Unlike real estate or publicly traded assets, the value of a note is not always the same as the original loan amount. FMV reflects the current economic reality of the note, not just what was funded at closing.
Outstanding Principal vs Market Value
A common assumption is that FMV equals the original loan amount or the remaining principal balance. In reality, FMV may be influenced by several factors beyond the balance owed.
FMV for a note typically considers:
- Outstanding principal balance
- Payment history and consistency
- Interest rate and terms
- Remaining term of the loan
- Current status of the borrower
In many cases, a performing note with consistent payments may be reasonably valued near its outstanding principal. However, changes in performance can affect value.
How Payments and Defaults Affect FMV
Payment history plays an important role in determining FMV.
- Performing notes: Notes that are current and paying as agreed are often valued at or near outstanding principal.
- Late or inconsistent payments: These may reduce the market value of the note.
- Notes in default: Defaulted or non performing notes may have a lower FMV than the principal balance, depending on recovery expectations.
FMV should reflect what a willing buyer might pay for the note given its current status.
Who Typically Provides the Valuation
For private lending notes, FMV is commonly provided by:
- The note servicer
- The borrower or issuer
- The sponsor or investment manager
- A qualified third party familiar with the loan
The valuation should be reasonable, supportable, and reflect the status of the note as of year end.
Documentation and Reporting
Supporting documentation should clearly show:
- The outstanding principal balance
- Payment status
- Any changes to terms or performance
- A stated value or explanation of how the value was determined
This documentation allows the custodian to report FMV accurately without making assumptions.
Keep the Purpose in Mind
FMV reporting for private lending is about accurate reporting, not taxation. Reporting a lower FMV due to performance issues does not create a tax consequence, and reporting a higher FMV does not trigger income.
FMV is simply a snapshot used for compliance and recordkeeping.