its aircraft and engine leasing, parts and component repair divisions, Florida-based GA Telesis is equally bullish about its future in the changing marketplace, with the company reporting strong growth over the past two years.

The company’s presi-dent and CEO, Abdol Moabery, says that ‘airlines need cash, and leasing spares brings liquidity. There is a growing trend for airlines to take en-gines off their balan-ce sheets.’

He believes there is also a trend for air-lines to move away

AeroturbinePortfolio: 80+Type: CFM56, CF6, PW2000, PW4000, V25000, JT8D-200Service: Leasing, sale, exchange, MRO

Aeroturbine’s Miami facility

‘We like to see ourselves as offering an ‘out-of-the-box’ way of thinking – as opposed to a typical lease company that says: ‘sign here, pay this and we’ll see you when the lease is over’

Michael King, President and CEO, Aeroturbine

GA Telesis:Portfolio: 50+Type: all major OEMsService: Leasing, sale, exchange, parts, component repair

Abdol MoaberyPresident and CEO, GA Telesis

GA Telesis’ Fort Lauderdale headquarters

COVER STORY

AviTrader MRO – June 2010

PW, and its range of tailor-made lease services covers the spectrum from short-term to long-term, purchase-leaseback, sales and exchange.

‘Our lease programs are very flexible,’ said Moabery. We’re not limited financially – we have the ability to do transactions of all sizes and we’re capable of pulling them together quickly. We also have the lar-gest engine part-out in the world, allowing us to come up with strategies for airlines looking to phase out and which don’t want expensive end-of-term capital expenditures.’

The firm is headquartered in Fort Lauderdale, yet the vast portion of GA Telesis’ leasing business is interna-tional, with clients ranging from Air France, KLM, TAP, Air Baltic and to Air Transat, among others, as well as US carriers Delta and Continental.

Financier-backed leasing

Another option for aircraft is the long-term leasing option offered by financing companies such as the Shannon-based Engine Lease Finance Corporation (ELFC) and Australia’s Macquarie, both of which are owned by banks and specialise in providing flexible engine support programs.

ELFC is the biggest bank-owned engine financing and leasing company, with 240 engines in its portfolio and a market share of at least 12 per cent. The company is headquartered in Shannon and is owned by BTMU Capi-tal of Boston, a wholly-owned subsidiary of The Bank of Tokyo Mitsubishi UFJ – one of the world‘s largest financial institutions.

Because of its financier backing, ELF has access to exten-sive funding at favourable rates, allowing it to provide individually tailored low-cost flexible financing for its cli-ents, which have included over 120 airlines over the years, including major carriers like Virgin and low-cost carriers such as EasyJet and Spice Jet.

President and CEO Jon Sharp explains that the business is based on long-term operating leases of up to seven years, with a certain degree of flexibility. ‘We believe we’ve pro-spered as a company because we’ve got the model right. Flexible long-term leases are the most efficient model for airlines, because they don’t know when they’re not going to need a certain type of engine. We can hold an asset for 15 years and manage the cycle, whereas airlines cannot afford to. We take the risk away from them. Good compa-nies can do this and still make money.’

‘The best model for airlines,’ continues Sharp, ‘and the one they prefer, is to aim for 85 to 90 per cent of their spare engine requirements to be achieved through long-term leases, with the remaining 10 per cent or so managed

through pooling arrangements or long-term leasing.’

ELFC is first and foremost a long-term operating lessor. With 240 engines in its portfolio and average lease terms of five years, around 42 engines per year are returned. ‘That’s a lot to re-lease, about one a week’, said Sharp. ‘We would like a rapid turnover, but the real world doesn’t work like that, so we’ve finessed our program by offering short-term leases. We currently have 10 to 12 engines out on short-term leases. ‘

The company’s third line of activity is portfolio manage-ment. Through its five joint-venture partners, Mitsubishi UFJ Lease & Finance, Sumitomo Corporation, DVB/Deuca-lion Funds, Volvo Aero and GSI Fonds, it has created vari-ous ownership sharing structures on packages of leased engines, with ELF remaining as managers and maintaining the direct customer relationship.

The green-time lessor

Another financier-backed company in the market is TES Aviation Services, a ‘engine risk management’ firm headquartered in Brigend, Wales, and owned by Frank-furt-based DVB Bank.

TES has carved out a niche in the market as a ‘green-time lessor’. According to the company’s lease mana-ger, Julian Rees, TES acqui-res engines with the intent of ‘tearing them down into a supply of serviceable used material for our fleet ma-nagement customers’.

