4 Types of Engine Leases
An engine lease is a negotiated transaction agreement in which the owner, (the “LESSOR”) of the engine, (the “Asset”) provides the Asset for use to a third party, (the “Lessee”) for compensation in the form of periodic rentals for an agreed period of time, (the “Lease”). The Lease is a contract between the Lessor and Lessee for using the Asset wherein the Lessor retains ownership of the Asset while the Lessee has possession and the right to use the asset per the terms of the Lease. The Lease Agreement contains negotiated terms and conditions providing Lessee the right to use the Asset while the Lessor retains ownership of the asset.
In an operating lease agreement, the Lessee pays a fixed monthly lease fee for use of the engine plus a maintenance reserve fee for each hour or cycle the engine is operated. The maintenance reserve is paid monthly based on the hours or cycles the engine was operated during the preceding month. If the engine requires a shop visit during the term of the operating lease, the Lessor reimburses the Lessee for the cost of the shop visit up to the amount of maintenance reserve accumulated. If the engine does not require a shop visit during the term, the Lessor retains the maintenance reserve fund The term of an operating lease is usually short compared to the economic life of the engine being leased. Since the lease will be shorter, the Lessor has to recover the cost of the asset from multiple Lessees’. With an operating lease the asset does not appear on the Lessee’s balance sheet.
A finance lease (also known as a capital lease), is defined when one of the following conditions are met:
- At the end of the lease term the Lessee has the option to purchase the engine at an agreed price.
- The lease payments are more than 90% of the market value of the engine.
- The term of the lease is over 75% of the engine’s usable life.
With a finance lease the engine appears on the Lessee’s balance sheet, as it is viewed as a purchase.
Power by the Hour Leases
Power by the hour leasing is a form of operating lease wherein the Lessor retains ownership of the engine and provides the engine to the Lessee on a fixed cost basis. The fixed cost is either a cost per flight hour or cost per month. Power by the hour eliminates the requirement for the Lessee to pay hourly maintenance reserves for the use of the engine in addition to a fixed monthly lease fee.
Utilizing the power-by-the-hour program, the Lessee is protected from the unexpected cost of premature engine failures or capital cost to refurbish their owned engines that require replacement due to LLP expiration, AD compliance, or performance degradation.
Lessor is responsible for the cost to refurbish or repair engines that require removal from the aircraft and a shop visit to resolve discrepancies. Exceptions are:
Failures resulting from ingestion of foreign objects that result in foreign object damage to the engine that exceed the manufacturer’s published limits; and
Engine operation beyond the manufacturer’s published limits such as exceeding EGT or RPM limits; and
Failures due to misuse or abuse, such as dropping the engine. Typically, the Lessee’s aviation insurance will cover the cost to repair foreign object damage or damage due to misuse or abuse.
Advantages to the Lessee utilizing Power by the Hour leasing;
- Eliminates the capital cost of refurbishing Lessee’s owned engines
- Eliminates the unexpected and unplanned expense of premature engine failures
- Eliminates Lessee’s need for on-site monitoring of the repair shop during engine shop visits
- Allows Lessee to establish known annual engine operating cost
- Provides reduction in capital assets
- The Lease is an off balance sheet transaction since it is an operating cost
Sale and Leaseback
In Sale and Leaseback Transaction the Lessee owns the engine and desires to sell the engine to reduce capital investment or to generate cash. The Lessee sells the asset to the Lessor who purchases the asset and immediately leases it back to the Lessee as an operating or power by the hour lease. The purchase lease back transaction improves the liquidity of the Lessee by reducing the Lessee’s debt to equity ratio.