Flawed valuation undercuts ResCap noteholders’ diminution in value claim
A recent ruling in the multifaceted Chapter 11 bankruptcy litigation of Residential Capital (ResCap) contains a noteworthy analysis of the alleged diminution in value of the collateral of junior secured noteholders (JSNs). Bankruptcy experts have observed that only a few decisions have tried to measure the decrease in value of collateral.
‘Global summary’ valuation: ResCap was one of the leading originators and servicers of residential mortgage loans in the country. In May 2012, ResCap and its affiliated debtors petitioned for Chapter 11 bankruptcy. The JSNs held or managed entities holding junior secured notes. To keep their business operating as debtors in possession, the debtors sought to obtain post-petition financing and authorization to use the cash collateral encumbered by existing debt facilities. They negotiated a cash collateral order with the JSNs that established the latter’s right to adequate protection for the use of their collateral.
In subsequent litigation over ResCap’s reorganization plan, the JSNs claimed a right to recover an adequate protection claim of $515 million based on the diminution in the aggregate value of their prepetition collateral as used during the case under a number of consensual orders.
Both sides agreed that the amount of the adequate protection claim was the difference in the value of collateral between the effective date and the petition date. Moreover, they agreed that $1.88 billion was a baseline value at the effective date. They disagreed over the value of the collateral on the petition date. The JSNs had the burden of proof. They presented opinions from four experts who sought to determine the fair market value of the various assets that were part of the collateral by considering, to the extent applicable, the prices the assets commanded in a post-petition auction process and adjusting back to the petition date. Also, one of the experts presented a single "global summary" of the opinions, arriving at a net fair market value of $2.79 billion.
The court found the valuation unreliable. For one, it incorrectly assumed the debtors could have sold the JSN collateral on the petition date free and clear of certain obstacles. However, at trial, one of the experts admitted that the sale of mortgage servicing rights would have required consent from the residential mortgage-backed securities (RMBS) trustees and government-sponsored entities, coming at a high cost. Also, in this case, most of the assets could not simply be handed to a buyer who could instantly benefit from full value “as if the assets were commodity products.” According to the court, the experts “ignored the reality” of the dire situation of the debtors just prior to the bankruptcy. Thus, even though it was “mindful” of the JSN money the debtors had spent during the case, the court found this spending did not mean they incurred a diminution in the aggregate value of their collateral.
An extended discussion of In re Residential Capital, LLC, 2013 Bankr. LEXIS 4844 (Nov. 15, 2013) is in the February issue of Business Valuation Update; the case will be available soon at BVLaw.
TIC interest valuation: real estate or security?
Robert Buchanan (PCE Valuations) reports on a pending Tax Court case that will address the valuation of an undivided interest in real estate—a tenant-in-common (TIC) interest. A valuation his firm had performed several years ago was of a 40% TIC where there was no formal entity into which the real estate or the interest had been contributed.
“Our valuation approach was that this interest was a security and is a passive investment because investors do not have any decision-making power,” he says. “When it comes to real estate joint ventures, like TIC interests, a non-managing, non-control, undivided interest is likely to meet the definition of a security established by the Investment Advisors Act and various case law. Therefore, our approach focused on the rate of return that would be required by investors to buy the interest, given an assumed holding period and related risks. Conceptually, we viewed this as no different from valuing a non-control interest of an entity that holds the same real estate.”
IRS challenge: The IRS disagrees with his company’s analysis and views the TIC interest as a mere real estate interest, with its value based on an appraisal of the underlying real estate by a qualified real estate appraiser. That appraisal was for $4 million, so the value of the 40% interest, without consideration of its noncontrolling and nonmarketable nature, would be $1.6 million.
“The reason for the IRS challenge was that our valuation approach produced a materially lower value,” he says. “We are anxiously awaiting the ruling … fingers crossed.
Will the PCC’s goodwill alternative affect valuation analysts?
The Financial Accounting Standards Board has released the first two GAAP alternatives created by the Private Company Council (PCC). These alternatives provide private companies with (1) an alternative accounting model for goodwill; and (2) a simplified hedge accounting approach for qualifying interest rate swaps.
The goodwill alternative, Accounting for Goodwill Subsequent to a Business Combination, allows a private company to amortize goodwill over a period of up to 10 years and to apply a simplified impairment model to goodwill. Step 2 of the impairment test would be eliminated and replaced with a simpler calculation. Companies that choose the alternative will have to test for impairment only when a triggering event occurs that would indicate that the fair value of an entity may be below its carrying amount.