‘When we acquire engines that still have useful life re-

maining, we lease them out. The majority of our leases are short to medium-term, usually to cover shop visits’.

‘We have a number of customers with whom we are able to supply ‘platform solutions’ as we offer materials supply and asset management services in addition to engine leasing. Customers like Air Astana in Kazhakstan and Sriwijaya in Indonesia, for whom our technical services team provide fleet management service, have en gines out on lease, and we also keep their shop visit costs down by being able to supply LLPs and other serviceable material for their shop visits.’

The economic downturn has meant greater competition in the short-to-medium term leasing sector from the MROs themselves, which have been offering low-cost lease en-gines to incentivize shop visit work coming their way, as well as OEMs and companies like Aeroturbine. Unical, AAR and Kellstrom compete on the materials supply side, while firms like Royal Aero and SGI are rivals for technical service provision.

But Rees maintains that TES has very few competitors able to offer all three services as a package. Furthermore, the de-velopment of the company’s engine fleet management soft-ware package, EFPAC, has given it the edge and is currently being used by a range of airlines and lessors worldwide.

The global downturn has proved a boon to TES, with air-lines turning to leasing over ownership and asset values dropping – meaning the company has been able to further its acquisition strategy as well as move into a new state-of-the-art 130,000 square foot facility in Wales last year.

Here come the OEMs

OEMs have moved strongly into both the leasing and MRO sectors and their market share in both sectors has tripled in the past 10 years, according to a seni-or industry executive, in no small part because of the price concessions that airlines will receive on their or-ders from the manufacturer.

The two biggest OEMs, GE and Rolls-Royce, both have engine leasing outlets that have prospered in recent years, thanks to the leverage they have through their connection to the larger parent company and the con-sequent range of services they can offer.

GECAS Engine Financing is a financing unit of General Electric Capital Aviation Services (GECAS), a wholly-ow-

ELFC:Portfolio: 240Type: All major OEMsServices: Long & short term leases, portfolio managementClients: 120+ airlines

Julian ReesLease Manager, TES Aviation Group

TES Aviation Services’ new facility in south Wales

GE Engine Leasing:Portfolio: 400+ enginesType: All major OEMsService: Short/long term, sale-leaseback, exchangeGuaranteed availability: through SES

AviTrader MRO – June 2010

COVER STORYned GE subsidiary, and it is cur-rently one of the larger players in the leasing sector, with more than 400 owned, serviced and managed engines in its portfo-lio. Although it’s part of the GE family, the company leases and finances not only GECAS pro-ducts but CMFI, Rolls-Royce, Pratt & Whitney and IAE engi-nes as well.

The company offers eve-rything from one-day short-term leases to operating leases, sale/leaseback, engine exchanges, guaranteed availability (for CMFI engines through SES, a GE joint venture company), structured, long-term financing options and asset management.

For airlines looking for more than just an engine to lease, the appeal of GECAS Engine Leasing is its broad range of products and services, coupled with a huge global reach, the depth of experience and the reputation offered by parent company GE Capital.

‘We have great customer relationships, engines from a variety of OEMs and specialised teams all over the world,’ says Julie Dickerson, senior vice president and general manager at GECAS Engine Leasing. ‘We’re able to leverage being part of the GE family; we work closely with GE Aviation to offer customers the whole package.’

Rolls-Royce’s leasing subsidiary, Rolls-Royce & Partners Finance (RRPF) is a joint venture between Rolls-Royce and US-based financier GATX, and has 340 engines in its portfolio, with a market value in excess of $2.5 billion, serving 45 customers in 22 countries. The company is the world’s largest spare engine lessor of Rolls-Royce and IAE engine.

The company only invests in Rolls-Royce and IAE engines, because, according to RRPF vice president Bobby Jana-gan, ‘our superior technical knowledge of Rolls-Royce designed engines, and our extensive knowledge of cus-tomers who operator RR and IAE equipment and utilize RR’s used parts trading division to exit from engines at the end of their investment period, allow us to source

funding with relative ease and more cheaply than our com-petition’.

RRPF also provides a ‘cradle to grave’ service, offering a wide range of leasing services, from flexible operating leases, purchase-leaseback and en-gine sales, coupled with over 20 years of accumulated tech-nical, financial and leasing expertise. Furthermore, the company provides a short-

term leasing program on V2500s to cover urgent spare engine needs, in case of, for example, bird strikes or other unforeseen emergencies.

Because of its large stock of V2500 engines, the company does offer availability guarantees and has rarely encounter-ed problems in serving its clients. ‘In 2007, the market was very tight,’ said Janagan, ‘and we didn’t have any spare engines – they were all leased. Now, after the down-turn, fleet utilization is down and there’s excess capacity.’

