Welcome to the first white paper in our Thought Leadership series. This piece is by Dan Roberts, our C.O.O. and General Counsel. In it, he discusses the three standard ways that leased helicopter Maintenance Costs are managed.
Q: At a high level, how are maintenance costs handled on leased helicopters?
A: The basic principle is that the operator should only pay for maintenance costs incurred in respect of its operation of the helicopter.
Take for example a helicopter being delivered on lease to an operator. The engines are due for overhaul every 3,000 hours. At delivery, one of the engines has 1,000 hours remaining until overhaul. If an overhaul of this engine is required during the lease, the operator should be responsible for one third of the overhaul cost.
Q: Why doesn’t the leasing company pay for all major maintenance? I would not pay anything if even a tyre needed replacing on a rental car.
A: Certain helicopter leasing companies do cover major maintenance costs. These niche players usually specialise in a particular helicopter type. They are actually combining a leasing business with a parts-supply and maintenance business. Operators may offer leases of this type from time-to-time to other operators if they have idle aircraft.
Mainstream helicopter leasing companies exclude maintenance costs from the basic rent paid for the helicopter. These leased helicopter fleets are diversified across various helicopter types and they usually have no in-house maintenance or part-supply capabilities.
You do not pay for maintenance costs on a rental car due to the short term nature of the contract. But if you leased a car as is common over a three-year term, then you would be responsible for these costs. It’s a different business model.
Q: So, what is the basic rental fee covering, if maintenance costs are excluded?
A: The basic rental fee in a mainstream helicopter lease covers:
- The cost of deploying the capital required to purchase the helicopter.
- The long-term depreciation of the helicopter.
- The overheads and profit of the leasing company.
Each of the above should be a reasonably steady cost over time and is largely unrelated to the utilisation of the helicopter. This is why leasing companies generally operate based on fixed monthly payments rather than payments per flight hour.
Q: How are maintenance costs normally handled in helicopter lease arrangements?
A: There are essentially three ways of achieving the basic principle outlined at the beginning of our discussion. These are:
- Betterment / Detriment (sometimes called “upsie / downsie”).
- Maintenance Reserves.
- Power by the Hour.
In Betterment / Detriment, everything is sorted out at the end of the lease term through a payment from the operator to the leasing company, or vice versa. I’ll explain in a bit more detail how this works in a moment.
In Maintenance Reserves and Power by the Hour the operator pays a fixed amount per flight hour and the costs of maintenance events should be then fully covered with no additional costs to the operator.
Going back to the engine overhaul example from earlier:
- In Betterment / Detriment, the operator pays for the full cost of the engine overhaul during the lease, but then gets compensation from the leasing company at the end of the lease term calculated by reference to the 2,000 hours of engine utilisation prior to delivery.
- In both Maintenance Reserves and Power by the Hour, the operator pays a fixed fee per engine hour. But there should then be no additional costs to the operator when the engine overhaul is required. The cost is covered by a combination of the reimbursement of the Maintenance Reserves paid by the operator and the “top-up” of these Maintenance Reserves by the leasing company.
Q: If Betterment / Detriment applied in the example of the engine overhaul, would the leasing company not just pay for 2/3 of the cost of the engine overhaul?
A: That would be workable. But Betterment Detriment is not usually structured this way. Instead, the Betterment Detriment calculation is made by working out the difference between the hours until overhaul (or since overhaul) at delivery in comparison to return and multiplying this difference by an agreed rate per hour (normally the hourly reserve rate payable by the operator).
Q: What about parts other than the engine; can Betterment/Detriment apply to them?
A: Normally a select bundle of rotable parts (components that need to be overhauled or replaced at certain varying hourly intervals) are identified and kept track of over the term of the lease. At lease expiry, by calculating the difference between the hours until overhaul (or since overhaul) at delivery in comparison to return for all the rotable parts and multiplying this difference by an agreed rate per hour will determine on balance who owes whom; i.e., the net result might be a payment from lessor to operator or vice versa (hence the term “upsie / downsie”).
