OEMs dismiss lessors as collateral damage

Jon Sharp, CEO of Engine Lease Finance Corporation, on how OEM strategies aimed at blocking PMA, DER and surplus parts traders has significantly undermined the value of lessors’ older assets

The single biggest issue facing the engine leasing sector today (and to a lesser degree, the aircraft leasing industry) is the impact on our balance sheets of OEM initiatives designed to protect their share of the spare parts market.

These strategies aim to prevent PMA producers and the surplus parts industry encroaching into the OEMs’ market share and that’s understandable. However, in reality these strategies do not so much attack PMA producers, but hurt leasing companies, who are not the intended target.

Every leasing company, whether it’s an aircraft or an engine lessor, follows two basic business precepts. The first is that you buy the right asset at the right price and you lease it out to generate revenue. The second is that at some time in that its lifecycle – at the appropriate time – you will liquidate that asset.

For both aircraft and engine lessors the ultimate end-of-life solution is the same: sell the engine to a parts broker, who will tear it down and turn it into components which are then recycled back into the MRO industry. And this is where the problem lies with how OEMs have approached tackling the PMA and surplus parts firms.

Starting with CFM International, certain OEMs are increasingly applying a policy retrospectively that means if any non-OEM part has been installed in the engine, they will not provide technical support and warranties are voided. Nor will they take on any component into their MRO systems that has been taken out of that engine when it is broken down or refurbished.

This has dramatic implications for us lessors. Say, for example, I bought an engine 15 years ago and put it on lease to Airline A. After six years I got it back and then put it only lease to Airline B. A further three years down the line it is leased to Airline C. Then I put it onto short-term lease agreements with a further two airlines burning off the hours and cycles remaining on the engine.

Now I have a lump of metal and some reserves sitting in my bank account, so it’s time to sell the engine. I go to a parts broker who says they’ll give me $3m for the engine which they intend to tear into components. Then they ask for a certificate, back to day zero, stating that there was never an influencing PMA part installed in the engine, otherwise without such certification they are unable to sell the parts back into what is an OEM-controlled MRO market.

I go back to Airlines C, D and F and ask for this new certification and their response is: “Why should I commit technical resource and cost to do something that was not a condition of the lease?” They may in the end help because of good relationships, but we will be asked to pay for this.

Then I go to Airline B, which had the engine 10 years ago, and they say: “What engine? All the staff who were here then have moved on.” And even if they can help, I can’t go to Airline A because they went into bankruptcy five years back and no longer exist.

I go back to the broker without the certification, and instead of paying me $3m they offer me $1m or don’t take the engine at all.

So what the OEMs have done, in a bid to protect their market share, is wipe money of my balance sheet. And that is the same for every other leasing company who acquired aircraft or engines in years past with no need at that time for a contractual undertaking to provide this certification, the application of which is retrospective.

What’s really annoying is that the lessors, as far as the OEMs are concerned, are the good guys, because in our lease agreements we prohibit the installation of non-OEM parts, and yet we are the ones being hurt hardest by this retrospective strategy. No lessor can afford to have the residual value – the ultimate liquid value in its assets – destroyed in this way and the OEMs need to address it.

Recently the OEMs have been saying more loudly that the leasing companies are their friends – we, of course, own 40% of all aviation assets and are likely to own a higher proportion in future – and in some cases that they recognise that there has been a “disconnect” between their strategy and the impact it’s had.

The message seems to be: “We see that you’ve been damaged, we didn’t intend it and we’re sorry.” However contrition is not enough.

Last November, I was at a conference in San Francisco and the moderator, George Dmitri of Ascend, asked how many of the leasing companies present would not invest in an aircraft powered by engines made by a certain OEM. Eleven hands went up. Wake up time.

The engine manufacturers are beginning to realise that they are damaging their reputations with leasing companies. They are consequently damaging their own liquidity and their ability to market their products. They say that they are going to do something about it. So far there have been lots of words, but little delivery in practice. Without that delivery, the effect on the leasing community is being written off as collateral damage.

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