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Loan Sales and Other Credit Risk Management Techniques Chapter 27

Loan Sales and Other Credit Risk Management Techniques Chapter 27. Financial Institutions Management, 3/e By Anthony Saunders. Loan Sales. Loan sales have taken place for over 100 years. Correspondent banking Small banks selling parts of loans to larger banks. Participations.

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Loan Sales and Other Credit Risk Management Techniques Chapter 27

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  1. Loan Sales and Other Credit Risk Management Techniques Chapter 27 Financial Institutions Management, 3/e By Anthony Saunders

  2. Loan Sales • Loan sales have taken place for over 100 years. • Correspondent banking • Small banks selling parts of loans to larger banks. • Participations. • Expansion of loan sales during 1980s. • Due to expansion of HLT loans. • Early 1990s decline in loan sales followed by recent expansion. • Expanding economy and resurgence in M and A’s.

  3. Bank Loan Sale Market • May be sold with or without recourse. • Types of loan sales • Emerging market • Domestic • Traditional short term • HLT Loan sales

  4. Traditional Short Term • Key characteristics • Secured by assets of borrowing firm. • Loans to investment grade borrowers or higher. • Short term. • Yield closely tied to commercial paper. • Denominations of $1 million +.

  5. HLT Loan Sales • Key characteristics • Term loans. • Usually senior secured. • Long maturity (often 3- to 6-year maturities). • Floating at rates tied to LIBOR, prime or a CD rate. • Strong covenant protection. • Usually distinguished as distressed / nondistressed.

  6. Types of Loan Sales Contracts • Participations • Limited contractual control. • Assignments • Currently form bulk of the market (90% +). • All rights transferred on sale of loan. • Normally associated with Uniform Commercial Code filing.

  7. The Buyers and Sellers • Buyers: • Often segmented. • Example: distressed HLT loan buyers generally investment banks, hedge funds, vulture funds. • Inter-bank loan sales in traditional market historically due to branching restrictions. • Insurance companies and pension funds in long-term loans.

  8. The Sellers • Major money center banks, U.S. government and its agencies. • Good Bank - Bad Bank: • Establishment of subsidiary banks specializing in handling nonperforming loans (NPLs). • Increases value of Good Bank. • Allows structuring of Bad Bank to improve management incentives and operating efficiency.

  9. Other Sellers • Foreign banks • ING is a major market maker (HLTs). • Investment Banks • Bear Stearns. Generally large HLTs. • Government agencies (HUD for example) • Increased due to Federal Debt Improvements Act, 1996. • Largest sales to date, RTC.

  10. Why Banks and Other FIs Sell Loans • Credit risk management • Reserve requirements • If sold without recourse, removed from balance sheet. • Fee income • boosts reported earnings under current accounting rules.

  11. Why FIs Sell Loans (continued) • Capital costs • Meet capital requirements by reducing assets. • Liquidity risk reduced by loan sales. • Glass-Steagall • Loan sales are a substitute for underwriting.

  12. Factors Deterring Future Loan Sales Growth • Access to commercial paper market • Legal concerns • Fraudulent conveyance. • Customer relationship effects • Customers may take negative view of having their loan sold to another party.

  13. Factors Encouraging Loan Sales Growth • BIS Capital Requirements • Market Value Accounting • Asset Brokerage and Loan Trading • Government loan sales • Credit rating of loans offered for sale

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