Q: What is the difference between Maintenance Reserves and Power by the Hour?
A: Maintenance Reserves payments are paid to the leasing company. Power by the Hour payments are made to a specialist third party – the “PBH provider”. These payments are usually made monthly based on the number of hours flown during the month at an agreed per hour rate. The PBH provider will be either the manufacturer or an independent provider such as JSSI or HeliOne.
The key difference lies in cost and risk. Power by the Hour is more expensive than Maintenance Reserves, but the PBH provider guarantees (with certain limitations) both the availability of parts and the cost of maintenance. Power by the Hour carries an additional cost in low utilisation scenarios as it invariably includes a “minimum hour” requirement.
The guarantee of parts availability is a major benefit of Power by the Hour. If the operator is performing a contract with limited spare capacity, then knowing that parts will be delivered within a defined timescale greatly enhances its ability to deliver under the contract.
The Maintenance Reserve structure is cheaper, but does not offer these guarantees.
After maintenance is performed, the leasing company will reimburse the Maintenance Reserves to the operator. Normally the Maintenance Reserves are divided into separate “funds” for each major maintenance cost. The leasing company would normally add funds to the Maintenance Reserves to reflect any pre-delivery utilisation of the helicopter (sometimes called a “top-up”).
However, with Maintenance Reserves, the operator takes the risk both on a lack of parts availability and/or maintenance cost overruns.
Furthermore, if a component requires early removal, the Maintenance Reserves may be insufficient to cover the cost of its replacement. In contrast, under Power by the Hour the full cost of the replacement would be covered even if the part requires removal earlier than its scheduled removal date. This can be particularly important for “on condition” parts where the time remaining until overhaul is an estimate based on industry averages rather than a specific maximum utilisation dictated by regulatory requirements.
Q: How does the leasing company pay for the Maintenance Reserve “top-up”?
A: The Maintenance Reserves paid (but not used) by previous operator(s) of the helicopter should provide the funds the leasing company needs for the “top-up” contribution to the Maintenance Reserves.
Q: OK. But why is there no “top-up” concept in the Power by the Hour concept?
A: There is an equivalent. When a used helicopter is placed into a “Power by the Hour scheme” the PBH Provider usually requires a “buy-in” fee to be paid – either at the time of induction into the program or at the time of relevant maintenance event. In the case of a new delivery helicopter, there is no buy-in because all the parts on the helicopter are at zero time.
Q: Who enters into the Power by the Hour agreements – operator or leasing company?
A: Either approach can work. If the transaction is setup correctly, there should be no real difference between the two approaches.
If the operator enters into the PBH agreements, the leasing company should enter into a side agreement with the PBH provider transferring the benefits of the PBH agreement to the leasing company after return of the helicopter.
If the leasing company enters into the PBH agreements, the lease agreement should confirm that the operator can benefit of the PBH agreement throughout the lease term. A side letter with the PBH provider can also be helpful in this scenario to avoid any misunderstandings.
Q: Why would an operator accept Betterment Detriment? It seems quite unfavourable.
A: Operators often actually prefer Betterment Detriment because it avoids “trapping” operating cashflow into a Maintenance Reserve or PBH program.
Under Betterment Detriment, an operator might have to pay for some expensive major maintenance during the lease term without any contribution from either a PBH provider or the leasing company. But the benefits to cashflow in avoiding Maintenance Reserve or PBH agreement payments usually outweigh this negative.
Our earlier example of the engine overhaul makes Betterment Detriment look unfavourable for the operator as it has to pay for the expensive engine overhaul during the lease term. But if you look at all the parts on the helicopter collectively, things will look different. The engine overhaul might be the only major maintenance needed during the lease term.
Q: From the operator’s perspective, how would you rank the various alternatives?
A: The guarantees offered by Power by the Hour programs are vital for most operators making this usually the preferred option. If these guarantees are not so important for some reason, then Betterment Detriment is generally preferred over Maintenance Reserves. An example might be a helicopter operating in the “spot market” or for which there is a large supply of readily available spares.
