Understanding appraisers in aircraft values
There has been an active discussion in the comment section on the “Rate 35” post and the relative merits of appraisals and appraisers with respect to the Airbus A320 and Boeing 737NG.
We’ve been involved in the airline business since 1979 and from 1990, when we co-owned Commercial Aviation Report (CAR), have followed the appraisal business. Given the discussion in “comments,” we think a dedicated post is worthwhile.
CAR created the industry’s first commercial appraisal conference in 1990. ISTAT–the International Society of Transport Aircraft Traders–at that time was still largely a small, professional organization, far difference than what it is today.
CAR’s first conference brought together nearly every appraisal company then in existence in the US to compare and discuss appraisals of what was called Enhanced Equipment Trust Certificates (EETCs) and appraisals published by the firms.
At the time, EETCs were a popular method of financing airplanes, particularly for the poorer US airlines. The theory was that several tranches (or levels) of funding “enhanced” the credit protection. The A tranche had the highest level of credit protection, followed by the B and C tranches. EETCs were typically structured at an aggregate 80% loan-to-value (LTV) and the credit rating agencies rated the EETCs on the basis of airline credit, the equipment type and equipment age of the airplanes covered by the EETCs.
In theory, the lenders then were well protected in the event of a default.
This was put to the test in 1991 following the Iraq invasion of Kuwait. But this is getting ahead of the story, so stand by.
The appraisers provided valuations for each of the aircraft contained within EETCs and three appraisers were hired to provide these. It was off these appraisals that the LTV was set.
In that 1990 CAR conference, we ran our own math and showed that appraisals in the sample EETCs selected for discussion varied by 25%-35%–a wide number, we believed that (to skip a lot of discussion) demonstrated that appraisals were as much art as science at the time (and, we believe, to this day). One of the appraisers opined that appraisals would be considered accurate if they were within 10% of each other.
The challenge, of course, is that each appraisal firm has its own methodology in creating appraisals. What was true then and what is true now is that the methodologies meant that some firms tended to put more generous than others. Typically these firms were hired by the airlines floating the EETCs because they wanted to get as much money out of them as possible.
This meant that for new airplane purchases, airlines typically had appraisals well in excess of their actual purchase prices so that the EETCs often funded 110%-125% of their actual purchase price.
For used airplanes, the valuations were also usually generous when it comes to EETCs.
How do appraisers come up with the valuations? There is a lot of detail to this, but on a macro level, they look at the list prices published by the airframe manufacturers (OEMs); they try–usually unsuccessfully–to get the OEMs to tell them some actual sales prices; and they go to their market sources for sales prices on new and used aircraft. Prices used to be included in FAA filings and Department of Transportation filings. The airlines and OEMs got DOT to withhold these prices as commercial sensitive, and when the industry tumbled that we at CAO were reading the FAA filings, getting the numbers and publishing them, the airlines and lessors objected and literally made a federal case out of it. The FAA published a rule-making case in the federal register and, although we put up a good fight (including American Airlines conflicting out our lawyer in the process), we knew we would lose and we did. The numbers were then redacted from all future FAA filings as commercially sensitive.
The absence of the numbers from the FAA and DOT made it all the more difficult for the appraisers to get good values in their research.
Then came the 1991 Gulf War, and ultimately 40% of the US airline capacity went into bankruptcy: Pan Am, Eastern, Continental, TWA, the first Midway Airlines, and several others. Continental and TWA were prolific users of EETCs, particular for older aircraft. All these bankruptcies put the “enhanced” theory to the test and it royally flunked. Aircraft values plunged so precipitously that the 80% LTVs were meaningless protections. The lenders who were supposed to have ample values were burned anyway.
The credit rating agencies over the years have stepped down the LTVs until today EETCs and similar instruments are more in the 50%-60% LTV range on valuations provided by appraisers.
So how do appraisers come up with values today? As noted above, they talk with the OEMs and the market. Airbus and Boeing hold appraiser seminars to discuss the values and virtues of their airplanes.
Over the years Boeing has been particularly effective at this. As we noted in the Rate 35 comment section, Boeing’s 737NG generally rates higher than the A320 in part because it typically has 12 more seats in airline service and it has one engine type to the A320′s two types. It is generally more difficult to place A320 V2500 engined airplanes than A320 CFM equipped aircraft, and lease rates for the V2500 aircraft typically are (today) $60,000-$70,000 less than CFM equipped A320s. This is reflected in the values.
Boeing is so good and forward-thinking for these appraiser meetings that it was already promoting the virtues of the 787 before the roll-out of the the first one.
Airbus over the years had been far behind Boeing in briefing the appraisal community. It has gotten better in recent years, but by then the “damage” had been done.
Another element in 737s being valued better than A320s is the difference in Airbus and Boeing philosophy through downturns. Boeing would cut production and lay off thousands of workers. Airbus would maintain production and the worker levels (since laying off didn’t really save Airbus money under European labor laws). Thus, to sell the A320, Airbus often cut prices–or so Boeing told appraisers, and appraisers independently confirmed. This practice led to an over-supply of A320s and depressed values, appraisers concluded.
Finally, one reader asked whether the appraisers had agendas like the rating agencies did during the lead-up to the 2008 corporate bust in which companies like AIG were triple A rated but collapsed anyway.
As with any industry, there are good appraisers, mediocre ones and not so good ones. Back in 1990, when CAR staged that first conference, there was a widespread belief that some firms were “for sale” to their clients. There was one notorious story that illustrates.
Appraisers, in addition to publishing appraisal books and doing specific jobs, also do what is called “desktop appraisals.” This is when someone is buying or selling an airplane and needs a quick idea what an airplane is worth. Appraisers generally don’t like to do these because a good appraisal required understanding the hours and cycles of the aircraft in question and its place in the maintenance cycle from the last heavy maintenance check or to the next one. These are critical components of doing a good appraisal.
Then there is what is called “Base” and “Current Market Value” appraisals. A Base appraisal is defined as the value of an airplane in a stable market with good supply and demand. A CMV appraisal takes into account an inflated or depressed market and whether there is a supply and demand imbalance. There is today’s price and future pricing as far out as 20 years.
The notorious story involved one appraiser who was called by a potential buyer for a desktop appraisal. The buyer was given one figure. Then the potential seller called, as it happened, the same appraiser and a different, higher figure was provided for the same airplane. Within the community, the appraiser’s integrity was a matter of discussion.
On the EETCs, the same appraisers were routinely used all the time because they were known to give the highest appraisals. This did not infer anything untoward–these were, in our view, among the reputable firms. It’s just that their methodologies were among the more generous. We tended to like the conservative appraisers.
Some appraisers lean toward Boeing airplanes for the single-aisle aircraft, but the A319 tends to be better than the 737-700. Most tend to like the A330 better than the 767; and all like the 777 over the A340. They are still feeling their way on the A380 but generally don’t favor the airplane because of limited remarketing potential and low launch customer pricing.
So here is a long-discussion of the appraisal community and how they do their work.