The Engine Lease Market Today: More Dynamic Then Ever
The engine leasing market today is more dynamic today than at any other time in its relatively short history of twenty five years. Changes over the past five years brought on by the sector realizing full maturity have been greater than any other time and perhaps the whole of the sectors first twenty years of history. The Lessor base continues to grow in the basic product markets of sale and leaseback, short term leasing and greentime fleet exit management. There are massive order books for both next generation narrow body engine families, the CFM LEAP and the Pratt & Whitney GTF as the 737 and A320 fleets renew and grow. The new sale and leaseback, large engine leasing market continues to be dominated by GE Engine Leasing and Rolls Royce Partners Finance but deals can be done by independent lessors, particularly on the GEnx and GE90 engines. Developments in short term leasing of the most modern narrowbody engine types point to this segment as the most dynamic part of the market all together today.
Engine leasing has a proven track record so many investors now pursue it as returns on various big ticket asset classes are experiencing historic low cyclic value. The traditional sale and leaseback market continues to see significant volumes booked by the bigger, more traditional participants but the lessor base active in smaller transactions continues to expand. There are several reasons why the market has developed this way. First, although there are several new entrants to the market in the last two to three years the portfolios of each are still relatively small and cannot withstand significant lessee or asset type exposure. The new entrants bid very aggressively on the best asset and operator combinations but are still beholden to prove liquidity to their owners and therefore avoid concentrations the larger transactions require. Third, many are partially specialised in their asset focus, particularly the Japanese investor joint ventures that are tied to one of the MROs. Fourth, and perhaps most surprising, is funding, although seemingly plentiful these days is more expensive for the smaller lessors and therefore their growth has tended to be somewhat cautiously pursued.
In the large engine sector the sale and leaseback market continues to be dominated by the OEMs. The market is practically exclusive to GE and Rolls Royce engine offerings and their respective leasing entities, GE Engine Leasing and Rolls Royce Partners Finance, own or lease a large majority of the spares. With engine and QEC list prices costs from $18m to $35m for the Trent, GEnx and GE90 variants this is only sensible. However, airlines want options and so they will award SLB mandates for the larger engines to the stronger independents to retain some flexibility and a diversified supplier base. The recent entry of MTU to the long term leasing market may be the most interesting development in this segment. They have a very successful engine MRO business with known and reliable capability covering the CFM56-7 and V2500 markets. This capability now includes the GE90.
The topic of OEM support has been prevalent in the industry press for several years now. Flight Hour Agreements (FHAs) in their many forms and acronyms dominate the engine market and continue to be incorporated in a bigger share of fleet management and new engine order management contracts each year.
After so much focus on the topic the past five years the lessor community has learned to manage the issue and the relevant risks much better. The single biggest practical issue has always been, and will continue to be transfer of security value related to cash or documented value for maintenance life used on an engine from the lessor to the OEM. As FHAs are heavily customized the additional exposure can be for full maintenance and part/component value or, as is quite typical, for maintenance life only. In many cases the lessor can collect or accrue for value of LLP replacement thus reducing lessor exposure by the relevant amount. The most significant change in the market has developed over the past five to seven years accelerating quite rapidly over the past two to three. History indicates engine leasing to be both a profitable and relatively low risk activity. The typical leasing life of an engine started with a primary sale and leaseback term of seven to eight years. It was then customary to extend the lease with the existing customer or write a new secondary lease of three to five years. After the secondary lease lessors typically wrote a series of shorter leases that would match engine utilization to a third shop visit when the lessor could then make a decision to invest further in a third visit or sell the engine into the parts market.
Today the cycle of leases has changed significantly. Although lessee extensions are still quite common new, secondary leases with length of term of three to five years has reduced year on year for the past five years. The reasons for this are three. First, airlines/lessees worldwide have developed robust cost control systems not previously seen. Airlines regularly look to pass costs like shipping, test cell runs and local counsel back on lessors. A combination of the economic downturn and the advent of low cost carriers have made this discipline a prerequisite for survival. Second, the primary narrowbody engines the CFM56-5B and 7B and V2500-A5 variants are more reliable than ever. Third, as the combination of the first and second reasons have developed a large inventory of spares has built and lessees will take more spares risk with the knowledge the short term market can support their needs for AOG, engine repairs and most individual engine shop visit programs. This has also broadened the development of the greentime market. As the decision for a third shop visit and further investment versus a part out exit has become more difficult to measure potential upside fear of the downside has driven decisions to exit earlier in the engine life cycle.
Experienced lessors know this and have adapted. Recent entrants to the market have not had any lease maturities at this early stage in their lives and have not yet had to address the issue.
However, they will have to adapt and it is expected the short term segment will prove to be even more dynamic over the near and midterm periods. Aircraft lessors, aircraft breakers and private equity firms all know and understand the majority of value in ageing aircraft is held in the engines. Lessors hesitate to spend on heavy refurbishment for remarketing, breakers see an opportunity to leverage their knowledge and experience and equity funds chase any opportunity that will produce a meaningful return in a world devoid of high return opportunities. Each has entered the short term engine leasing market to monetize the value of maintenance life remaining on their engines. These companies already were, or have become, agile asset managers. They are not beholden to any Roe, Road or IRR calculations. They simply lease for revenue and their growing ranks have only served to increase spares availability further. If you review any of the established advertising venues for engines availability it is easy to conclude the majority of firms advertising engines for lease today did not exist five years ago.
Consider short term leasing market development one step further and we see increased activity in the greentime sector of the market category. Whilst the sector has a long and proven history of good returns for savvy and experienced participants it too has expanded greatly in recent years. Greentime leasing in it true form previously held its space in the engine leasing cycle described a series of short term leases that burned off every hour and cycle possible until the only option was final parting out of the engine. Although the description is still accurate the timing of the cycle has been shortened by the same surplus of engines noted here from market change these past five years. Airlines are in a good position to manage engine spares. Greentime lessors know this and have adapted to offer commercial terms that compete with much more robust engines for short terms.
In conclusion change in the engine leasing market in the last five years has been more dynamic than in the previous twenty five. Although the timing of the entry of new engine models and OEM support packages are both testing the ability of lessors to win acceptable new volume sale and leaseback business and manage risk more efficiently it is the significant change in engine availability in the short to midterm that has driven most change. The ability to adapt quickly in a dynamic market has never been more important for the engine leasing sector.