Debts, Loans, and Promissory Notes
Appraisal Economics values a wide range of debt securities ranging range from simple promissory notes to exotic instruments with complex terms. We have valued unsecured promissory notes due from individuals, illiquid auction rate municipal securities held by publicly traded companies, and credit facilities with complex embedded derivatives.
Individual clients and their attorneys, accountants, and financial planners often retain us for gift and estate tax-related work. We appraise debt instruments for tax planning purposes, sometimes held in revocable, irrevocable, grantor retained annuity, or other types of trusts. We provide the rigorous supporting documentation that must accompany Form 706 when an estate’s tax return is filed with the U.S. Internal Revenue Service. Corporate clients often engage us to value for financial reporting purposes senior term loans, revolving credit facilities, asset-backed loans, debentures, fixed and floating rate securities, and various types of fixed income securities and structured products with debt-like characteristics. We also analyze the terms and covenants of proposed transactions to provide a solvency opinion when parties are in the due diligence stage of negotiating a deal.
Often we are called to appraise one or more promissory notes included in a decedent’s estate. These notes may be secured or unsecured, and can be due from an individual or a legal entity, such as a limited partnership that holds real estate and marketable securities. It is not uncommon for these notes to bear interest at a fairly low “applicable federal rate” (AFR). After an analysis of the credit risk and projected cash flows, it is common to conclude that the debt’s AFR yield is below the market interest rate. Accordingly, the fair market value is lower than the face value of the promissory note, resulting in a discount from the reported value and lower gift or estate taxes. The cost of hiring a qualified appraiser to perform and support this analysis can be negligible compared to the tax savings. For this reason, may attorneys use promissory notes as one element of a holistic estate planning strategy.
It is important to note, however, that the IRS can and does audit these returns and appraisals in an attempt to rightfully prevent fraud and abuse. This makes it critical to hire a firm that is highly experienced, has the proper qualifications and credentials, and has a reputation for integrity. On many occasions, we have been hired by the IRS to review appraisals prepared by other appraisers and submitted by taxpayers. Our task has been to review the appropriateness of the methodologies employed and the reasonableness of the conclusions of other appraisers. Our unique perspective, experience, and reputation may be part of the reason our concluded values are often undisputed. If an inquiry or audit does occur, we are confident that we have performed a thorough analysis and have selected reasonable and defensible assumptions, and we are well prepared to respond and support our conclusions.
To value a debt instrument, we review the history of the security, the terms of the legal documents governing the obligation, the financial position and credit risk of the debtor, any assets that serve as collateral or other enhancements to protect the creditor’s position, and the probability that the creditor will be repaid in full and on time. Based on our analysis, we determine appropriate market interest rates, which are used to conclude the fair market value. If the debt has any embedded derivatives, such as embedded call or put options, our analysis typically includes an option pricing model or a Monte Carlo simulation to value the equity components of the security.
To learn more about our decades of experience valuing debt instruments – ranging from simple promissory notes to portfolios of debts with embedded derivatives – and how our experience valuing performing and reviewing valuations can help you, please Contact Us.