Janagan adds that RRPF has done well throughout the finan-cial downturn of the past two years, due to continued growth in the leasing market, as tighter lending policies mean more airlines are opting to lease spares rather than buy.

‘The market value of spare engines has grown from around $10 billion a few years ago to $20 billion now, and it will be worth $30 billion over the next 10 years. Prices are going up in line with inflation and the cake is getting bigger, with emerging markets like China and India. New growth in the leasing market will boost the market value of the leased engine population to as high as $20 billion.’

RRPF is well-poised to take advantage of that growth on the basis of its long-standing brand recognition and its track record as a lessor. And unlike rivals Willis and ELFC, which specialise in the narrow-body leasing sector, RRPF also offers a range of Trent twin aisle engines and plans to further boost its portfolio of wide-body spares to cater to growing demand, particularly in emerging markets.

The MROs offer a ‘one-stop shop’

Engine leasing is also offered by MRO providers such as market leaders MTU Maintenance, Lufthansa Technik and Delta Tech Ops as an additional support service for their customers.

Unlike the traditional lessors and financier-backed com-panies, primarily interested in long-term leasing, the MROs specialise in short-term leases to cover shop visits, for both scheduled and unscheduled maintenance.

Dr. Margot Gräfe, director of engine leasing CF34 at MTU Maintenance, the largest independent provider of com-mercial engine MRO services in the world, says that ‘we are an MRO first and foremost – that is our core business.’

‘But we also offer short-term leases as an additional support. The core business of an airline is to fly, not to source OEMs, MROs and spare engines. By leasing engines, we can provide a one-stop shop for our custo-

mers.’ MTU provides spares from its own portfolio of about 40 spare engines, most of which are leased from major engine leasing companies.

The company is able to leverage its relationship with pa-rent company MTU Aero Engines, a joint-venture partner in IAE, which manufacturers the V25000 engines.

LOOKING AHEAD – 2010 AND BEYOND

All the players in the spare engine leasing sector are loo-king to 2010 for a return to equilibrium, after the bumper years of 2006 and 2007 and the ensuing downturn that hit the airline industry hard. In fact, the industry’s meltdown may not have been as bad as previously thought, now the dust is settling, with stronger-than-expected results pos-ted in the early months of 2010. Earlier this month, IATA announced a complete about-face to its previous prediction of $2.8 billion losses for 2010, forecasting profits of up to $2.5 billion on the back of a strong recovery in Asia and the Americas, rising fares and increased business-class book-ings. Although activity in the sector is clearly picking up, IATA director general and CEO Giovanni Bisignani warned that oil is a ‘wild card’ and over-capacity is still a danger.

For the spare engine lessors, the recovery is good news indeed. ELFC’s Sharp says he can see that ‘oversupply is beginning to peter out and the demand for leaseback finance is going down. Short-term demand is picking up too’, while Rolls-Royce’s Janagan commented that the changes were far less severe than expected: ‘we were ex-pecting many more airlines bankruptcies but we haven’t seen it happen – partly because of lower fuel costs and very low interest rates.’

One of the hurdles the lessors are facing is the issue of pricing. Although oversupply is diminishing, it’s still a lessee’s market to some extent, particularly in the short-term sector; Aeroturbine’s Bridges points out that one of the most notable changes in the past two years has been ‘the premiums for short-term leases, which have all but been washed away in the recession. There’s not much difference now between long- and short-term leasing’.

Other concerns include the issue of green legislation on emissions, which could accelerate the obsolescence of current models in the spare engine portfolio, and whether the OEMs will develop new engines – a challenge for the lessors, given that as a new engine is launched, there will be none floating around the leasing market.

Europe’s economic recovery remains tenuous, and could be devastated by higher fuel prices. If oil rises above $100 per barrel, the continent will be hit hard by its higher taxes on fuel and increased pressure on consumers, who, facing higher prices on air travel and on the home front, will stay firmly at home. But double-digit growth in emer-ging markets, particularly China, India and Latin America, is the best news in a long time for the industry as a whole – and while it’s not quite full steam ahead for the les-sors, it’s certainly a case of ‘proceed with caution’ – and a good dose of optimism.

Julie DickersonSenior VP and General Manager,GE Engine Leasing

GECAS Engine Leasing technical team inspecting a GE90 spare

Rolls-Royce:Portfolio: 340 enginesMarket value: $2.5 billion+Type: RR, IAEService: Short/long-term, purchase-leaseback, sales

Bobby JanaganVice President, RRPF