ISTAT News | 01 June 2020
Jetrader: ISTAT Certified Appraisers: Valuing Aircraft During Market Disruptions
This article was originally published in the Summer 2020 issue of Jetrader magazine.
In light of the current unprecedented environment, the aviation community and, in particular, the aviation financing community, continue to rely on appraised values, but with increased scrutiny. This article is meant as guide to provide ISTAT members a better understanding of the mechanics and philosophy behind the valuation process of ISTAT Certified Appraisers and how specifics of the aircraft market, as well as individual appraiser methodologies, contribute to a variety of opinions.
The aviation industry is in extraordinary times. As we look to the past to help guide us through today and the future, we are reminded of challenging times the industry has endured. While not a perfect determinant of current challenges, this history allows us to set some indicative guardrails for the severity of the current market and its potential for recovery. Aircraft value depreciation forecasts were challenged immensely after 9/11 and the global financial crisis, as market circumstances left quite a few aircraft economically impaired for years to come, causing financial pain for many in our industry. ISTAT Certified Appraisers are using these lessons learned to respond to the current environment.
This crisis may reshape the aviation landscape forever and is undoubtedly forcing all of us in the aviation finance community to reassess how to best go forward. Industry methodologies and models will be challenged, as they should be. No player in the aviation industry should come out of this crisis without an inward-looking audit of their own assumptions and supporting philosophies. For ISTAT Certified Appraisers, this might include a view toward depreciation, economic life, and other weighing factors that underpin views toward Base and Current Market Values.
Appraised values are the appraiser’s opinion of the value of an aircraft or other asset. The opinion is constructed upon independent methodologies, a set of data points and a calculus of the intrinsic underlying value of the aircraft (Base Value). To this end, each appraiser will take their own view on economic life and depreciation along with weighing other factors relevant to the marketability and liquidity of the asset. Appraised values are not meant to be the same among firms, nor should they be. As firms may take different views of the various market segments and specific aircraft types, with regards to overall longevity and/or competitive positioning, values will undoubtedly often differ.
Different methodologies among appraisers especially come to light with older, less frequently traded aircraft. As aircraft enter into more mature profiles, and closer to end of life, the availability of data points typically becomes fewer and further between, especially for out-of-production models and those types with limited ubiquity. Because of this, appraisers may have to develop Current Market Value and/or Base Value opinions by also relying upon data points from similar aircraft, etc., using their own respective methodology and notion of “highest and best use” of the asset. As a result, values may exhibit wider disparities toward the end of an aircraft’s life.
It is also important for us to touch upon the three pillars that guide ISTAT Appraisers Program appraising methodologies. These fundamental approaches are: Replacement Cost Approach, Income Approach and the Market Comparable Approach. These methods are core to appraising and become constructive tools when overlaid with the concepts of “highest and best use” and “value in use.” Both of these notions will undoubtedly see further scrutiny as potential opportunities start to take on variations to the usual pricing models that now have to account for a lack of income and potentially a different residual construct for the transaction. As well, auditors will have to challenge assumptions provided for “value in use” as additional lease terms and subsequent assumed cash flows may no longer be viable.
In a market where an aircraft might not have much liquidity, it is essential to think about some of the fundamental definitions that guide ISTAT Certified Appraisers, especially in light of the overarching relationship between intrinsic and current value. The definitions below are critical components of our valuations and will help provide valuation guidance in an environment where data on trading is limited.
Base Value vs. Market Value
Base Value is the underlying intrinsic value of an aircraft or other asset, and not necessarily always the highest value. As recently as the beginning of the year, many appraisers had Market Value exceeding Base Value for many aircraft types, reflecting the then-strong demand. Now the pendulum appears to be swinging in the other direction. When looking at appraisals, especially between those issued at the end of last year and now, it is important to look at that delta between these two value types, and then distil how the appraiser relates these two values and the assumptions that support their respective methodology and to provide proper guidance on their values.
