Valuation

This case centers on the valuation of a distressed mezzanine debt portfolio intended for acquisition by a private real estate investment fund. The portfolio comprised over 15 individual debt issues issued by more than 10 distinct real estate borrowers, the majority of which were either in default or actively undergoing financial restructuring.

Valuation Methodology:

To deliver a rigorous and comprehensive assessment, AFS employed a multi-faceted valuation framework that combined market-based data, discounted cash flow modelling, and third-party benchmarking. The valuation results were expressed both as a percentage of the outstanding principal and in absolute euro terms, offering insight into the portfolio’s value under prevailing market conditions and issuer-specific circumstances.

The multi factor approach started with the critical step of the analysis of each issuer’s financial health and judicial status whether in default, restructuring or simply late for payments. Each issuer was assigned a risk grading that incorporated quantitative financial metrics (e.g., leverage ratios, liquidity position), qualitative factors (e.g., information quality, recovery plans), and legal status. This grading directly influenced the valuation models by adjusting recovery expectations and discount rates, allowing differentiation between issuers with varying credit profiles. For instance, mezzanine debt linked to issuers with late payments was valued higher than debt from issuers already in default, reflecting a relatively stronger probability of repayment and lower risk premiums.

It was followed with two main approaches and a third confirmatory approach:

1. Market-Based Valuation:
   The valuation used trading prices of distressed and defaulted debt securities, referencing mid-prices from a broad sample of European issuers’ bonds. Adjustments were made to account for differences in seniority , and loan terms relative to the benchmark instruments. This approach provided a market-driven perspective on the value of non-performing real estate debt.
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2. Discounted Cash Flow (DCF) Analysis:
   For mezzanine assets with a plausible recovery potential and forecastable cash flows, a forward-looking DCF model was constructed. Cash flow projections incorporated expected principal repayments, interest accruals, and restructuring outcomes with the repayment horizon aligned with typical timelines observed in debt restructurings. A risk-adjusted discount rate was derived from the yields of distressed but performing loans, reflecting credit risk, liquidity risk, and macroeconomic factors.
   Future cash flows were discounted using this risk-adjusted rate.
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3. Control Analysis:
   The valuation was cross-checked against third-party industry statistics on default probabilities and recovery rates to ensure robustness. This confirmatory layer ensured alignment with broader market expectations and historical performance.

Conclusion :

The combined application of market-based pricing, discounted cash flow projections, and benchmarking, augmented by issuer-specific credit analysis, provided a robust and defensible valuation framework for the distressed mezzanine debt portfolio. This comprehensive approach captured the nuanced interplay between market dynamics and individual asset risk profiles, thereby enhancing valuation accuracy and ultimately supporting informed decision-making for portfolio management.

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