The secondary loan market is the sale of loans that happens when syndication of the original loan is closed and allocated. It includes trades or sales of syndicated loans lenders make in the original syndicate and those subsequent purchasers make. There are reasons why a lender may want to sell part or all of its commitment and they are explained below.
First, it is to realize capital. In the case of a long-term loan, a lender can sell its share to realize capital and enhance its liquidity to be in a position to take advantage of other lending opportunities.
The second reason for secondary loan market, is for risk management. A lender can consider that too much emphasis on a specific type of industry, maturity, geography or borrower has weighted the loan portfolio. By selling its loan, the lender can lend elsewhere hence reaping from new lending opportunities as well as diversifying its portfolio.
The third reason is regulatory capital requirements. The ability of a bank to lend is subject to external and internal requirements to retain a particular percentage of its capital to cater to its existing loan obligations. A lender can use the secondary loan market to actively manage its loan portfolios to adhere to regulatory capital requirements.
Finally, it is to crystallize a loss. A lender can sell its commitment in case the borrower gets into hardships hence realizing an instant value for its commitment other than keeping a commitment whereon assurance is given that the borrower can repay its debt. Also, a lender can incur huge costs in watching over a borrower in financial hardship. Specialists with distressed debt offer a market for these loans.
On the other hand, a borrower can decide to buy the commitment in a facility due to these reasons.
First, is to develop and expand relationships. A primary lender can choose to increase its exposure to a particular borrower hence bettering its profile and building a relationship with them so that the borrower can assume the role of an arranger or agent in future syndications as well as cross-sell commodities to the borrower.
The other reason is to make a profit. Traders seek to utilize the secondary loan market as a way of earning a profit by selling on a purchased debt at a level that is higher than its buying price, usually in a short gap of time.
Last but not least, it is to own a portion of the debtor company. Investors may purchase a huge part of a borrower’s debt with a view of gaining control of the company. Alternatively, the investor could be in need of influencing the insolvency of the borrower or restructuring the process. The investor could be investing based on its assessment of the likelihood of the company is going to be successfully rescued, the ultimate goal being to benefit from any subsequent increase in the worth of the business. In addition, the investor could be having a view that the recovery via insolvency or breakup value will be enough to gain from its original investment.