Market Value vs. Lease Encumbered Value
Current Market Value is the “spot” trading value of the asset in the current market. This value is for a “naked,” or unencumbered, aircraft. Lease Encumbered Value discounts rental stream cash flows and the asset’s residual value at lease-end based on expected return conditions and an appropriate discount rate. However, with many lessees proposing power-by-the hour constructs without any real minimums or base monthly rental, any assumed cash flow becomes an arbitrary exercise. Critical to this analysis is the actual technical return of the aircraft (forecasted or otherwise) and how this relates to previously negotiated return conditions vis-a-vis any expected endof- lease compensation, and what kind of value that might constitute at return (full-life, half-life, run-out or something in between).
Current Value vs. Residual Value
ISTAT defines Residual Value as the value of an aircraft, engine or other item at a future date, often used in connection with the conclusion of a lease term. Future values are loosely defined among appraiser methodologies and can be presented under various differing assumptions. The future values one usually observes in an appraiser’s valuation publication or database tend to be constructed from Base Value, which, as we have previously noted, would be the intrinsic value of the asset over its lifetime in an assumed stable market, and not necessarily a “future market value.” Any future market values are likely to be supported by a set of assumptions, which should be carefully reviewed before relying on them. This would include “soft market” values, which are increasingly being used given the current market. Additionally, it is possible to get a disconnect between Current Market Value and a future value, whereby the future value might actually be higher than the Current Market Value. This relationship, optically, can seem at odds with logic, especially now. This usually is predicated upon the connection between Current Market Value and Base Value and any applicable discounts or premiums used by the appraiser to reflect their view of the market for that particular asset, at that given moment. Those discounts or premiums tend not to be applied to future values, which results in either a significant increase or decrease in value for the next period. This construct also applies to the difference between a previously forecasted value and that value as of today.
Given what we have learned from previous cycles, one might be inclined to provide broad assumptions on asset values, but it should not be the definitive angle of attack on how to assess current values and potential recovery, especially for aircraft that are further down the curve in terms of age and maintenance life cycle. Newer, core aircraft are expected to remain in service or will ultimately return to service, but there will always be the odd exceptions due to one-off circumstances for opportunistic aircraft owners. Aircraft that are facing expensive airframe and/or engine overhauls that have material cash maintenance reserves on account might be broken down for parts. Conversely, older aircraft that may have just finished expensive maintenance prior to the current crisis may return to service. Needless to say, the simple “half-time” construct might need to be reconsidered with a more concerted effort to review maintenance status. Aircraft that are core to a fleet will have a better chance of returning to service, even if having to be parked for longer than expected. We should not forget that many airlines were backfilling their fleets as they waited for new narrowbody aircraft to deliver. This backfill of capacity is no longer needed, and those aircraft that were on short stub leases will most likely be returned. For owned aircraft, airlines remain adept at creating “Franken-aircraft,” whereby components and engines are assembled based on life remaining from other aircraft or engines. For leased aircraft, remaining tenor, return conditions, and end-oflease compensation or penalties will play large factors in the decision to retire or return.
We, as ISTAT Certified Appraisers, understand that we will be significantly challenged by this current market. For our clients, the simplicity of pulling up a value from an online subscription needs to be carefully reconsidered for its appropriateness, and extracting such a value should be the first step of many in their analytical approach. These values, while valid, should not instantly be taken at face value, nor should one immediately subscribe to the fundamentals of the past where a half-time current market value would be the default placeholder. As always, when compared to other large industrial sectors, ISTAT Certified Appraisers are working to provide guidance in an opaque market with limited data points. We also are prepared for the challenge and to be challenged; we have many tools in our toolbox when it comes to assessing value, and it is in this type of market that most, if not all, of those tools should be utilized. Thinking outside the box, for all parties concerned, should be the standard course of action in this uncertain market.
Of note, as 2019 came to an end, the ISTAT Appraisers Program embarked to review our definitions to ensure they were properly constructed, could withstand the test of time, and were appropriate given the challenges of our market (good or bad), its inherent cyclicality and history of exogenous shocks. It is important to note that this task is not being conducted with the goal of changing anything, but rather to ensure that our structure remains intact and relevant, and to only change or amend if needed. At ISTAT Americas earlier this year, the IAP spent much of our continuing education session walking through this important project. Needless to say, while our work was not all for naught given where we are today, the current environment does add a layer of complexity and furthers our discussions to include how we manage and support our industry in unprecedented times.