Valuing assets: could COVID-19 be a game-changer?
20 May 2020: Aircraft are extreme assets at the best of times. Even in good times, it is hard to make sense of their values. A downturn that grounds thousands of them makes the assessment of value even more of an ordeal. That is where expertise and experience count.
Phil Seymour is the President of the International Bureau of Aviation (IBA), the aviation data and consulting firm based in Surrey, UK. He is also an International Society of Transport Aircraft Trading (ISTAT) Senior Appraiser Fellow and was the Chair of the Appraiser Programme from 2012 to 2018. This means that he, and the team he leads, are the experts the banks, leasing companies, airlines, and others, turn to for an appraisal of aircraft assets and, ultimately, their value.
Under COVID-19 conditions, this is a complex task made so much more complicated by market conditions.
First up, all aircraft are not equal. They come in different sizes, with different ranges, different engines, different modifications and different ages – to mention just a few variables. And they are operated under different business models, under various ownership structures, with associated financing and maintenance packages. It is fair to say that owning an aircraft is a precarious choice, yet banks and leasing companies continue to do so; and airlines have continued adding fleet and operating aircraft over the decades, in spite of the obvious ups and downs.
At present, there are lots of downs. There is no surprise that several large US carriers have already received significant support: American Airlines, Delta, United, Southwest, JetBlue and Alaska lead the table for the size of their support packages. In Europe, Air France-KLM and easyJet have needed support – the latter drawing on the Coronavirus Corporate Financing Facility – and Cathay in Asia-Pacific has needed help.
But given that the crisis is so much more prolonged than expected, the support accessed may prove to be woefully inadequate, and make less impact on long-term outcomes than desired.
So what does all this mean for valuations? “We are getting questions from banks, leasing companies and airlines on how to assess their asset values in particular with respect to impairment,” says Seymour. He is referring to the core principle in ‘IAS 36 Impairment of Assets’ that an asset must not be carried in the financial statements at more than the highest amount to be recovered through its use or sale. In some cases US GAAP is the relevant standard and there are of course subtle differences in how that test is considered.
The IAS36 standard says: “If the carrying amount exceeds the recoverable amount, the asset is described as impaired. The entity must reduce the carrying amount of the asset to its recoverable amount, and recognise an impairment loss.”
We could potentially be looking at thousands of impaired assets being operated by airlines, all of which may have business models under serious strain. Added to that is the conundrum that many aircraft owners (often banks and lessors) have little intimate knowledge of the aircraft on their balance sheets, many of which are looking increasingly distressed.
Seymour points to two tests that can be applied under IAS36. The first is fair value less the cost of sale; and the second is value in use. “But if an aircraft can’t fly, does it have a value in use,” he says. “And if the market is dead, what is a fair value less the cost of sale? The value could be zero.”
Clearly none of these valuation methods makes sense – you couldn’t sell these aircraft in any sensible way if you wanted to, so how should appraisers, like Seymour, respond to banks, lessors, lessees and anyone else that retains his company for the purpose of valuing aircraft assets?
This is where ISTAT comes in. After the Gulf War in 1991, a huge number of aircraft were not flying and many airlines ceased operations. ISTAT stepped in and worked up a definition of aircraft base values. “The Base Value of an aircraft is the longer-term economic value of the aircraft, rather than the spot value that could be realised today,” says Seymour.
“Even if the coronavirus crisis takes two to three years to resolve, an aircraft still has an economic life of 25-30 years and so it is still a valuable asset,” he says, although he concedes that COVID-19 could be a game-changer for aircraft values going forward.
So which assets are most vulnerable? “If it were just wide-body aircraft that are vulnerable, why did Flybe fail?” says Seymour. “The better question is how does the aircraft fleet fit with the airline’s business plan – and this can only be evaluated on a case by case basis.”
He continues: “Often, the most vulnerable aircraft are the largest aircraft in that particular airline’s fleet.” So an airline operating a mixed wide-body and narrow-body fleet could see the wide-bodies as vulnerable aircraft from the values point of view; a regional airline with a few narrow-bodies and the remainder being turboprops would probably be concerned about the narrow-bodies. It is all relative and connected to business models.
Then comes the thorny question of repossession…but only if an airline is truly destined to fail. “Repossession is not really a solution for an accountant,” points out Seymour. It does not resolve the value question. That brings us back to impairment.
“Loan to value covenants in aircraft finance documentation might not be met under COVID-19 conditions,” says Seymour. “True, it might not seem like a fair test in this situation but, if the airline is a going concern and the specific aircraft is an essential part of its future plans, we could use the Base Value as a fair proxy for Value in Use. The alternative could result in the airline taking a huge impairment – and that impairment will not go away in subsequent years."
Clearly there are lots of questions to ask and lots of parties to be brought together to discuss potential solutions to a situation no one could have foreseen. The Gulf War and the aircraft Base Value adopted by ISTAT in 1991 is what appraisers have to work with. Will it be enough?