European debt valuation FAQs
Real Estate | Kennett Square, PA
Managing Partner, Board Member
Head of Europe
Real Estate | London
Debt valuation is important for any entity required to report fair value. Historically, there have been different valuation policies, methodologies, and opinions making comparisons difficult and leading to inconsistency. To facilitate transparency and confidence in the valuation of institutional real estate and infrastructure investments, consistency around debt valuation is critical.
Below we summarize some of the most common questions on debt valuation with the purpose of clarifying best practice and addressing some arising queries.
Why mark debt to market? Why fair value?
Regulatory and reporting requirements drive a need for valuation for most institutional investors who need to report fair value. Revaluing debt is a component of the fair value calculations. Fair value also facilitates confidence and trust in the capital markets. Two key principles that enable this are: fair value needs to be aligned and supported with market participant behavior and fair value needs to reflect appropriate and supported volatility.
Does marking these loans to market rather than just reporting an amortized cost offer a benefit to investors?
Marking debt to par (amortized cost) implies all debt impacts equity returns the same way, regardless of contractual interest rates. Marking debt to market benefits investors by clarifying the attributable impact of above/below market interest payments on performance returns.
Do market moves affect buy and hold investors?
Even if you are holding debt to maturity, it is important to quantify the difference between contract and market debt service. Margins might drastically change, as we saw during the COVID-19 pandemic, and this will have an impact on your overall income returns.
How do you evidence “market participant” behavior for benchmarking market rates given that loan pricing is typically private information?
Chatham is regularly engaging with the debt and capital markets teams from our clients (global real estate investors). This gives us insight into current market participant behavior. Our valuations team hosts quarterly calls where we present refreshed market information. Chatham also has access to more than 18,000 loans in our internal database. We see many new originations every month through our advisory business and have access to the supporting facility documents for these real estate transactions.
Has Chatham’s approach led to questions from auditors? How does this methodology address auditor’s questions and concerns?
We encourage active dialogue with auditors regarding methodology, market support, and questions that may arise during the audit process. These discussions start with alignment to the relevant accounting standards such as IFRS and the different NAV calculations. We also proactively work with our clients to answer any audit related queries. Additionally, we provide dynamic tools, such as a live model, where auditors can see the calculations used to arrive at our conclusions.
Do you approach valuation of fixed-rate debt the same way as floating-rate debt which is then fixed with a swap?
Practice differs when it comes to valuing swapped floating-rate debt. INREV and EPRA only require that fixed-rate debt be marked to market. However, it is important to consider how fixed-rate debt is defined (e.g., a strong argument can be made that a swapped floater is effectively fixed-rate debt). There needs to be more consistency around valuations for floating-rate debt that is swapped to avoid having inconsistent NAV calculations.
How do you measure the creditworthiness of the tenant occupying the underlying collateral? What specific measures do you consider and what do you generally consider to be the threshold for each measure? If there is a guarantor, do you also take that into consideration?
The credit profile of tenants or the borrower is part of the risk profile that was underwritten during the loan origination process. Similarly, guarantees and recourse provisions are considered in the original pricing of the loan. By anchoring to the origination rate, we are accepting the risk that the lender analyzed as a part of the deal at origination. Subsequent to origination, deriving an appropriate discount rate becomes an exercise in understanding how the capital markets and how the risk profile of the investment has changed since origination.
How do lenders and borrowers work with valuers to ensure the valuations of properties that are the subject of ESG loans are as accurate as can be?
We focus on the risk profile of the investment, so we assume ESG components were incorporated when the loan was originated. Only if the risk profile changes, or the ESG criteria is not met during the life of the loan, will the loan valuation differ.
As more regulatory and reporting entities such as INREV, EPRA, IFRS, and AIFMD require funds to fair value their debt, the need for a debt valuation approach that is reflective of market conditions rises.
Debt valuation methodologies for financial reporting
This paper provides a framework for measuring the fair value of debt that is rooted in a thoughtful observation of market behavior and in a way that facilitates transparency, consistency, and confidence in fair value measurements for financial reporting.
Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.
Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.21-0198
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