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

2. Irwin/McGraw-Hill 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. Irwin/McGraw-Hill 3 Bank Loan Sale Market May be sold with or without recourse. n Types of loan sales Emerging market Domestic »Traditional short term »HLT Loan sales

4. Irwin/McGraw-Hill 4 Traditional Short Term n 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. Irwin/McGraw-Hill 5 HLT Loan Sales n 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. Irwin/McGraw-Hill 6 Types of Loan Sales Contracts n Participations Limited contractual control. n Assignments Currently form bulk of the market (90% +). All rights transferred on sale of loan. Normally associated with Uniform Commercial Code filing.

7. Irwin/McGraw-Hill 7 The Buyers and Sellers n 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. Irwin/McGraw-Hill 8 The Sellers n Major money center banks, U.S. government and its agencies. n 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. Irwin/McGraw-Hill 9 Other Sellers n Foreign banks ING is a major market maker (HLTs). n Investment Banks Bear Stearns. Generally large HLTs. n Government agencies (HUD for example) Increased due to Federal Debt Improvements Act, 1996. Largest sales to date, RTC.

10. Irwin/McGraw-Hill 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. Irwin/McGraw-Hill 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. Irwin/McGraw-Hill 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. Irwin/McGraw-Hill 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