22:49
Faizan
What you see is not what you get
Most private promissory notes are not worth the amount printed on their face. This surprises many individuals because we have been trained to believe, and trust that the amount printed on financial documents is definite and absolute. We all trust a $100 bill will buy $100 worth of groceries; we all trust a Bank Certificate of Deposit will be repaid with US dollars. But, private promissory notes are not the same as dollars and bank certificates of deposit. Let's dig into some basic reasons why the purchase price of notes is discounted. The reasons below are just the basic reasons for note discounts.
The principal reason for the discounting of private notes is they lack the backing of the full faith and credit of the United States of America. Because private notes have uncertain repayment capabilities, they are riskier than US government financial instruments. The discounts arise because of the repayment risk. A promise to repay a debt, even if backed-up by a mortgage on real estate, is not as safe as a promise backed-up by the US government. By discounting the value of the note its yield is increased; the increased yield compensates for the increased risk. Consequently, many private notes sell at a discount from their unpaid balance to compensate for the risk of non-repayment.
Basic factors that cause note discounts
No promissory note market place. Most financial assets are bought and sold at a market place. It may be a physical location like the New York Stock exchange or it may be an electronic marketplace. We are all familiar with stock markets, bond markets, cattle markets, used car markets, gold markets, silver markets, etc. But, no promissory note market place exists. All private note transactions are done privately, between the seller and the buyer; they negotiate with each other, and the results of the transaction-the price paid-is only known to them.
The number of note investors is small
Everyone wants to have a $100.00 bill in their wallet, but, not everyone wants to have their savings invested in a piece of paper called a promissory note; Most people want cash money in their wallet; they do not want a promise from someone to pay them money in the future.
Promissory note investors are the type of person who actually wants to own that piece of paper that contains a promise to repay the money plus interest at some future date. Statistically speaking, note investors comprise less than 1.0% of the population. Because 100% of the population would prefer cash money, and less than 1.0% is willing to invest in promissory notes, they comprise a very small potential market.
Because there are relatively few buyers and sellers for private notes in the country, and because they reside in different states, the buying and selling happens at a much slower pace than would happen on a centralized, public market. The small number of potential note buyers results in less bidding and price competition; notes sell at discounted prices. Because there are few buyers, note sellers must discount the note to induce a purchaser to buy.
No two promissory notes are the same. Because each promissory note was custom tailored to fit a specific business transaction, each note has its own language, terms, and conditions. It might have been drafted for a divorce settlement, a partnership liquidation settlement, as a gift note, or as a mortgage note--to name a few examples of different types of notes. Therefore, each note and its documentation must be studied and analyzed individually. This requires skill, time and expense.
Summary Promissory notes are discounted to reflect risks. The key reasons causing the risks and the discounts are:
No promissory note market place exists
The number of note investors is small
No two promissory notes are identical
Remember, a lot of stuff in the system is miss-priced and not realistically valued.
This article focused on three basic risk factors that cause notes to be discounted, but it was far from a complete presentation of the many other risks that can affect the valuation of notes. In a subsequent article, we will explore those additional factors.
Lawrence (Larry) Tepper specializes in the valuation and appraisal of promissory and mortgage notes, and other cash-flow financial instruments nationally. Nation-wide services for banks, trust companies, self-directed IRA accounts, estates, attorneys, CPAs, and individual investors.
Consulting Services-Free Appraisal Price Quotes
EDUCATION AND TRAINING
Law Degree /Accounting Minor University of Denver
Managing Colorado Real Estate Broker-- Promissory Notes Specialization
Certified Commercial Investment Member from the National Assoc. Realtors (CCIM)
PRACTICAL EXPERIENCE
35 + years of national promissory note and mortgage note appraisal and valuation for Banks, Trust Companies, Attorneys, CPA's, Estates, Trusts, Executors, Administrators, and Financial Advisors.
Most private promissory notes are not worth the amount printed on their face. This surprises many individuals because we have been trained to believe, and trust that the amount printed on financial documents is definite and absolute. We all trust a $100 bill will buy $100 worth of groceries; we all trust a Bank Certificate of Deposit will be repaid with US dollars. But, private promissory notes are not the same as dollars and bank certificates of deposit. Let's dig into some basic reasons why the purchase price of notes is discounted. The reasons below are just the basic reasons for note discounts.
The principal reason for the discounting of private notes is they lack the backing of the full faith and credit of the United States of America. Because private notes have uncertain repayment capabilities, they are riskier than US government financial instruments. The discounts arise because of the repayment risk. A promise to repay a debt, even if backed-up by a mortgage on real estate, is not as safe as a promise backed-up by the US government. By discounting the value of the note its yield is increased; the increased yield compensates for the increased risk. Consequently, many private notes sell at a discount from their unpaid balance to compensate for the risk of non-repayment.
Basic factors that cause note discounts
No promissory note market place. Most financial assets are bought and sold at a market place. It may be a physical location like the New York Stock exchange or it may be an electronic marketplace. We are all familiar with stock markets, bond markets, cattle markets, used car markets, gold markets, silver markets, etc. But, no promissory note market place exists. All private note transactions are done privately, between the seller and the buyer; they negotiate with each other, and the results of the transaction-the price paid-is only known to them.
The number of note investors is small
Everyone wants to have a $100.00 bill in their wallet, but, not everyone wants to have their savings invested in a piece of paper called a promissory note; Most people want cash money in their wallet; they do not want a promise from someone to pay them money in the future.
Promissory note investors are the type of person who actually wants to own that piece of paper that contains a promise to repay the money plus interest at some future date. Statistically speaking, note investors comprise less than 1.0% of the population. Because 100% of the population would prefer cash money, and less than 1.0% is willing to invest in promissory notes, they comprise a very small potential market.
Because there are relatively few buyers and sellers for private notes in the country, and because they reside in different states, the buying and selling happens at a much slower pace than would happen on a centralized, public market. The small number of potential note buyers results in less bidding and price competition; notes sell at discounted prices. Because there are few buyers, note sellers must discount the note to induce a purchaser to buy.
No two promissory notes are the same. Because each promissory note was custom tailored to fit a specific business transaction, each note has its own language, terms, and conditions. It might have been drafted for a divorce settlement, a partnership liquidation settlement, as a gift note, or as a mortgage note--to name a few examples of different types of notes. Therefore, each note and its documentation must be studied and analyzed individually. This requires skill, time and expense.
Summary Promissory notes are discounted to reflect risks. The key reasons causing the risks and the discounts are:
No promissory note market place exists
The number of note investors is small
No two promissory notes are identical
Remember, a lot of stuff in the system is miss-priced and not realistically valued.
This article focused on three basic risk factors that cause notes to be discounted, but it was far from a complete presentation of the many other risks that can affect the valuation of notes. In a subsequent article, we will explore those additional factors.
Lawrence (Larry) Tepper specializes in the valuation and appraisal of promissory and mortgage notes, and other cash-flow financial instruments nationally. Nation-wide services for banks, trust companies, self-directed IRA accounts, estates, attorneys, CPAs, and individual investors.
Consulting Services-Free Appraisal Price Quotes
EDUCATION AND TRAINING
Law Degree /Accounting Minor University of Denver
Managing Colorado Real Estate Broker-- Promissory Notes Specialization
Certified Commercial Investment Member from the National Assoc. Realtors (CCIM)
PRACTICAL EXPERIENCE
35 + years of national promissory note and mortgage note appraisal and valuation for Banks, Trust Companies, Attorneys, CPA's, Estates, Trusts, Executors, Administrators, and Financial Advisors.
