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  • Writer's pictureGary Crichlow

Base Values, a Trick or Treat?

Updated: Nov 13, 2023

AV Analysis Week 43

A regular update where our in house team of aviation experts and ISTAT certified appraisers use our data to analyse values, market movements and notable aviation news.


This week, our Head of Commercial Analysts, Gary Crichlow, shares his thoughts on AviationValues’ approach to providing Base Values.


Introduction

Our database tracks, and updates values daily, for over 25,000 live commercial passenger Widebody and Narrowbody aircraft with an aggregate Current Base Value of USD 615 bn. A further 13,000 are on order. Aircraft appraisals underpin much of the leasing, financing, trading and accounting activity that enables these aircraft to perform their fundamental function: to transport passengers and cargo from point A to point B.


Over the past 40 years, the practice of determining what an aircraft is worth has been codified into a set of standards and definitions by the International Society of Transport Aircraft Trading (ISTAT). While these definitions are largely accepted by the aircraft investment community, the level of familiarity and understanding of what they actually mean, and how they should be applied to a specific deal, varies significantly.


In this article, we aim to shed some light on one specific area where, in our conversations with a wide cross section of clients and industry professionals, we’ve noted some ambiguity on what our values are meant to reflect. Where they disagree with other appraisers, or where they don’t align with the user’s agenda.


We’re talking about Base Values. Ubiquitous in aviation finance, we’ll explain the three things knowledgeable investors ought to be aware of when using them, and why:

  1. There is no ISTAT rule defining how an appraiser should calculate, their Base Values. It is purely down to each appraiser to decide for themselves what a ‘balanced market’ looks like.

  2. There is absolutely no ISTAT requirement that Base Values remain static. Appraisers can and do update their Base Values.

  3. Any value, Base Value included, is a snapshot in time and is only valid as of its effective date.

Base Values: Separating Fact from Folklore

Base Values are widely used in aviation finance, primarily as a means of answering two questions:

  1. ‘What will the asset be worth’ over an investment time horizon, and

  2. ‘Where are we in the cycle’ between market highs and lows

Our research into how the concept of Base Value developed indicates that, prior to its introduction in the 1980s, the day to day Market Value of an aircraft presented a challenge to investors due to its sensitivity to volatile economic drivers. Base Value was proposed as an attempt to provide a hypothetical value of the asset, as per ISTAT, ‘in a stable market with a reasonable balance of supply and demand’ where day to day economic volatility was replaced with a set of ‘average’ economic conditions.


The rest, as they say, is history: Base Value has proved to be an extremely successful concept that, on one hand, could be said to obscure market realities; but on the other, to have been the key that unlocked the growth of investment in commercial aircraft as an asset class over the past 40 years.


Base Values are now an integral part of the commercial aircraft finance sector. But like all values, they need to be understood to be used properly.


In particular, we have noted that Base Value is often prone to conflation with a “real” measure of the aircraft’s worth. Our concern is for investors, who can open themselves up to significant risks if they do not understand how their appraiser derives those Base Values, what the numbers are actually meant to represent, and their limitations when applied to the very real market risks inherent in the investment.


It’s Not the Size of the Value. It’s How You Use It.


Like all values, Base Values are provided by the appraiser subject to certain underlying assumptions: amongst others, a Base Value is meant to apply to a specific, ‘balanced market’ scenario. Once they’re provided, however, the appraiser has limited control over how they are used. Therefore, anyone consuming Base Values for investment purposes should, ideally, have some familiarity with the underlying theory in order to ask the right questions.


In essence, the principle is that over time, Market Value fluctuates around a balance point represented by the Base Value. During the aircraft’s economic life, Market Value would be above Base Value 50% of the time, and below it the remaining 50%. An illustration of this concept over the life of a theoretical aircraft is below.


Regular consumers of Base Values may also understand Base Value to be founded in a ‘historical trend of values.’ Although this specific aspect of ISTAT’s definition was removed at the beginning of 2023, the general consensus amongst appraisers appears to remain that Base Value is meant to be a long term trend. Traditionally, Base Values are updated infrequently, and this has led to a view, espoused by many consumers of values, that ‘Base Values aren’t supposed to change.’


There are three issues here that savvy investors need to be aware of when relying on Base Values.


Issue 1: Who Decides What a ‘Balanced Market’ Actually Looks Like?

The first issue is that it is completely within the appraiser’s gift to define the market conditions relevant to a supply/demand balance. ISTAT does not prescribe any methodology, it only prescribes the value definition.


Therefore, any savvy investor would do well to go beyond simply interrogating the Base Value numbers themselves: as the adage goes, a broken clock is still right twice a day. Probing questions should be asked about how those numbers are derived. The client should be satisfied that there is a robust underlying methodology and that the balance point is not arbitrarily set.


We would deem it a warning flag that should be queried if a long historical trend of Base Values relative to Market Values does not at least approximate the theory represented in the chart above. It may indicate that the appraiser’s selected balance point has been set too high or too low.


For our part, AviationValues starts from a position that we will not define, arbitrarily or otherwise, where the balance point “should” be. Instead, we rely purely on the historical trend of Market Values, believing this to be the most reliable way of letting the market data speak for itself.


