Ask most people what a loan is worth and they’ll tell you the balance. Face value, carrying value, whatever is sitting on the balance sheet. That answer is intuitive, but it’s usually wrong.
Nobody makes that mistake with equity. When you value a business, you expect the answer to differ from book value, sometimes by a lot. Debt gets treated differently because the cash flows are contractual, and contractual feels certain. But fair value asks the same question it asks everywhere else: What would a market participant pay for this today?
The difference between valuing debt and equity
Equity investors accept a wide range of possible outcomes. If a company grows, they benefit from that upside. If it struggles or fails, they may recover little or nothing — as equity holders are generally last in line behind lenders and other creditors. Equity can offer significant return potential but also significant volatility.
It’s a familiar framework. The distinction, and the underlying challenge, is that debt doesn’t follow the same logic. Lenders exchange that upside potential for a defined stream of payments and a higher priority claim on the borrower’s assets. The return is largely defined upfront, but a loan’s value can be influenced by factors unrelated to the borrower’s performance. It can perform exactly as expected and still be worth more or less than its face value at a given point in time.
Understanding why requires looking beyond the borrower’s ability to repay and considering how the loan compares to alternative investments in the market.
Debt doesn’t reward you for being right
Consider a $1 million loan with a five-year term and a fixed interest rate of 5%. The borrower continues to make payments on time, and there are no concerns about repayment. On the surface, nothing has changed.
Now, assume market interest rates rise to 10%.
If the lender wanted to get out of their position, a prospective buyer of the loan would be unlikely to pay the full $1 million. After all, why purchase a loan yielding 5% when comparable investments are now generating 10%? Instead, the buyer would discount the purchase price until the loan’s expected return better aligns with current market conditions. In this scenario, the loan might be worth approximately $810,000 despite performing exactly as intended.
The opposite is also true. If market rates decline, a loan with a higher fixed interest rate may become more attractive, increasing the amount a buyer is willing to pay.
This is where equity-trained thinking can lead people astray. When valuing a business, the primary question is how the company is expected to perform. When valuing a loan, performance remains important but is only part of the equation. Fair value reflects what a market participant would pay for that loan today, meaning both the borrower’s creditworthiness and prevailing market conditions influence the result.
Why this distinction matters
The importance of debt valuation has grown in tandem with the expansion of private credit. More funds, portfolios, and debt investments are being brought to market, creating greater demand for reliable fair value assessments.
As organizations grow, valuation expectations often evolve as well. Institutional investors, auditors, and other stakeholders increasingly expect debt portfolios to be evaluated through an independent, market-based lens rather than solely through the perspective of the holder.
Understanding how debt is valued has become more than an academic exercise. Recognizing that a loan’s contractual value and its market value aren’t always the same is essential for accurately assessing debt investments. As debt portfolios grow in size and complexity, overlooking that distinction can lead to decisions based on assumptions that the market simply doesn’t share.
