Will There Be Independent Engine Lessors in 2049?

Tom Barrett’s Article for The Airfinance Journal’s Special Supplement – Guide to Financing and Investing in Engines 2019

Given the prevailing OEM dominance in all things engines related and as Engine Lease Finance Corporation (ELFC) approaches the celebration later this year of its first 30 years as an independent engine lessor, Tom Barrett, ELFC’s recently appointed president and chief executive officer, suggests the independent spare engine lessor will be around in 2049.

When I joined ELFC with the industry in its infancy, I was of the view that the leasing industry, along with its independent lessors (and my career in it), would only exist for a handful of years. Almost 30 years later, I am of the view that strong independent leasing entities are a crucial component of the market and it remains vital that companies such as ELFC continue to serve airlines for the next 30 years. Before outlining why I hold this view, I think it is worth reflecting on how original equipment manufacturer (OEM) dominance of maintenance, repair and overhaul (MRO) has evolved over the past 30 years.

In 1989, when ELFC was founded, there was little mention of OEM dominance of the aftermarket. OEM dominance was confined to the process of manufacture and sale of new engines and engine parts. The OEM was happy to take the margin (or loss in the case of installed engines) on spare engines and engines parts. At the time there were sufficient airlines and MRO shops which would only purchase and install new OEM parts. However, like most of the inefficient industries of the world that need to adapt, the historically loss-making airlines (heavily regulated and often government subsidised) eventually had to focus on their core purpose of efficiently serving the travelling public, their customers. The consequence was their exit from MRO shop ownership and their reduced use of the “new-only” restriction for engine parts. This, in turn, led to the proliferation of used serviceable parts (USM) suppliers which created efficiencies through their pricing and logistical expertise. In response, OEMs sought to generate alternative revenues through the acquisition of MRO shops, locking in the use of their new parts through these shops and their full maintenance programmes that would come later, along with their entry into the spare engine leasing business. With the aftermarket percentage of total revenues running at well over 60% for one of the OEMs, and with new parts price increases on an engine in production for several years over the past five years running at more 4.4% per annum, it is clear the OEMs have succeeded in preserving revenues in the MRO and parts supply sectors. This then brings me on to the engine leasing sector.

In 1989, all the OEMs were beginning to dabble in engine leasing: Rolls-Royce was founding RRPF; CFMI (together with its partner GPA) had founded Shannon Engine Support in 1988; and GE was later in the 1990s going to get much more active through GE Engine Leasing. However, at the same time, ELFC, Willis Lease Finance (1986) and a few other (long gone) independent lessors were to be founded with a view to entering this new industry sector. While many of the early independent entrants are no more, ELFC and others have succeeded by always remembering that they must maintain their focus on the customer – in our case, the airlines which, in turn, serve the travelling public.

Do Airlines Need Independent Engine Lessors?

Undoubtedly, the past 30 years have seen a proliferation of independent aircraft leasing companies, up to 100 active at present, which are very well funded, structured and managed. This has resulted in airlines being sure of obtaining very competitive pricing and being able to demand customer oriented terms. With the aircraft asset, which is increasingly being commoditised by its 100 active participants, there is no OEM exerting dominance (acknowledging of course GECAS’s strong position) and arguably fewer barriers to entry. However, the very complex nature of the engine as an asset, with so much value attributable to operational life, it has made it impossible for so many independents to proliferate successfully. With the success of GE Engine Leasing, RRPF and PWEL in owning, managing and leasing very significant portfolios, there is undoubtedly a possibility that the dominance in the MRO sector could be replicated in the engine leasing sector. ELFC is of the view that its role as a strong independent controls the potential for the OEMs to dominate at the delivery of the spare engine, during the operational period and ultimately at the point of overhaul or retirement when USM fulfils a crucial role. ELFC itself, or through its INAV parts company subsidiary, provides vital competition in all these stages of the engine life cycle for the benefit of airline customers. Strong independents, which are very competitively funded, such as ELFC, see to it that the initial sale and leaseback lease rentals are very competitively priced. Similar to the aircraft leasing sector right now, the competition is particularly fierce, with several new entrants providing pricing that will leave them short in the event of any cyclical downturn. ELFC, as a customer focused entity, will continue to react to these competitive market forces as appropriate.

Beyond periods of the initial introduction into service, it remains vital that short term lease rentals and spot rentals are competitively priced, and it is only through the independents’ short-term activity and those long-term lessors with inventory that the airlines can be satisfied that rentals will continue to remain competitive. However, it is in the area of used serviceable material that the independent lessors, having harvested the operational life of the engine, will truly serve the customer by keeping used serviceable materials in supply and ensuring that they remain a viable alternative to the new materials, favoured by the OEMs with their full list pricing.

