7.3.1
| The methodology surrounding NPV computation can be split into two parts: (i) the mathematical mechanistic considerations and (ii) the choice of inputs. The mathematical considerations surrounding NPV computation are well documented in accounting rulebooks, practitioner guidelines and academic literature. Consequently, institutions have limited room to deviate from these rules and are expected to apply rigorously these principles in a transparent fashion. Institutions can exercise some judgement regarding the choice of inputs, although a tight framework is generally provided by accounting standards.
|
7.3.2
| Mechanics: In addition to generally accepted principles, institutions should pay attention to the following:
|
| | (i)
| The cash-flows from the facility or asset to be valued should reflect the contractual obligations of all parties. |
| | (ii) | Contractual mechanical optionality should be reflected in the cash flow structure. |
| | (iii) | Behavioural optionality should be tested. |
| | (iv)
| The granularity of the time buckets should closely reflect the granularity of the cash flows. This is particularly relevant for large facility restructuring, for which cash-flows occurring at different dates cannot be grouped in the same time bucket. |
| | (v)
| For the purpose of estimating the present cost of rescheduling a facility, institutions should compute the difference between the NPV of the original and the newly issued facility. The modelling mechanics described above should be identical for both the original facility and the new facility.
|
7.3.3
| Inputs: For a given set of mechanistic rules in place, the choice of inputs has a materia impact on the NPV values produced by the model. In particular:
|
| | (i)
| The discount factor should be chosen to reflect the opportunity cost of lending or investing the same notional elsewhere at a similar level of risk. It should reflect the contractual obligations of all parties involved in the transaction. |
| | (ii)
| In the context of facility rescheduling (or restructuring), the discount factor employed to compute the NPV of the original and the new facilities should be based on the same effective interest rate as the contractual obligations of the original facility. |
| | (iii)
| In addition, if there is evidence that the creditworthiness of the obligor has deteriorated, a credit premium should be added to the discount factor of the newly rescheduled facility. The calibration of this credit premium should be substantiated by market analysis and comparables. If no credit premium is added, justification should be provided. |
| | (iv)
| In the context of facility rescheduling (or restructuring), the cash-flows of the original and new facilities should reflect the original and the new contractual obligations, respectively. This is applicable to the principal repayment flows and interest rate payments. In particular, if the interest of a restructured facility has been dropped, the received cash-flows should include lower interest payments. |
| | (v)
| In the case of assets and facilities with floating interest rates or resetting rates, the source of the input rates should be clearly identified. Assumptions regarding forward rates should be based upon the term structure or interest rate at the date of valuation. |
| | (vi)
| In the context of facility restructuring (or rescheduling) with floating rates or resetting rates, the reference interest rates should be identical for both the original facility and the new facility. |
| | (vii)
| If several choices of inputs are envisaged for the same asset, institutions should perform several valuations under a different set of inputs and choose the most appropriate one. This choice should be clearly justified, documented and validated. The chosen set of assumptions are not necessarily those leading to the lower P&L impact.
|