Impact: Although the goodwill alternative is designed to cut the cost of compliance for private companies, they may elect not to adopt it. That’s because if they are acquired by a public company, they would have to undo the election and restate financial statements. So there may be little impact on valuation analysts—for now.
The FASB also voted to add a project to its technical agenda to consider similar alternatives to the existing goodwill impairment model for public companies and not-for-profit entities. Of course, if this is approved, private companies would have less risk of restatements, so more of them may adopt the alternative. This would have a greater impact on valuation analysts.
IVSC issues exposure draft on valuation bases
The International Valuation Standards Council (IVSC) has published an exposure draft of guidance and illustrative examples to assist practitioners in understanding and correctly applying the principles in the International Valuation Standards, primarily those in the IVS Framework, in different situations. The three principal bases of value contained within the IVS Framework are:
- Market value: The estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm’s-length transaction after proper marketing and where the parties had each acted knowledgeably, prudently, and without compulsion;
- Investment value: The value of the asset to the owner or a prospective owner for individual investment or operational objectives; and
- Fair value: The estimated price for the transfer of an asset or liability between identified knowledgeable and willing parties that reflects the respective interests of those parties.
The IVS Framework also defines “special value” and “synergistic value,” which are components of one or more of the above three bases of value. Special value is an amount that reflects particular attributes of an asset that are only of value to a special purchaser. Synergistic value is an additional element of value created by the combination of two or more assets or interests where the combined value is more than the sum of the separate values.
Comments on the exposure draft are invited and should be submitted no later than March 31.
Pratt’s Stats Hall of Famers for 2013
With the help of business intermediaries who submit deal information, Pratt’s Stats continues to be the leading private company merger and acquisition (M&A) transaction database. BVR has created the Pratt’s Stats Hall of Fame to thank those intermediaries who have contributed the most transactions. For 2013, they are: Brad Bottoset (The Liberty Group), Bob Howells (Business Brokers of San Antonio), Stanley L. Pollock (Professional Practice Planners Inc.), and Frank Stabler (Certified Business Brokers). Sincere thanks to these and all of the individuals who have helped BVR improve the database to make it the most useful source of deal data.
BV movers . . .
Ed Belanger has been appointed Corporate Valuation Services (CVS) practice leader at Great American Group Inc. He has 20 years of experience in the valuation of business interests and intangible assets over a wide range of industries … Steven D. Henry, MAI, has joined Pluris Valuation Advisors LLC as vice president in the Newport Beach, Calif., office … Fesnak LLP, a leading accounting and business advisory firm, announced that W. Michael Wolfe has been promoted to partner and will be responsible for continued leadership and expansion of the firm’s BV practice section.
Super lineup of CPE events
BVLaw Case Update: A One-Hour Briefing (January 22). Featuring: Sylvia Golden (Business Valuation Resources) and James Alerding (Alerding Consulting). BVR’s legal editor and one of valuation’s most experienced voices examine the most important judicial decisions of the past six months. Their docket includes a New York divorce case that keeps on giving—valuation issues—and a peculiar Tax Court case that illustrates what happens when a taxpayer fails to pay its appraiser and is left to take on the IRS without expert testimony.
HIPAA, Valuation and Litigation: Civil and Criminal Implications for the Unaware (January 28). Featuring: Mark Dietrich. The 2014 Online Symposium on Healthcare Valuation begins with the series curator on the legal liabilities appraisers face when engaging in healthcare appraisals and the very serious consequences of ignoring the legal responsibilities of those with access to healthcare records.
Valuing Hotels (January 30). Featuring: Mark Dayman (CapVal-American Business Appraisers LLC) and Kari Lazarova (Valuation Aspects LLC). Learn how to properly value what may be one of the most ubiquitous business types in existence. From the deceptively simple to the dauntingly complex, Dayman and Lazarova will cover what every appraiser needs to know.
Private Company Considerations in Measuring Fair Value (February 4). Featuring: Mark Zyla (Acuitas Inc.). BVR’s 2014 Online Symposium on Fair Value Measurement continues with a look at potentially game-changing proposals by the Financial Accounting Foundation’s Private Company Council (PCC) to make changes and exceptions to GAAP for private companies. Join Symposium curator Zyla to find out how these alterations, subject to FASB endorsement, could affect valuation, fair value measurement, and GAAP standards.
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