Aircraft Operating Leases Engine Performance Restoration Maintenance Reserves - Concept Explanation

Aircraft Operating Leases Engine Performance Restoration Maintenance Reserves Basic Concept Explanation 1.

Introduction

Aircraft operating leases Maintenance Reserves (MRs), also commonly referred to as Supplemental Rent1 or Maintenance Rent,2 are a very specific provision of aircraft operating lease contracts.

As discussed in the MRs Basic Concept Explanation Paper3 (Paper One), MRs are designed to account for the monetary effect of utility consumption of leased aircraft's high-cost components. They also provide security for the lessor in the event of a default and possible repossession.

One of the highest cost items of aircraft operating leases is the cost to restore the performance of aircraft jet engines (Aircraft Engines). This is commonly known as Performance Restoration (PR) in aircraft operating leases.

There is a growing number of publications about PR MRs written by several experts in the field.

However, many of these publications may still be too highly specialised for readers who are unfamiliar with the concept and are therefore too difficult to understand.

For many non-technical participants in the aircraft leasing industry working for airlines, MROs, financial institutions, consultancy bureaus, etc., and non-technical disciplines (legal, contracts, trading, etc.), this concept may still appear unclear.

This paper attempts to provide a basic understanding of (i) Aircraft Engines PR and (ii) the PR MR Rate concept.

Aircraft Engines have other high-cost parts such as Life Limited Parts (LLPs). The monetary effect of utility consumption of LLPs is also usually included in aircraft operating leases. However, this concept is not covered in this paper.

2.

Performance Restoration of Aircraft Engines – Basic Explanation

A practical way to explain Aircraft Engine PR to a broader audience is by establishing a parallel between how car engines and Aircraft Engines work.4 Some over-generalisations will need to be done; however, the underlying concept will remain valid.

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.

2.1.

Car Cylinder Engines

In simple terms, an internal combustion engine, such as the one in cars, works entirely on the 1

IATA – Guidance Material and Best Practices for Aircraft Leases. 4th Edition, May 2017 Definition of Maintenance Rent. Law Insiders (www.lawinsider.com) 3 Maintenance Reserves Basic Concept Explanation – Omar Zuluaga, July 2020, https://www.slideshare.net/OmarZuluaga1/aircraft-operating-leases-maintenance-reserves-basic-conceptexplanation/ 4 Suck, Squeeze, Bang and Blow – Citizen Sailor, July 2009, http://www.navyaircrew.com/blog/2009/07/18/suck-squeeze-bang-and-blow/ 2

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principle of compression. Fuel injectors mix gasoline and air, and they spray this combination into a combustion chamber, where it is ignited, creating combustion that expands in the cylinders of the engine to power the car and make it move.

If compression is not efficient, then the engine loses power.

A major consequence of low compression is that to deliver the same ‘power’, the engine needs to work at a higher temperature regime (i.e., more fuel).

The engine may overheat even with only the driver on it and just attempting to climb a small hill.

2.2.

Aircraft Engines

Similarly (different principle though), Aircraft Engines work by using compressed air.

The engine sucks air in at the front with a fan. A compressor, which is made with many blades attached to a shaft, raises the pressure of the air. The blades spin at high speed and compress or squeeze the air. Then, the compressed air is sprayed with fuel and an electric spark lights the mixture. The burning gases expand and blast out through the nozzle, at the back of the engine. As the jets of gas shoot backward, the engine and the aircraft are thrust forward.5 In a way similar to that of car engines, if compression is not effective or aerodynamic inefficiencies exist inside the engine, then the engine loses power.

Similarly, to deliver the same ‘power’, the engine must work at a higher temperature regime (i.e. more fuel).

The engines may overheat even with only a few passengers and no cargo while trying to climb after take-off.

To ‘restore the performance’, Aircraft Engines need to go through a specialised maintenance shop where internal compression and aerodynamic properties are restored.

After the shop visit, the engine may not achieve the same efficiency when compared to what it had when it was new.

Some of the parallels established above are shown in the following graphic:

http://www.navyaircrew.com/blog/2009/07/18/suck-squeeze-bang-and-blow/

5

How does a jet engine work? https://www.grc.nasa.gov/www/k-12/UEET/StudentSite/engines.html

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3.

Aircraft Engine PR MRs – Unique Concept

As previously discussed, one of the main items subject to MRs in aircraft leasing is engine PR. Usually, it is difficult to explain how to quantify engine PR MRs to a non-technical audience.

Let us assume the following notional values using the same parallel as that used in Paper One as if Engine PRs apply to a rented car.

A person rents a car, and the car leasing company asks the person to pay a Basic Rent as mentioned in Paper One. This time, the length of the lease may be anything from 3 years to more than 10 years.

Following the example of Paper One, the lessee will pay a fee per month whether or not the lessee uses the car daily and whether the lessee uses the car for a few kilometres one day or many kilometres on other days (the Basic Rent).

The leasing company tells the lessee (the person who rented the car) that the car's engine, under certain considerations, could potentially run for 100,000 km until it requires a repair.

