Valuing Private Credit in an AIF: A Practitioner's Guide

Valuing a private credit NCD held in a Category II AIF portfolio requires more than applying a discount rate to contractual cashflows. The analyst must consider the instrument’s covenant package, the issuer’s evolving credit profile relative to origination, the liquidity premium appropriate for the remaining tenor, and — crucially — how the portfolio-level concentration affects the fund’s NAV computation under SEBI’s reporting framework.

This note walks through the framework we apply in practice. It is written for fund managers, CFOs, auditors, and LPs who want to understand what sits behind an independent valuation output — not just the number at the bottom of the page.

The four inputs that actually move valuation

For most Indian private credit instruments, four things determine the valuation. Everything else is either noise or a specific-case adjustment layered on top of these.

1. Contractual cashflows. Coupon schedule, amortization profile, call or put features, step-up coupons, prepayment premia, and the economic impact of any structural features (coupon accrual, PIK, bullet redemption).
2. Issuer credit position. How the issuer’s credit profile has evolved since origination — financial performance, leverage, liquidity, covenant compliance, and forward visibility — and how that evolution maps to the instrument’s subordination.
3. Discount rate. The market yield at which a comparable instrument would be originated today, constructed from a risk-free curve plus credit spread plus instrument-specific adjustments.
4. Liquidity. The portion of total expected return that reflects the time cost of not being able to exit the position until scheduled redemption.

Getting any of these badly wrong produces a bad valuation. Getting all four approximately right produces a valuation that will survive auditor review, LP scrutiny, and — if necessary — regulatory examination.

Constructing the discount rate

Most valuation disputes we see trace back to discount rate construction. The common failure mode is embedding credit risk, liquidity, covenant adjustments, and mark-up for subordination into a single number without documenting how that number was derived. The resulting valuation is defensible only if the number happens to be right.

We decompose the discount rate into explicit components:

• Risk-free rate — the appropriate G-Sec yield for the instrument’s remaining tenor
• Credit spread — observable reference spread for the issuer’s credit rating (or implied rating)
• Subordination adjustment — additional spread reflecting the instrument’s position in the capital structure
• Covenant adjustment — tightening or loosening relative to standard comparables based on the specific covenant package
• Liquidity premium — spread for the instrument’s private nature and remaining tenor

Each component has an audit trail. Each is sensitivity-tested separately. The final discount rate is the sum, not an opinion.

The liquidity premium deserves a specific comment. Private credit instruments in India typically trade (if at all) at a material spread to listed corporate bonds of equivalent credit. Research on Indian private debt suggests this premium ranges from 100 to 300 bps depending on tenor, issuer profile, and market conditions. We benchmark against recent primary issuance for comparable instruments where observable, and apply structured judgement where not.

Covenant-adjusted modelling

Covenant packages matter more to valuation than standard methodology acknowledges. Two otherwise-identical instruments, one with a full set of financial maintenance covenants and information rights, the other with a thin covenant package, are not worth the same amount — even if their contractual cashflows and issuer rating are identical.

In our framework, the covenant package affects valuation in two ways:

1. Probability of pre-maturity action. Stronger covenants increase the probability of an early intervention (acceleration, restructuring, refinancing) that protects investor value. Weaker covenants permit credit deterioration to proceed further before any remedy is available.
2. Discount rate adjustment. Where observable, the spread differential between cov-heavy and cov-lite primary issuances of comparable issuers flows through to the discount rate as a covenant adjustment.

For bilateral NCDs in AIF portfolios — which typically have bespoke covenant packages, not standard listed-issuance language — this adjustment is routine rather than exceptional.

Issuer credit profile: tracking evolution

Origination credit is a point-in-time view. Valuation requires the current view.

For each instrument, we track the issuer’s credit profile on a rolling basis: latest financial performance, leverage and coverage metrics, liquidity runway, covenant compliance, rating actions, and management commentary. The purpose is not to rebuild a rating — that is the rating agency’s job — but to identify where the issuer’s profile has materially moved from the origination view, which in turn moves the credit spread component of the discount rate.

This is the step most often shortchanged in internal AIF valuation processes. The discount rate at origination gets carried forward with minor adjustments; the credit profile that justified that rate has moved substantially; the valuation does not reflect the movement; the auditor raises a concern at year-end.

An independent valuation process rebuilds the credit view quarterly and documents the conclusion in each valuation memorandum.

Portfolio-level considerations under SEBI’s framework

For Category II AIF NAV computation, instrument-level valuation is necessary but not sufficient. SEBI’s framework requires portfolio-level considerations including concentration-adjusted valuation where a position represents an unusually high portion of the fund, appropriate treatment of linked positions (where multiple instruments share a common underlying risk), and consistent treatment across positions to prevent cherry-picking of methodology.

Our valuation output therefore includes both instrument-level memos and a portfolio-level overlay documenting:

• Concentration analysis and any concentration-based adjustments
• Linked-position identification and consistent treatment
• Methodology consistency across the portfolio
• Reconciliation to prior-period valuation with variance explanation

The LP pack that follows from this is explicitly designed to answer the questions a sophisticated LP will ask, not just the minimum required by the framework.

Sensitivity is non-optional

Every valuation we deliver includes sensitivity tables across:

• Discount rate (typically ±50 bps, ±100 bps)
• Credit spread (±50 bps, ±100 bps)
• Prepayment assumption (where relevant)
• Default and recovery (where relevant)
• Covenant remedy timing (where structural features depend on it)

The purpose is to make the valuation robust to scrutiny. An auditor or LP asking "what if your discount rate is 50 bps too low" should receive an answer, not a question in return.

What a valuation memorandum should contain

For our own work, the minimum content of an instrument-level valuation memo is:

1. Instrument description — issuer, instrument type, key contractual terms
2. Cashflow model — documented assumptions, scenario construction
3. Discount rate decomposition — each component, each source, each adjustment
4. Issuer credit view — latest profile, changes since origination, rating position
5. Covenant analysis — package summary, covenant-based adjustments
6. Benchmarking — comparable instruments and observable market data
7. Sensitivity analysis — all parameters tested
8. Concluded valuation — the number, with basis and sign-off

If a memo is missing any of these, the valuation has not been done. Whether the missing piece matters for a specific instrument is a matter of judgement; whether it was considered is not.

Final observation

The quality of private credit valuation in Indian AIFs has improved materially over the last two years, driven by LP pressure, SEBI framework updates, and auditor scrutiny. It still has further to go. Funds that build credibility on LP reporting and valuation governance early will find that credibility compounds; funds that do not find themselves in increasingly difficult conversations as portfolios mature.

Getting this right is a discipline, not a one-off project. Independent valuation is the forcing function that keeps the discipline in place.

For a discussion about quarterly valuation for a Category II private credit AIF, or independent review of an existing valuation framework, get in touch.