Aircraft Operating Leases - Maintenance Reserves - Basic Concept Explanation

Aircraft Operating Leases Maintenance Reserves Basic Concept Explanation 1.

Introduction

Aircraft operating leasing Maintenance Reserves (MRs), also commonly referred to as Supplemental/Additional Rent1, 2 or Maintenance Rent3, are a very specific provision of aircraft leasing contracts.

I have been dealing with MRs for the past 15 years, explaining this concept to different stakeholders in the business.

It is surprising that for some participants in the aircraft leasing industry (airlines, MROs, financiers, consultants, etc.), the concept of MRs still appears unclear.

There is a growing number of publications on the subject written by several experts in the field.

However, many of these publications may still be too highly specialized for readers who are not familiar with the concept, and therefore too difficult to understand.

This paper provides a basic understanding of the concept.

2.

Leasing an aircraft – Key difference

A practical way to explain MRs to a broader audience is by using the parallel example of leasing/renting a car.

Based on my experience, this is an effective way to explain the concept to students, colleagues, and business associates who do not work in technical areas.

This explanation makes a notional parallel by demonstrating MRs as they would apply to car rentals.

2.1.

Scenario 1

Person 1 rents a car from Car Rental Company 1 Person 2 rents a car from Car Rental Company 1 (same type of car) Lease term (1 week) and conditions are the same. Same pickup/return days/times.

Rent fee is the same: $500 per week Car usage considerations At the end of the rental period, the number of kilometres traversed by each car was: Person 1: 500km Person 2: 100km Person 1 total payment = $500 Person 2 total payment = $500 Total billed by the Car Rental Company = $1,000 Person 1 and Person 2 are friends, and while leaving the car rental premises, they discuss the deal they each received.

Person 2 feels dissatisfied and cannot understand why he was charged the same amount of money when in fact he drove 400km less than Person 1.

1

IATA – Guidance Material and Best Practices for Aircraft Leases. 4th Edition, May 2017 Maintenance Reserves – The Basics. Avitas (www.avitas.com) 3 Definition of Maintenance Rent. Law Insiders (www.lawinsider.com) 2

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2.2.

Scenario 2

Person 1 rents a car from Car Rental Company 1 Person 2 rents a car from Car Rental Company 1 (same type of car) Lease term (1 week) and conditions are the same. Same pickup/return days/times.

Rent fee is the same: $200 per week There is an additional charge of $1 per km driven in the car during the rental period.

This additional charge is the notional aggregate calculated by the Car Rental Company to compensate for replacement units that wear over time, such as brakes, tires, shock absorbers, etc., as well as to create a separate fund to pay for engine repairs when performance degrades due to high mileage.

Car usage considerations At the end of the rental period, the number of kilometres traversed by each car was: Person 1: 500km Person 2: 100km Person 1 total payment = $700 (base rental charge of $200 plus $500 usage charge) Person 2 total payment = $300 (base rental charge of $200 plus $100 usage charge) Total billed by the Car Rental Company = $1,000 Person 1 and Person 2 are friends, and while leaving the car rental premises, they discuss the deal they each received.

Person 2’s perception is that he was fairly charged less given the lower usage on the car.

Scenario 2 resembles aircraft leases that include Maintenance Reserves/Maintenance Rent (MR).

The rent fee of $200 per week is what is commonly referred to as Basic Rent in the aircraft operating leasing world, while the usage charge of $1 per km is in fact the equivalent of the Maintenance Rent rate (MR Rate).

3.

3.1.

Basic Rent vs Maintenance Rent Basic Rent

An aircraft leasing Basic Rent is the rent that a lessee needs to pay for the right to use the aircraft.

The most common Basic Rent is accrued in a monthly fee.

Even if the aircraft stays parked for that whole month, the lessee is still liable for monthly Basic Rent payments.

Basic Rents vary widely. These may range from amounts below $100,000 to amounts beyond a million dollars per month, depending on the type and age of the aircraft and other commercial considerations.

3.2.

Maintenance Reserves/ Maintenance Rent - (MR)

Maintenance Rent is a variable rent that depends on the usage of the aircraft, as opposed to Basic Rent, which is a fixed amount per month.

Using the parallel established with the rental car example, the notional equivalent MR Rate in aircraft leasing is a charge for each Flight Hour (FH), which is similar to the charge per kilometre used in the rental car example.

A simplistic way to explain this concept is by assuming a notional MR Rate of, let’s say, $100 for each FH. This means that if a lessee (airline) utilized the aircraft for 300FH during a given month, then the lessee will receive an MR invoice corresponding to 300FH times $100, equal to $30,000.

As with the previous description of the $1 per km charge used in the rental car example, the charge of $100 per FH is supposed to cover the cost of wear and tear on the aircraft.

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In other words, it is supposed to compensate for the cost of utility consumed.

The cost of utility consumed is the equivalent cost of restoring the aircraft and its engines, among other high cost components, back to an airworthy condition after scheduled mandatory checks (airframe) and performance restoration (engines) at certain points in time during their lives/operation.

As such, unlike Basic Rent that is usually treated as revenue, Maintenance Rent is treated as a collateral to compensate for utility consumed.

4.

Maintenance Reserves Management

In aircraft leases, usage, expressed in terms of flight hours (FH) or landings (flight cycles - FC), is reported at the end of each month by lessees. Subsequently, lessees usually get two invoices from lessors, one covering the Basic Rent and a second covering MRs (cost of utility consumed).

An agreement in which utility consumed is billed by a lessor on a monthly basis is usually referred to as a lease that includes MRs. Conversely, if utility consumed is billed at the end of the lease (no monthly payments, just one lump sum at the end of the lease), then that is what is commonly referred to as an End of Lease (EOL) payment lease.

Additional and more complex considerations related to the treatment of MRs once mandatory checks (airframe) and performance restoration shop visits (engines) take place are not discussed in this paper.

Finally, whether an aircraft operating lease should be structured by way of MRs or EOL payments depends on commercial and risk considerations.

5.

Conclusion

Aircraft operating leases include a unique concept called Maintenance Reserves/Maintenance Rent.

It is designed to account for utility consumed to restore high cost components of a leased aircraft.

The understanding of this concept is key to many stakeholders in the aircraft leasing industry as it has legal, risk, and commercial implications, among others.4 I hope this paper sufficiently explains the concept.

About the author: Omar Zuluaga is currently working as Vice President and Head of Technical Support at AerCap. He has spent fifteen years working in technical areas of the aircraft operating leasing industry. Prior to that, he worked in airline technical operations for ten years.

Omar Zuluaga holds a Bachelor of Science degree in Aviation Electronics from the Riga Civil Aviation University in Latvia (formerly RKIIGA) and a Master of Science degree in Aviation Management from Arizona State University. linkedin.com/in/omar-zuluaga-47596016

4

Basics of Aircraft Maintenance Reserve Development and Management. Shannon Ackert, August 2012

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