The leasing company also tells the lessee that the average cost to repair the engine is $1,000.

Under the considerations above, the cost to use the engine for each kilometre equates to 1 cent/km ($1,000 divided by 100,000 km).

Thus, the lessee will receive two invoices every month: one for the Basic Rent (per month) and one for each kilometre used on the engine.

The leasing company asks the lessee, at the beginning of each month, to report the number of kilometres used on the car during the preceding month. Subsequently, the lessee will receive a corresponding invoice. For instance, if the car was used 2,000 km during a given month, then the lessee should expect a $20 invoice.

It means that, if one cent is put in a notional fund for each kilometre used, then once the engine reaches 100,000 km, the amount saved in such account will be $1,000, which will be enough to cover the cost to repair the engine.

Likewise, if the usage on the car at the end of the lease is, let’s say, 80,000 km, then the leasing company will have $800 accrued in a notional fund that will be used to pay the cost to restore the performance of the engine when time comes.

In the aircraft operating leasing world: 3.1.

Mean Time Between Removal (MTBR)

The 100,000 km interval of the car engine mentioned above is what is usually referred to as MTBR (Meant Time Between Removals) in Aircraft Engines terms. It is usually expressed in terms of Flight Hours (FH).

Depending on the aircraft-engine types and combinations, Aircraft Engines may achieve an extraordinary number of ‘hours on wing’ up to 50,000 FHs since new in some instances (First Run, i.e., since new). This can equate to more than 12 years of operation (based on an assumed usage of 4,000 FHs per year). After their first PR (Second Run time/period), these engines typically achieve less hours on wing compared to First Run. Also, Aircraft Engines MTBRs depend on a great extent to the flight length of typical missions. For example, engines that are utilised for flights of less than 1 hour during their life tend to achieve lower MTBRs compared to those engines utilised on flights of 2 or 3 or more FHs during their life.

This given the thermal stress suffered by Aircraft Engines during each on/off cycle (Flight Cycle).

In addition, engines used in sandy or corrosive environments tend to achieve lower MTBRs.

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3.2.

Performance Restoration (PR) Shop Visit (SV) Cost

The $1,000 cost to repair the car engine is usually referred to as the PR Shop Visit (SV) Cost.

In Aircraft Engines terms, the cost of PR SVs may be in the region of a few million dollars. This is the typical case of engines attached to regional or narrow-body aircraft. However, the cost of PR SVs may go up to amounts beyond a ten million mark. This is the typical case of engines attached to certain wide-body (long haul, more than 250 seat) aircraft.

PR SV Costs are mainly driven by the level of internal deterioration due to heat, erosion and fatigue6.

In addition, airlines may achieve significant SV cost discounts in case the volume of PR SVs is high enough to attract discounts from shops.

3.3.

Maintenance Reserves/Rent (MR) Rate

The rate of 1 cent/km is usually referred to as the Maintenance Reserves or Maintenance Rent (MR) Rate in aircraft operating leases.

It is typically calculated by dividing the SV Cost by the MTBR. The typical Unit of Measure is dollars per Flight Hour ($/FH).

Depending on the engine and aircraft type, it may range from amounts below $100/FH to amounts beyond $500/FH. 4.

Management of Engine PR Maintenance Reserves

Once an aircraft is delivered, the lessee needs to report the hours performed on each engine every month.

The lessee will receive a monthly invoice (MR invoice) on top of the Basic Rent invoice.

When the engine needs a PR, the lessee sends the engine to the shop, gets the engine repaired, pays the bill, and then asks the leasing company to return the money accrued in the MR fund via submission of an MR Claim.

If the engine has FHs consumed at delivery, the PR fund will not be enough to cover the SV cost. In those cases, the lessor usually provides an additional contribution based on utility consumed at delivery. This is referred to as a ‘Lessor Contribution’ or ‘Top-Up’ to the lessee.

In addition, if the lease ends and the engine meets the return conditions, then the lessor keeps the MR fund which is equivalent to the number of hours used on the engine at return since new or since the last PR. In turn, that money is used by the lessor as a ‘Top-Up’ to the next lessee.

5.

Conclusion

Engine PR MRs are crucial in aircraft leasing. They are the highest dollar item of monthly MR invoices. For older aircraft (around 15 years or older) the engine PR MRs can translate into a monthly expense higher than the Basic Rent itself.

As MR Rates depend on highly unpredictable SV Costs and MTBRs, this is usually an item heavily negotiated while agreeing on aircraft Leases. It is an area where the technical and legal teams from both the airline (lessee) and lessor need to work cooperatively to ensure smooth management of Engine PR MRs during the lease.

Finally, the economics of a leasing deal (for both the lessor and the lessee) depend greatly on the level of Engine PR MRs. In fact, this is typically a factor that has a significant effect while agreeing on the value of an aircraft that is being sold while on lease.

6

Engine Maintenance Concepts for Financiers. Shannon Ackert, September 2011

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I hope this paper sufficiently explains the concept of Engine PR and its associated PR MR Rates definition, application and implications.

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

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