The balance point at any given date is found by using an exponential regression to find the curve of best fit through a window of historical data up to that date. The balance point is the value of the fitted curve as at the valuation date, and hence is defined as the Base Value. This leads to a historical view of Base Value that looks like the below example:


Issue 2: Base Values Don’t Change. Or Do They?

The second issue is the idea that Base Values don’t change. This is a misconception: Base Values can change, and do change.


Traditional appraisal practice appears to run to annual or semi-annual updates, with ad hoc adjustments in light of unprecedented market changes such as those precipitated by Covid-19. The important point here is that the Base Value update frequency is, like the balance point determination, also completely arbitrary: ISTAT does not require that Base Values be changed on any defined time interval. The only requirement is that the Base Value measure the appraiser’s view of the market supply/demand balance point at the point in time of the valuation.


Following on from our approach to defining the Base Value as the result of the exponential regression of the historical time series, we take the view that yesterday’s Market Value data is just as important in determining today’s market balance point as the Market Value 20 years ago. As history moves forward every day, our historical time series window moves with it.


The result is a slow-moving Base Value curve for each aircraft around which the historical Market Value genuinely fluctuates, rather than a Base Value that experiences sudden changes.


Issue 3: Base Values, Like All Values, are Cinderella: They're Rags the Day Before and Day After


From our discussions, and indeed our ISTAT appraisers’ own previous experience as aircraft financiers and consumers of appraisal services, we understand that our clients, when doing deals, or approaching impairment testing dates, or loan to value (LTV) covenant testing dates, crave stability. A static Base Value (or any other value, for that matter) that doesn’t change is much easier to consume because it avoids difficult internal conversations and external renegotiations.


However, it is important to keep in mind that, as per ISTAT, the date that a value is given is essential:

‘The date is essential because market values and market circumstances can vary over time or with the passage of events. Thus, the Appraiser’s opinions need to be understood in the context of the time when those opinions are rendered.’ (p. 35, ISTAT Appraisers Program Handbook, 2023-02-01)


Therefore, a value opinion given at the date a deal is agreed is valid for that date only. It is a snapshot in time.


ISTAT Certified Appraisers are ethically bound to avoid giving values that are grossly inaccurate; consequently, if they have reason to believe that their value opinions need to change materially due to a change in market circumstances, they must do so. This does not invalidate their preceding value opinion. Perhaps more importantly, it does not prohibit the appraiser from changing their value opinion again in future. Rather, it underscores that any value, given by any appraiser, is a snapshot in time only.


From this standpoint, having access to a Base Value that is known to move, very slowly day to day, could actually be an advantage: a daily updated Base Value calculation can be monitored to manage expectations, mitigating the risk of a Base Value opinion that can change materially and without warning.


Conclusion

When evaluating Base Values provided by any appraisers (ourselves included), savvy investors should avoid at all costs conflating the numbers with the real market. In particular, there are three considerations that they should keep in mind, in order to distinguish fact from fiction:

  1. There is no ISTAT rule, or universally agreed standard, defining how an appraiser calculates, or should calculate, their Base Values. It is purely down to each appraiser to decide for themselves what a ‘balanced market’ looks like. Appraisers have a responsibility to provide accurate and representative Base Values (or Values full stop). A broken clock is still right twice a day, so it is not enough to observe whether an appraiser’s Base Value matches a particular transaction. The methodology any appraiser employs is extremely important, and ought to stand up to scrutiny. This includes an analysis of whether the historical relationship between Market Value and Base Value indeed shows a roughly equal fluctuation of Market above and below Base.

  2. There is absolutely no ISTAT requirement that Base Values remain static. Appraisers can and do update their Base Values. The current generally accepted practice appears to be to update Base Values on an annual or semi annual basis. Furthermore, ad hoc changes to Base Values can occur unexpectedly and at any time. We would question the basis of this review frequency. If annually or semi annually, why not quarterly, monthly, weekly … daily? In our view, we see no reason to ignore or downplay recent Market Value data in formulating the long term view that Base Value is generally expected to represent.

  3. Any value, Base Value included, is a snapshot in time and is only valid as of its effective date. It is clearly easier to complete a deal when the underlying numbers don’t change. However, any appraiser can change their values at any time; indeed, if they are ISTAT Certified, they are obligated to do so if leaving their values untouched results in a grossly inaccurate value. This requirement applies to all values, including Base Values, and a value change on a given date does not invalidate the value opinion on any date prior. Indeed, there is nothing preventing the investor from concluding a deal based on a Base Value snapshot as at a particular date. From this standpoint, our daily updated Base Values can actually be an advantage: the investor can rely on our Base Value at a particular date, or choose to monitor our trend. The daily update cycle, showing very gradual movement day to day, gives them time to manage expectations as the deal progresses, or as the LTV covenant or impairment test date approaches, and avoids the headache of a sudden and unexpected material change.

For more information on how we calculate our Base Values, our Market Values, Forecast Values or for any queries on our data driven, daily updated analytics, get in touch.

Data as of October 2023.


Disclaimer: The purpose of this blog is to provide general information and not to provide advice or guidance in relation to particular circumstances. Readers should not make decisions in reliance on any statement or opinion contained in this blog.


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