Loan Sales and Loan Sales and Other Credit Risk Other Credit Risk

Management Management TechniquesTechniques

Chapter 27

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K. R. Stanton

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Overview

This chapter discusses the growing role of loan sales and other techniques that can be used to address the control of credit risk in FIs. The use of loan sales is not new and may even involve foreign loans. With development of secondary markets for many types of loans, and securitized variants, loan sales are employed even by relatively small FIs.

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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&A’s.

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Bank Loan Sale Market

May be sold with or without recourse. Types of loan sales

Emerging market Domestic

Traditional short term HLT Loan sales

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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 +.

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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.

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Web Resources

Visit:

Loan Pricing Corporation www.loanpricing.com

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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. Complexity associated with accrued interest

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The 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. Foreign banks important buyer of domestic

loans Insurance companies and pension funds in

long-term loans. Mutual funds and nonfinancials

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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.

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Other Sellers

Foreign banks ING is a major market maker (HLTs).

Investment Banks Bear Stearns. Generally large HLTs.

Government and agencies (HUD for example) Increased due to Federal Debt

Improvements Act, 1996. Largest sales to date, RTC.

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Web Resources

FDIC www.fdic.gov

Housing and Urban Development www.hud.gov

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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.

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Why FIs Sell Loans (continued)

Capital costs Meet capital requirements by reducing assets.

Liquidity risk reduced by loan sales.

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Factors Deterring Future Loan Sales Growth

Access to commercial paper market Customer relationship effects

Customers may take negative view of having their loan sold to another party.

Legal concerns Fraudulent conveyance.

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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 Purchase and sale of foreign bank loans

Goldman Sachs fund to buy troubled loans from Japan’s second largest bank, SMFG.

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Pertinent Websites

BIS www.bis.org

HUD www.hud.gov

FDIC www.fdic.gov

FASB www.fasb.org

Loan Pricing Corp. www.loanpricing.com

SEC www.sec.gov

Wall Street Journal www.wsj.com