Private Debt Valuation

With the rise of private debt as an asset class, especially for institutionnal investors, I am call to find a valuation model to price private debt for the firm I'm currently working for. Especially finding quantitative or even qualitative inputs that affect the price.

I first started with simply discounting the cash flow of each debt contract that we have in our private debt portfolio. I separate between three categories, US company with fixe rate, Canada's company with fixe rate and floating rate(US and Canada all in an automatic way). The yields I use for discounting CF are the USD corporate, CAD corporate from Bloomberg terminal and I do interpolate for the credit score I don't have. That is for those with the fixed rate. For some I arrive very close (under 1%) but for other it doesn't makes any sens with over 10% away. It is to mention that I did it first for the issuance date, observe the initial credit spread and add it at the valuation date for the reference yield with the specific credit score.

For the floating rates, I substract the USD swap Curve and CAD swap curve from the corresponding yield and add it to the corresponding floating rate(LIBOR 3M by example).

I'm really at the beginning of the project, so if you have any valuation Model for private debt or any tips where I can head to, that will be appreciate. Any ressources or books would be good to. The main goal of my project, is not to find the exact price for every debt contract, which is basically impossible due to the heterogeneity of this market. But to find the main characteristics, from covenants by exemples that drive the prices of various private debts, more for a governance goal.

The first things I observed that influence the price I have are, the duration, the credit score, the time until maturity and callable bond, but it is more like an intuitively remark than a mathematically one. Something interesting to, is the fact that for a lot of debt contracts, if I change the credit score for 1 or 2 notch higher, I arrive a lot closer to the price (under 1%).

Thank you in advance for any help on the wild subject of fixed income and private debt.

Comments (7)

Jun 18, 2017 - 9:07pm

Maybe to be clearer, I will try to explain more specifically what I did for my first Method.

Evaluation method 1

We look at three cases for the valuation of private debt securities :

1) Fixed rate USD
2) Fixed rate CAD
3) Floating rate (CAD/USD done in the same time)

1) Fixed rate USD/Cash flows are made in USD. We may need to pay particular attention to Canadian companies with US dollar payments, for now, if the flows of the security are in USD, they are treated as US companies regardless.

Our reference curves or baseline basket are the bond term structures with Bloomberg's BVAL prices constructed periodically at market close. These benchmark curves are constructed with fixed-rate senior and unsecured US dollar and CAD bonds. If the curve BBB is used, then it is a mixed bond BBB +, BBB, BBB-. This will be our curves corresponding to our opportunity cost.

i) First, we find our rate at the issue date for the corresponding internal credit rating. It will be our opportunity cost and what we might have otherway. This will be our initial gross discount rate used only to find the specific premium. 

ii) The specific premium is calculated: SP = coupon rate (%) - corresponding BVAL yield at issue (%)
iii) We calculate the yield at valuation date. That is to say, our rate corresponding to our reference basket according to the internal credit rating at the valuation (e.g. if we have a debt rated BBB, then we will take the rate corresponding to the curve BBB BVAL of Bloomberg with equivalent time remaining before the maturity of the debt). If one does not have the curve according to the internal credit rating, then one uses conventional interpolations using a spline VBA function to find the corresponding credit spread.
iv) Add the specific premium calculated in (ii) to the rate calculated in (iii). We assume the SP is constant over time. Net discount rate (generic yield)= Gross discount rate at valuation date + SP.

v) Our net discount rate in (iv) is the rate that will be used as a yield input in the EXCEL XNPV function. Vi) This function calculates the net present value of a set of payments. In our case, the set of payments (input value) is the amortization table of each debt that we leave our databases, whether it is a refund in principal or interest. Payments are discounted for a year corresponding to 365 days. The entry date corresponds to the payment schedule corresponding to cash flows. The first date is the valuation date. The rate entry is our net discount rate calculated in iv).

vi) The result of this equation is compared with the money value of the asset observed.

2) CAD fixed rate. Cash flows are made in CAD

i) These are exactly the same steps as for the USD fixed rate with a few exceptions.
ii) Since we only have investment grade curves (BBB and higher) for securities denominated in CAD, then a step is added.
iii) The credit spread for the curves denominated in USD is calculated.
iv) This credit spread is then applied for the CAD benchmark rate and in this way, we have our gross benchmark discount rate at issuance based on the internal issuance credit rating.
V) Then the following steps are similar to the one for the USD fixed rate.

3) Floating rates (part of which I have the most doubt) cash flows are variable over time and depend on a reference index (e.g. LIBOR 3M, CDOR 1M, CDOR 3M, etc.)
i) We first calculate the credit spread, or rather the discount rate appropriate to the issue by removing the portion of the fixed part:
CS = Discount rates at valuation date (appropriate BVAL rate)-SWAP rate (CAD or USD)
Always for a discount rate and a SWAP rate of the same maturity as for the time remaining before the maturity of the debt.

ii) Then, the specific premium for the debt contract is calculated, in particular, given by the following equation:
SP = coupon rate-CS

iii) Finally, the net discount rate used as input in our XNPV function is given by

Net discount rate = CS at valuation + Reference index (e.g. LIBOR 3M) + SP

I find relatively poor result, from results inferior to 1% and over 10% for a lot more.

Thank You for any advices.

Best Response
Jun 19, 2017 - 1:47pm

Without reading what you wrote in detail (helpful, I know), what you should basically be doing is calculating (i) the projected YTM on the deal once you close, (ii) the implied rating of the Company based on whatever criteria you want, and (iii) the associated "benchmark" rate that corresponds to your investment (for example, relevant treasury + mkt spread for that rating as of closing date). This gives you what your implied premium over the base rate is

Then for the date that you're valuing the investment as of, you update for the benchmark rate (latest relevant treasury yield + latest relevant mkt spread) and add your premium calculated in the above starting point (and make any adjustments you deem relevant). This gives you your new discount rate, at which point you'll then discount the projected cash flows remaining on the life of the loan, resulting in your valuation

Jun 19, 2017 - 8:03pm

Ok Thank You!

I have two questions about that :

1) Is the implied premium you said is the difference at the initial date of the contract between the (relevant treasury +market spread) and the YTM in i)? Something like :

Implied premium=Estimate YTM once you close the contract-Relevant Treasury-Market Spread

2) How to we find the corresponding credit spread at any time if I have the implied rating of the company?

Jun 26, 2017 - 8:21am

Ok Thank You.

That is pretty much what I did but unfortunately, the prices that I find gives result that are not that good because it is no plain vanilla bond but really more exotics ones and a lot less liquid. I will continue to look further one case by one case.

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