Private Debt

CHAPTER 14Loan Valuation

How accurate are valuations in the absence of a tradable market for middle market loans? This is an important question for most investors in direct corporate loans for several reasons. First, many investors in public business development companies (BDCs) focus on the price‐to‐NAV ratio (the BDC market price divided by net asset value) as a potential measure of under‐ or overvaluation, signaling a buy or sell opportunity. If net asset value is incorrect, so is the valuation signal. Second, manager fees are based upon net asset value so mistakes in valuation can potentially cause fee overpayments. Third, some direct lending pooled vehicles allow investors to purchase or sell units at net asset value. Private BDCs and other registered and nonregistered, open‐end pooled vehicles are examples. For example, if net asset value is overstated, the excess value is passed from the new shareholders making investments to existing shareholders, and at the same time excess value is passed from existing shareholders to withdrawing shareholders. Excess value flows in the opposite direction when net asset value is understated. This chapter addresses how direct loan values are determined and whether investors can rely on them.

As background, the Financial Accounting Standards Board (FASB) defines asset value as fair value,¹ prescribed by ASC 820 most recently in 2011. ASC 820 defines fair value as “the price that would be received to sell an asset or paid to transfer ...