COVID-19, related government responses, and market dynamics have caused major disruptions to all markets, including residential credit and whole loans. In the last 10 days alone, originators have paused production of non-QM loans, home flippers such as Zillow and Opendoor have stopped purchasing homes, and liquidity has become the utmost concern for many investors.
While this market is very volatile and constantly changing, one constant is the need for robust valuation practices. Investment managers should be aware of the following considerations:
- Market volatility will draw increased scrutiny from auditors and regulators, as well as investors.
- Loan portfolios that were previously marked at Level 2 may experience reduced liquidity and drop to Level 3, thereby requiring a different valuation methodology and a reassessment of critical inputs to the valuation.
- Valuation inputs should be reviewed for their appropriateness and alignment with the market.
- Is the input supported by actual market transactions to actual market participants?
- Broker quotes may not be appropriate, depending on what the quotes represent. The crucial factor is whether the broker can transact at that price or if it is just an indicative bid.
- The use of a valuation model to determine fair value is acceptable under ASC 820 when the above does not exist. Valuation models present equally challenging issues, such as:
1. Does the model pricing reflect an orderly transaction among market participants?
2. Are the underlying inputs and assumptions appropriate, given the current market?
3. How should models factor in extreme market movements in a short timeframe?
- With these important details, many investment managers elect to use a third-party valuation provider. This provides increased documentation, transparency, and independence of the pricing process.
Given the depth of Phoenix’s client base and active trading desk, Phoenix can provide best-in-class insight into the whole loan market and deliver relevant portfolio analytics. We’d appreciate the opportunity to be your strategic advisor, and we look forward to helping you define and execute your goals.