I have checked on Google and youtube about secondary loan but couldn’t find much on the topic since it is known by several names in different countries and possibly searched using low-level terminologies used during the process. So, I’ve decided to write something about it so that people interested in this area might get benefited. As knowledge sharing is my idea, I will continue to share knowledge in a general way considering the confidentiality and sharing limitation been regulated in united states.
Selling debt and secondary loan market
Most of the time, people get confused with the term selling debt and secondary loan market. We know that it might be related with loan given by the middle/secondary group of bodies, and it is different from first degree loan. However, this is apparently true but it is too general to brought-in in this secondary loan market. Allow me to explain in a layman term to you.
Let’s start with, how organizations sell debts?? And to whom and who all comes into the process really matters. I am writing this to help people who really bother to understand how it works. Finance is a straight forward business which is mostly regulated by self understanding and some agreed laws (viz LSTA etc, could be different in different countries), and unlike bonds, loan has no such obligations. Loan is an independent practice which is there for investments. It does the same thing what it is designed for, it basically help poor organizations, I am sorry I have been little sarcastic, okie lets call them needy organizations. Guess we have learned something during MBA, BCG matrix with Cows, dogs, stars and the bullshit…. It does the same thing, taking money from the wealthiest organizations and gives it to needy organizations so that they can expand or strive. During the course of action, banks can play “inception” I liked that movie a lot? This will help in describing secondary loan mechanism which is extremely different from primary loan because of loan-debt and debt again and again from one to another hedge funds/fund managers or sometimes the investment banks.
How inception? Loan is once given can become debt and this debt can be sold to other banks or hedge funds/fund managers for generating profits. This is how it becomes complex, loan after loan after loan. I will try to make it simple with an example, say there are 3 people, A (AB myself), B (investment bank) and C (Hedge funds/fund manager). A asked B for lending him 4 dollars, and B lend A 4 dollars with an agreement of returning in a week time with 1 dollar interest. Now A has a debt of 4 dollars which he has to give it to B by the end of this week with 1 dollar interest. B has decided to borrow money from C and will seek someone else who can ask for loan again. B asked for 4 dollars from C and both agreed for a period of 1 week and $.50 interest. B gets a new guy D asking for loan and they agreed for another 1 dollar and a week payback. So, considering only these many loan/debt transfers B gets $1.50 as profit at the end of this week.
Note: B is the lender and A is the borrower. In secondary loan market, B is the assignee, C is assignor (transferring the paper) and A is the borrower.
In complex scenarios with bigger budget and uncertainties of the assignors and borrowers, due to LSTA (Loan syndicate trade association) it becomes transparent who all are different parties, and there is a whole set of approval system for the process. In this scenarios B (Investment Bank) will interact with C (Fidelity investments) asking their concerns of doing deal with A being the borrower. When C agrees then B hires an agent [agent could be someone from B (investment bank as well), or it could be from different institution, JP Morgan charges $XXXX for signing as an agent]. Agent now go to A (AB – myself) asking would you like to have a deal with C? Do you think C will be faithful? It solely depends upon A to accept (yes) or reject (No). If it is yes, the deal is done and debt is sold. This is how secondary loan market works; there are plenty of other stuffs with it.
I can understand the agony of not having finance background, but trust me finance is so simple and straight forward industry compared to other industries but yes it can become complicated at times.