3.4 Role of Events in Forecasts

The asset valuation takes into account various events through their impact on future cash flows.

• Events of defaults and dividend lockup can have an impact on:

  • Expected debt cash flows:

    • First, debt payouts stop for at least one period.

    • After the event, the “market value of debt” should be the expected value of debt in the mean debt restructuring scenario (the “exit value” according to Hasan and Blanc-Brude, 2017). If the company restarts paying its debt in the next period, it is out of default; a new debt service forecast is computed.

  • Maturity dates:

    • Defaults that lead to restructuring often lead to a new debt maturity date.

    • Expected equity cash flows: Likewise, equity cash flows must stop (they may have stopped earlier due to a lockup event).

    • Investment end date: In some cases, hard defaults lead to revisiting the expected end date of the entire investment. If the asset is heavily impaired, the analyst can take the view that this investment is likely to be declared bankrupt in a few years’ time. This new, shorter investment end date can have a very material impact on expected cash flows and asset value. This is also the case on the debt side.

• Events of debt prepayment can have an impact on:

  • Debt valuation: When senior debt is repaid early, credit risk is removed, and future debt service is cancelled (with or without penalties for borrowers (“make-whole clauses”, which are reflected in the final payouts). Hence, asset value in that year is estimated as the face value of outstanding debt (in line with IFRS 9).

  • Equity valuation: Repayment of all senior debt typically leads to its replacement with shareholder loans, hence the future value of all cash flows to all equity may increase significantly as a result.

• Events of debt refinancing can have an impact on:

  • Debt valuation: The new future debt service reflecting (usually) lower interest rates is reflected from that date onwards by the standard treatment of cash flows.

  • Equity valuation: Events of refinancing also impact equity valuations by (often) increasing expected FCFE, which is also reflected in the standard treatment of cash flows.

• Events of business-model change have an impact on future uncertainty:

  • They lead to resetting the uncertainty measure of the DSCR “system” (i.e., the covariance matrix of the state equation that determines the signal-to-noise ratio), thus reflecting that any “learning” from past data is less reliable from that point onwards and that information filtered from newer data should be given more weight.

_{Hasan, M. & Blanc-Brude, F. (2017). Discount rate term structure estimation with highly illiquid assets. EDHEC Infrastructure Institute-Singapore.}