HedgeStar provides full service support to all types of entities that need fair values for bonds (issued debt) or require valuations on bond investments. We value all types of fixed rate and floating rate bonds using market standard pricing methodologies.
HedgeStar provides valuations to issuers of debt that comply with the requirements of ASC 820-10-35. Our team of valuation professionals uses proprietary pricing models for all types of debt instruments including fixed rate bonds, notes and debentures, Build America Bonds, variable rate demand bonds, auction rate bonds and municipal bonds. We use a combination of historical trade data and market established yield curves published by independent sources to arrive at our yield assumptions.
Fixed Income Investments
Many of our clients have large portfolios of fixed income investments that require fair value reporting under ASC 820. We provide valuations for all types of fixed income investments from a simple U.S. Treasury security to complex collateralized mortgage obligations. Many of the portfolios that we analyze contain Level 1, Level 2 & Level 3 assets.
Independent Bond Valuation Services
HedgeStar can perform daily, weekly, monthly, quarterly or annual valuations based on the end-of-day market pricing, depending upon our client’s requirements. We can value bonds that are denominated in U.S. dollars or any of the major global currencies.
ASC 820-10-35 Determining Yield and Coupon Rates on the Measurement Date
Considerations for valuing Variable Rate Demand Bonds (VRDBs) include the maturity date of the bonds, the credit rating or credit characteristics of the issuer, and the coupon and yield of the bonds. With ASC 820-10-35, issuers valuing their liabilities are required to ignore any credit enhancement that was put in place for the benefit of bondholders. Since we know the maturity date of the bonds and can assess the credit of the issuer through independent ratings and credit analysis, the only remaining two variables are the coupon and the yield.
HedgeStar uses three methods to determine the market yield of the issuer’s bonds. First, we examine the issuer’s fixed rate bonds (if any) that have priced and traded in the secondary market on or about the date of the analysis. This information is available through the MSRB’s Electronic Municipal Market Access EMMA website: http://emma.msrb.org. Next we analyze the pricing of similar type and credit quality bonds issued in the primary market on or about the measurement date. This information is available through Bloomberg or other subscription based pricing services. We combine the data from our research of actual issuer bond trades and similar primary issues with market yield curves, such as the MMD curve, MMA curve, or Bloomberg yield curves that are available for municipal bonds of various types and ratings to arrive at the market yield for each bond.
Determining the coupon is a bit more challenging. One way to establish the coupon on the bond for purposes of valuation is to use industry averages for VRDBs or use published index yields, such as the Bond Buyer 25 bond revenue index or the AAA rated GO bond index, which is published and observable from a variety of sources. Another method is to project the coupon based on construction of a forward rate curve for the SIFMA index if the VRDBs are tax-exempt or a similar index such as LIBOR if the VRDBs are taxable. Construction of the forward curve also includes an estimate of the spread over which or under which the VRDBs historically traded relative to the index
ASC 820-10-35 Related to Bonds with Credit Enhancement
ASC 820-10-35 provides several clarifications related to measuring fair value of financial assets/liabilities in inactive markets. Included in the statement are several points related to measuring liabilities with credit enhancement attached to them. Under ASC 820-10-35 if a liability has a credit enhancement (such as a guarantee) attached to it, the effect of credit enhancement must be excluded from the fair value measurement of the liability. For example, in determining the fair value of debt that has a third-party guarantee the issuer can only consider its own credit standing, not the credit standing of the third-party guarantor. That credit enhancement is obtained for the benefit of the investor and does not represent an asset of the issuer. Any payments made by the guarantor under the guarantee result in a transfer of the issuer’s debt obligation from the investor to the guarantor. The issuer’s resulting debt obligation to the guarantor has not been guaranteed. Thus, the fair value of that obligation only considers the issuer’s credit standing and not the credit standing of the guarantor. Transactions with credit enhancement issued by a governmental entity or agency (the FDIC for example) and credit enhancement between a parent and its subsidiary, are not included in this accounting provision.
Credit enhanced bonds that have resetting coupons, such as VRDBs, present a valuation challenge under ASC 820-10 because the value of a bond at any point in time is a function of the coupon and the yield, and when the rates are variable instead of fixed, the coupon and yield are much harder to ascertain.
VRDBs are typically structured as long term bonds that have an investor put and are credit enhanced by a highly rated financial institution that provides credit support and liquidity. The issuer pays a fee to the credit enhancer and the credit enhancer is obligated to purchase any bonds that cannot be successfully remarketed by the remarketing agent or any bonds where the put on the bonds is exercised by the investor. In effect, the credit enhancer is providing both liquidity on behalf of the issuer and a high rating on the bonds.
VRDBs have a coupon resetting mechanism that allows the remarketing agent to reset the coupon rate on the bonds on a daily, weekly or monthly basis and remarket the bonds to new investors at par. In other words, VRDBs are structured as a long term liability but are priced and sold to investors as a short term investment instrument. This is possible because the short term investors have the right to put the bond at par and the credit enhancer is obligated to purchase any bond that is put back by investors.
As long as the credit enhancement is in place and there is no general market disruption, VRDBs can be resold by the remarketing agent. However VRDBs cannot be remarketed to traditional short term investors if they suddenly lose the credit enhancement (such as when bond insurers lost their “AAA and “AA”” ratings in 2008). Short term investors need the liquidity provided by the put and AA- or higher credit ratings in order to place those investments in money market funds.
Considerations for valuing VRDBs include the maturity date of the bonds, the credit rating or credit characteristics of the issuer, and the coupon and yield of the bonds. With ASC 820-10-35, we are required to ignore the credit enhancement. Since we know the maturity date of the bond and can assess the credit of the issuer through independent ratings and credit analysis, the only remaining two variables are the coupon and the yield. DerivActiv has developed proprietary pricing models for all types of issued debt and we use historical trade reporting data from EMMA and yield curves from MMD, MMA, and Bloomberg to establish benchmarks for fair value calculations.
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