December 2009 | Issue 42
The unprecedented turmoil in the capital markets over the past two years has required courts to sometimes think in new ways when valuing securities. This was demonstrated in the American Home Mortgage Holdings, Inc. Chapter 11 Bankruptcy case, (2009 WL 2855888 Bkrtcy. D. Del., Sept. 8, 2009). In determining the value of a portfolio of mortgage loans in this case, the Judge, (Christopher Sontchi), opted for a discounted cash flow approach over the use of market or sale value.
American Home had sold a loan portfolio to Calyon (an affiliate of Credit Agricole and Credit Lyonnais) in a repurchase or “repo” transaction. The repurchase agreement required American to repurchase the loans from Calyon upon the occurrence of an event of default.
Default and Claims
On August 1, 2007, (the “Acceleration Date”), Calyon served American with a notice of default. The acceleration of the repo agreement caused the Debtors to be obligated to repurchase the loans from Calyon for $1,143,840,000. Five days later, on August 6, 2007, American filed a voluntary Chapter 11 petition in Bankruptcy Court in Delaware. On January 10, 2008, Calyon filed proofs of claim against the Debtors in the total amount of $1,154,579,000, an amount which exceeded the repurchase price under the repurchase agreement.
On January 9, 2009, Debtors filed their objections to Calyon’s repurchase claims, seeking to either disallow them, or reduce them to an amount to be determined pursuant to Section 562 of the Bankruptcy Code. Section 562 instructs the court to use “commercially reasonable determinants” to measure the damages in connection with repurchase agreements. Debtors contended that the value of the portfolio exceeded the repurchase price, and that therefore there was no deficiency or damage claim.
Calyon argued that no “commercially reasonable determinants of value” existed on the Acceleration Date because the only appropriate valuation method is market or sale value, and Calyon could not have obtained a commercially reasonable price on the Acceleration Date because the market was distressed.
Debtors argued that on the Acceleration Date they had at least two different methodologies that reflected commercially reasonable values for the loan portfolio, a discounted cash flow analysis and a market analysis. Because both of these methodologies valued the loan portfolio at or above the repurchase price, the Debtors asserted that Calyon had no deficiency claim, and therefore no damage claim.
Debtors’ expert ascribed a value of between $1.148 billion and $1.163 billion to the portfolio. He testified that he had analyzed each of the more than 5,600 mortgages in the portfolio by applying a discount rate which he determined from a review of the Federal Home Loan Mortgage Corporation’s Primary Mortgage Market Survey. He then adjusted the interest rate to reflect what was happening in the mortgage market at the time, and finally applied the adjusted rates to the discounted cash flows (DCF) on each individual mortgage and totaled them to determine the value of the loan portfolio. He accounted for the delinquency rate of the portfolio as of August 1, 2007, and assumed a 50% recovery rate for loans identified as delinquent at the time.
The Debtors’ expert testified as to the appropriateness of a DCF valuation in all market conditions, noting that if there is a market for the assets at issue, the market should correlate closely with the DCF valuation, “unless there is something very, very strange going on in the market.” He also testified that where the market is dysfunctional, the DCF is still an appropriate valuation methodology because it values the asset’s cash flows, which continue regardless of market conditions.
Calyon presented an expert witness who testified that the market value of the loan portfolio was at best 10 cents on the dollar on the Acceleration Date. His stated basis for this conclusion was that unresolved questions as to ownership of the loans would have made it very difficult to find a buyer, analogizing the situation to attempting to sell a car without a title. Asked to assign a value to the loans under the assumption that there were no ownership issues, he opined that the value would be at a discount of about 50 cents on the dollar (the Judge didn’t disagree with this estimate).
The conclusion reached by the court, however, was that the DCF analysis carried out by the Debtors’ expert was credible, and represented a commercially reasonable methodology for determining the value of the loan portfolio. He found that Section 562’s reference to “commercially reasonable determinants of value” is not limited to market or sale value of an asset.
Because the value of the loan portfolio exceeded the amount of Calyon’s claim, Calyon had no deficiency claim and therefore no damage claim under Section 562.