Maintenance cash flow forecasting involves analyzing an array of factors to predict ongoing, maintenance-related expenses as an asset ages.
The aviation leasing industry has evolved rapidly since the 1970s, with an estimated more than 40 percent of the global fleet now on lease. As a growing number of airlines turn to leasing in order to avoid significant acquisition costs and have more flexibility in fleet planning, it is imperative for lessors to mitigate their financial risk by practicing effective maintenance management. A fundamental part of this is collecting cash maintenance reserves from lessees to cover major maintenance events.
Maintenance reserves ensure that when an aircraft is taken out of service for work such as airframe heavy checks, landing gear overhauls, engine performance restoration, and engine life limited part replacement there are enough funds to pay for the costs incurred. The lease agreement specifies what kind of maintenance events are to be covered through payment of reserves.
How are maintenance reserves determined?
Maintenance reserve rates are typically derived by taking the ratio of an estimated overhaul cost to a standard maintenance interval expressed in flight hours, flight cycles or calendar limits. For a given component, maintenance reserves are collected every month in a reserve account until the component requires an overhaul. Once the overhaul is completed (at lessee’s cost), the amount held in the relevant reserve account is refunded to the lessee, generally up to the cost of the maintenance event.
To confirm there is sufficient cash on hand to meet maintenance requirements, lessors rely on maintenance cash flow (MCF) forecasting. MCF forecasting involves analyzing an array of factors to predict ongoing, maintenance-related expenses as an asset ages.
An MCF forecast involves, at a minimum, the analysis of client-provided data such as leasing contracts, technical specifications, cumulative utilization, and prior maintenance activity. Certain assumptions are also factored in, such as projected maintenance costs of each event (based on historical data) and intervals (e.g. landing gears must be replaced after ten years). These factors are used to determine cash inflow and outflow projections throughout the life of the asset.
When it comes to evaluating a lessor’s exposure through MCF forecasting, getting a handle on future engine maintenance expenses is especially crucial.
Why is maintenance forecasting for engines so important?
The bulk of an aircraft’s value is concentrated in the engine—and maintenance represents a greater share of the total engine value as the engine ages. The proportion of asset value associated with the engine jumps dramatically from approximately 25 percent in a brand-new aircraft to 90 percent or more in an engine at the end of its lifespan.
Furthermore, the costs involved in engine repair and restoration can be significant. In fact, engine maintenance represents 10 to 15 percent of an airline’s total operating expenses. Consider the following:
- A single engine performance restoration shop visit (excluding life-limited parts / LLP replacement) ranges in cost from $1 million for regional jets up to $10 million for the largest widebodies.
- Complete LLP disk stacks (typically 20-30 per engine) have list prices ranging from $2.5 to $10 million.
- For a typical narrowbody aircraft, refurbishing one engine is needed every five to ten years and can cost up to $6 million.
Given the expenses involved with engine maintenance—and since the maintenance condition of the engines has such a significant impact on its value—engine maintenance projections must be as precise as possible.
Getting engine maintenance forecasting right can be tricky. This process is driven by complex factors ranging from operating conditions (e.g. sandy or hot/humid environments) to average flight length to the work scope and timing of previous maintenance events. Moreover, new-to-market equipment with no maintenance track record throws another wrench into the equation, often requiring input from manufacturers.
To optimize accuracy in forecasting engine maintenance needs, a considerably sophisticated model of maintenance reserve collection and expenditures is necessary, one that integrates multiple variables and parameters.
As a provider of MCF forecasts for over 80 percent of the asset-backed securitizations in commercial aviation, ICF is well-positioned to address the increasing complexities of this discipline with its current forecasting model and the upcoming MCF 2.0. ICF’s team of detail-oriented engineers, economists and International Society of Transport Aircraft Trading (ISTAT) Certified Appraisers are well-connected to the aviation marketplace, particularly to aircraft manufacturers and maintenance providers. Our goals include:
- Staying continuously “in the loop” with the latest data and innovations
- Providing increasingly detailed and highly transparent forecasts
- Delivering highly reliable MCF reports in a time sensitive environment
The Bottom Line
Both lessors and investors have incentive to embrace MCF forecasting. Lessors seek to capitalize on the more than 17,000 commercial jet aircraft deliveries that will be required by airlines over the next decade to meet growth and replacement needs. For their part, investors must be able to respond quickly to emerging buying and selling opportunities—particularly given foreign investment competition that was not present a few years ago.