How does loan trading actually work? Loans that are purchased and sold in the secondary market are classified based on their price. There are 2 main ways that loans are traded, either by par or distressed trading. Par trading occurs when the sale or purchase of a loan is above or at 90 cents on one dollar. Loans that are trading with a value of “par” are categorized as “performing loans,” as the borrower is making timely interest and principal payments.
All loan trade prices are reported as a percentage of par value. To calculate the real purchase price for a term loan to see if it is valued properly, is the purchase rate multiplied by the funded amount of the loan on the actual settlement date. When buying this loan, the purchaser is entitled to all the interest and accruing fees that are distributed after the settlement date. That said, the seller is entitled to receive all accrued but unpaid interest and fees up until the settlement date.
Distressed trading is when the sale or purchase of a loan occurs below the 90 cent threshold on the dollar. Loan prices for distressed securities are formulated the same exact method as they are for par trades.
There are three primary institutions that dabble in online trading trading, which includes banks, finance companies and institutional investors. In Europe it is a bit more toned down, as only banks and institutional investors are active. In the Eurozone, the banking sector is more comprised of commercial banks, while in the U.S. it is much more diverse and can include a commercial bank, a savings and loan institution, or perhaps a securities firm. Loan market trading is growing in both the investment-grade and high-yield markets, as companies feel more comfortable borrowing in this market.
Retail investors are able to invest in the loan market by purchasing prime funds. These funds originated in the 1980s as a way to facilitate trades for basic funds and astute investors. Managers then went on to accommodate the retail investor through closed-end and exchange-traded funds in the early 1990s. Not until the 21st century were open-ended funds introduced to the retail investor, as these types of loans offer liquidity and are redeemable each day.
Redemption funds and closed-end funds have been the standard in the past due to a lack of liquidity. The secondary loan market is simply not as liquid as open-end funds. Open-end funds significantly increased their attractiveness by the height of the real estate crisis (about mid-2008) these securities are responsible for about 15-20% of the loan assets bought and held by defined and mutual funds.
The secondary market for leveraged corporate loans has become grown significantly and is now well-established in the US. Trading gatherings and transfer documentation have seriously evolved over the last 20-years, and market participants involved in this market have been aided by increased transparency and liquidity. By far, leveraged loans that are most liquid are syndicated deals at origination by an established investment bank.
Industrial and commercial borrowers make up the bulk of the deals. Regardless of an individual’s trading strategy there is no question that the market continues to grow, as more folks are participating in these markets. As liquidity expands in this sector, we can see interest in these securities grow even further as investors remain on the search for yield.