It Is Not Just About Pricing

The services offered by the independents are not confined to ensuring good pricing for the airlines – over the past 30 years they have provided a vital service to their customers by their concentration, focus, development and refinement of the engine lease product itself. This is done by their constant need, through competitive pressures from the OEMs and other independents, to refine their lease language, offer flexibility, balance the risks appropriately and ensure a constant evolution of the engine leasing product. In the infancy of engine leasing, it was often the case that the airline retained no flexibility with regard to the redelivery conditions, which were inevitably zero time since overhaul. But through the years ELFC and others have consistently refined their product offerings to the point where customers are now able to access varied redelivery conditions, FX leases, floating rentals, variable lease terms (to mention just a few) thought to be impossible back in 1989. To paraphrase my colleague Joe O’Brien when he referred to the “residual” in providing feedback on the engine poll for this publication last year, “it’s about the customer stupid”. It is only the strongest of independents which can offer these variations of the core product and it remains crucial for the airlines that these independents serve them in this way.

Customer Is Not The Only Pillar

As many lessors have found out over the years, there are many non-customer-related reasons to fail. While many of these revolve around factors outside their control, such as shareholder or staff turnover issues, at ELFC the constant business focus on the other two pillars – shareholder and staff – have allowed us to continue strongly in the business. Since 2014 and the acquisition of ELFCby Mitsubishi UFJ Lease & Finance, ELFC has been supported by a very strong parent company with a long-term strategy to grow its international leasing businesses. Its success in doing this has been evident by the growth of its aircraft leasing company, Jackson Square Aviation, ELFC and the decision to invest vertically into the engine parts business in INAV which ELFC completed in 2017. For any business success, constant emphasis on staff is critical but in the engine leasing business where the asset class is so complex with considerable downside risk if poor management prevails, it is crucial that the engine lessor staff understand the asset, have considerable experience of managing the asset and are willing to work hard in a global industry to deliver the required expertise to the customer. In order to do this, it is safe to say that the engine leasing community has to leave its ego outside the door. Culturally, the focus in ELFC is on working with the customer, maintaining the relationship and ensuring that the customer will be happy to do repeat business.

OEMs Are Our Customers Too

While the customer emphasis outlined above might suggest to some that the strong independents are diametrically opposed to or in conflict with the OEMs, it is crucial for any independent lessor to acknowledge and recognise the fact that the success of the OEM product is critical to its own long-term prospects of success in this industry. It is for this reason that the independents will always want to work with the OEMs – eg, ELFC acquired more than $100 million directly from one OEM in 2018 and also has several engines on OEM leases – in order to serve its customer requirements in what has been a very buoyant market for the past few years. While different OEMs will reciprocate their relationship with the independent lessor in different ways, it is fair to say that most OEMs acknowledge that independent lessors provide a service that their customers require and consequently they are willing to work with the independent engine lessors to find ways to access the market beyond their own capabilities.

Uncertainties Exist

It is obvious that the engine leasing sector, like the aviation business in general, will remain cyclical and go through periods of irrational exuberance and unwarranted pessimism. If a company is to weather the uncertainties and storms ahead, it is crucial that it sticks to what it does best, understands its customer and reacts with a very high degree of flexibility as challenges are presented. The current challenges that I see for this industry are late or postponed entry into service, technical performance of the new engines entering service, uncertainty in particular markets brought about for a variety of regional reasons, the state of the global economy and irrational behaviour by leasing executives who seems to have forgotten the lessons of the past. For more than 30 years this industry has experienced cyclical, be they regional or global, downturns. It is fair to say, despite some regional issues at the moment, that the industry is going through a sustained period of profits and favourable market conditions for the airlines and the industry servicers of which the lessors are just one part. However, the common thread for the past 30 years is that each period of stability and growth has been followed by a period of oversupply. With the manufacturer production rates on new aircraft, despite the global growth forecast for travel, it is difficult to see how a period of oversupply will not arise at some point. This period of oversupply may be brought about by a slow market downturn where it can be managed appropriately, or it could be brought about by a significant market event that will provide less room for management of the downside risk. With the operating lease pricing, particularly on sale and leasebacks of aircraft and engines, prevalent at the moment, in my opinion, many lessors (particularly new entrants) are not building up sufficient reserves and cushion for them to survive any period of sustained downturn. This situation when (not if) it comes will result in a significant shake-out of the aircraft leasing community and will damage some of the new engine leasing entrants. ELFC can, with a high degree of confidence, predict that although its profitability will be impacted, it will, like it has before, be well positioned to react to the customer’s needs for flexibility and work through all of the challenges that the changing market will dictate. This can only be achieved by staff applying themselves creatively and innovatively to work with customers to solve their individual problems. As an independent, it is incumbent on ELFC to deliver in this way to its customers for the next 30 years.