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Maintenance Management – Protecting Aero and Rail Asset Valuations

Most Aircraft operating leases provide that the lessee is responsible for maintaining leased aircraft to required industry standards. To ensure flight safety the FAA issues Airworthiness Directives (ADs) and aircraft manufacturers issue Service Bulletins (SBs). ADs are legally enforceable regulations meant to correct unsafe conditions. Airframes, engines, avionics, and other aircraft components (landing gear, auxiliary power units,  hydraulics, electrical, etc.) must be properly maintained to ensure flight safety.

Maintenance reserve payments are a critical part of Lessor/Lessee lease negotiations. These ‘supplemental rents’ are generally calculated on a  flight hour, flight cycle basis and usually paid on a monthly in arrears basis. New equipment OEM warranties do not cover scheduled maintenance or major inspections. A current example is the troubles with new Pratt  & Whitney Geared Turbo Fan (“GTF”) engines which are used in about 40% of Airbus A320neo single-aisle jets. Pratt & Whitney’s parent RTX (formerly Raytheon) Chief Executive Greg Hayes recently made calls to customers[1] (this past July 18th) announcing an investigation had determined that contaminants in a powdered metal used to produce the PW1100 engine’s high-pressure turbine discs (part of the engine core) could lead to premature failure. “Engines delivered between the fourth quarter of 2015 through the third quarter of 2021  will need to be inspected to determine whether repairs are required.” Given time in service, an initial group of  200 engines is scheduled to be checked by mid-September, and up to an additional 1000 engines will need to be removed from service over the next year. Inspection and possible replacement of affected discs requires removing the engine, disassembling, inspecting, and then reassembling; a process that can take up to 60 days for each engine. Air carriers have complained that the GTF engine has had durability issues since introduced.  In May, Bloomberg reported about one in eight A320neos and other aircraft with the GTF was in storage for 30 days or longer awaiting repairs (spare parts shortages continue).

Taking equipment out of service for unplanned maintenance results in reduced capacity and disruption of flight crew and support personnel. As an OEM, Pratt & Whitney will be responsible for compensating customers for these engine inspections and repairs as planes are taken out of service. An initial charge of $500 Million has been taken to cover the cost of inspection, repair, and compensation for the first batch of GTF engines being checked. This adds to the more than 100 GTF-powered Airbus A320neo and A220 that have already been grounded due to earlier engine durability problems which included oil leak and vibrations concerns.  

For rail equipment, the Federal Railway Administration (FRA) and the Association of American Railroads (AAR) published a set of rules and regulations all railroad car owners (whether private or railroad-owned) must subscribe to in order to operate equipment in interchange service. The interchange rules are detailed in two manuals, the “AAR Field Manual” and the “AAR Office Manual”[2]. The Manuals provide that Railcar Owners are responsible for repairs to their cars necessitated by ordinary wear and tear and for regulatory safety requirements set by the Association of American Railroads. Railinc is the operating arm of the AAR that is responsible for the publication of rules, regulations, and railcar equipment mechanical status. Each handling road is responsible for the condition of cars operating on their line. Railroads inspect and perform “running repairs” to ensure cars are safe to operate. The handling road has the right to send the car owner a bill for necessary repairs. Private (non-railroad) car shops (with lower labor rates) provide service for specialized car types,  heavy repairs, complete refurbishment, and an alternative to higher-priced railroad running repairs. There are literally hundreds of components and a myriad of reasons for railcar repairs. Proactive management and audit of repair bills are required to ensure the right repair is being made and the right price is being charged. The Manuals also provide for damage settlement occurring resulting from unfair usage or improper protection by the handling road. With a freight car fleet of 1,625,000 cars, imagine the amount of data that is available.  

Looking for answers? Call RESIDCO, a proven Aero and Rail equipment management team.  

Glenn Davis, 312-635-3161

davis@residco.com

[1] Jet Blue, Spirit, Hawaiian Airlines, Wizz Air, Lufthansa, Mexico’s Volaris, and others.

[2] Association of American Railroads (AAR), Digital Field and Office Manuals.

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Demand Continues to Drive Equipment Investment

Pent up demand from pandemic lockdowns. Government stimulus ($5 Trillion). The Fed’s past abnormally low interest rate policy. These are the causes of the current distortions in economic activity. U.S. annual Core consumer price inflation remains high, 5.3%[1]. Wage growth continues. American Airlines pilots agreed to a new contract that boosts pay by 21% in 2023. Recent Class One national labor agreements resulted in a 24% wage increase during the five-year period from 2020 to 2024[2].

Current travel demand has driven Air Carriers back to nearly 100% of 2019 operations. Even with higher ticket pricing, there has been no slowdown in bookings. The lack of currently available new equipment[3] has resulted in a strong demand for immediately available narrowbody aircraft. Air transport markets are highly competitive, with low-profit margins. Fuel and labor are significant components of Air Carrier operating expenses. Any variation in these costs directly impacts operating profits. Lower energy prices and new engine technology provide direct economic benefits allowing more competitive pricing. Crude oil prices are down. July contracts for West Texas Intermediate (“WTI”) crude recently settled at $72.58 a barrel while Brent crude (the global benchmark) was $77.14 a barrel. China’s economic restart is stalling, Russian crude is continuing to flow, and the uncertain direction of the global economy is driving crude oil down further (WTI closed at $69.51 after the Bank of England raised interest rates to 5%). Without substantial technological improvements in alternative propulsion systems (or significant increases in the cost of crude), current equipment will remain competitive.

U.S. GDP data shows consumers are spending, and companies are hiring. In their June meeting the Federal Open Market Committee (“FOMC”) decided to leave interest rates unchanged (target range now between 5%-5.25%). Fed Chairman Powell signaled two more increases this year. Individual members of the FOMC expect a rate of 5.6% by the end of 2023. Rising interest rates paired with persistent inflation have led the Conference Board to predict, “A contraction of economic activity leading to a mild recession.” The Conference Board’s Leading Economic Index (“LEI”) is designed to provide an early indication of turning points in the business cycle. It’s declined in each of the last fourteen months. But 339,000 net new jobs were created in May (double what economists expected), auto sales are holding up, and April single-family housing starts were the most in four months.

Air transport is integral in the globalization of transport networks. More efficient engines and better aerodynamics have improved with each new generation of aircraft. Underlying price pressures and recession fears may lead to a slowing economy, but the U.S. economy continues to perform. The result is far fewer mid-life narrow-body aircraft are being retired. The pivot toward clean energy has begun but will take time and investment to complete.

It’s clear Aero and Rail needs will continue. Positioning transportation investment for the future requires underwriting discipline and an understanding of what drives demand for existing midlife Aero and Rail equipment. Build your portfolio strategically by focusing on practical solutions and best practices underwriting strategies. Call RESIDCO.

Glenn Davis, 312-635-3161

davis@residco.com

[1] Trading Economics, May 2023 data.

[2] American Association of Railroads, June 2023. “The average compensation of rail workers ranks in the top 10% of all industries, with an estimated average total compensation of $145,000 in 2022.”

[3] “We cannot make planes fast enough to satisfy demand” Guillaume Faury, Airbus, Paris Air Show.

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