If the lease term is long and a lot of major maintenance is expected in the early years, then Maintenance Reserves might be preferred by an operator over Betterment Detriment as otherwise the operator must wait until the end of the lease to (partially) recover the costs off the maintenance from the leasing company.
Q: Thanks. I now have a good picture of the issues from an operator perspective. But how do things look from the leasing company’s perspective?
A: The primary concerns of the leasing company are (1) to know that proper maintenance is being done on the helicopter by the operator and (2) to avoid a scenario where it will be required to pay for maintenance costs directly. This does not form part of its business model.
This risk is at its maximum with Betterment Detriment. In an operator default / repossession scenario a considerable amount of utilisation can be left “unpaid” by the operator. The lessor ultimately ends up paying for this utilisation, either through a “buy in” fee to a Power by the Hour program or as a Maintenance Reserve “top up” to the next operator of the helicopter.
The risk is much lower with Maintenance Reserves and Power by the Hour. With both Maintenance Reserves and Power by the Hour, the funds required for future maintenance on the helicopter are segregated from the general funds of the operator.
With Power by the Hour, there are two negatives for the lessor:
- The maintenance funds are not held by the leasing company – so there is a credit risk on the PBH provider.
- It is not straightforward to extract the funds as cash from the PBH program. The PBH provider will only partially refund the cash invested into the PBH program and in certain PBH programs this “cash out” can be further reduced by risk sharing mechanisms for maintenance cost overspends.
With Maintenance Reserves, the leasing company is holding the funds as cash in its own bank account – so the two negatives of Power by the Hour are therefore eliminated. But they are replaced with a different problem – the Maintenance Reserves may be insufficient to cover the maintenance costs.
Q: In practice, how would you recommend deciding how to handle maintenance costs on a particular lease transaction? What are the things to watch out for?
A: I would start by identifying all of the major maintenance cost items for the helicopter and the likely expenditure required for each item.
There is a lot of complexity in this exercise.
Engines may be split up into different “modules”, each of which should be considered separately. Components may be on-condition or time-monitored (measured by hours, cycles, months – or even a combination). Avionics require special consideration as do major airframe inspections and anticipated cabin refurbishments.
Once the major maintenance cost items are understood it is then possible to decide how best to handle each one in the context of the transaction.
It might be preferable to cover all of the costs of replacing components under Power by the Hour programs – a so-called “tip to tail” solution. Or perhaps it is better to cover only certain components by Power by the Hour and others with Maintenance Reserves or Betterment Detriment arrangements.
Airframe inspections are a fairly significant maintenance cost item which generally cannot be covered by PBH programs because they cover only components and not labour.
Avionics are a world unto themselves and are often covered under a fixed fee “extended warranty” arrangement – effectively Power by the Hour charged on a calendar basis.
It is important to pay careful attention to the following:
- The methodology used to calculate Betterment Detriment payments.
- What is included and excluded under the Power by the Hour agreements.
- Any operating restrictions imposed by the Power by the Hour agreements.
- Any exclusions from the reimbursement of Maintenance Reserves.
Finally, no matter how complicated the situation appears, it is always a good idea to refer back to the basic principle that the operator should only pay for maintenance costs incurred in respect of its operation of the helicopter and ask whether that has been achieved by the proposed arrangements.
Q: Thanks for such a good overview of helicopter maintenance programmes; there certainly is much to consider. One last question: How prevalent are Power by the Hour and Maintenance Reserve? Do all lessors and lenders require them?
A: My experience is that there may be some instances of operators not enrolled in some type of maintenance programme as we have discussed, however, the vast majority of operators will take advantage of one form or another based upon the type of and number or aircraft they operate, their financial standing (cash flow available to pay for maintenance when due) and most importantly, what the lessor or financier may require.
For the reasons I stated, lessor, lenders and insurance companies derive comfort in knowing operators are subject to Power by the Hour and Maintenance Reserves agreements. They likely will require them as a condition to leasing, financing or insuring.