Chap024 - Chapter 24 - Managing Risk off the Balance Sheet...

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Unformatted text preview: Chapter 24 - Managing Risk off the Balance Sheet with Loan Sales and Securitization Answers to Chapter 24 Questions 1. Loans sold without recourse means that after selling the loan the originator of the loan can take it off the balance sheet. In the event the loan is defaulted, the buyer of the loan has no recourse to the seller for any claims, transferring the credit risk entirely to the buyer. For the originator, it has completely eliminated this loan from its books. In the case of a sale with recourse, credit risk is still present for the originator because the buyer could transfer ownership of the loan back to the originator. Thus, from the perspective of the buyer, loans with recourse bear the least credit risk. 2. Short-term loan sales usually consist of maturities between one and three months and are secured by the assets of a firm. They are usually sold in units of $1 million or more and are made to firms that have investment grade credit ratings. Banks have originated and disposed of short- term loans as an effective substitute for commercial paper, which have similar characteristics to short-term loans. The accessibility of commercial paper by more and more corporations has reduced the volume of these short-term loans for loan sales purposes. 3. Commercial paper issuers are generally blue chip corporations that have the best credit ratings. Banks may sell the loans of less creditworthy borrowers, thereby raising required yields. Indeed, since commercial paper issuers tend to be well-known companies, information, monitoring, and credit assessment costs are lower for commercial paper issues than for loan sales. Moreover, since there is an active secondary market in commercial paper, but not for loan sales, the commercial paper buyer takes on less liquidity risk than does the buyer of a loan sale. 4. In a loan participation, the buyer does not obtain total control over the loan, while in an assignment, all rights are transferred upon sale, thereby giving the buyer a direct claim on the borrower. Transactions costs are higher for loan assignments than for loan participations since the loan must be transferred via a Uniform Commercial Code filing. Moreover, current holders of the loan must be verified as well as any impediments to transfer, thereby further increasing transactions costs upon loan sale under assignment. Monitoring incentives are higher and costs are lower under loan assignments as opposed to loan participations. This is because the buyer is the sole holder of the loan and thus there is no free-rider problem. Monitoring costs are lower since the loan assignment buyer need only monitor the borrower's activities, while the loan participation buyer must monitor both the borrower and the originating bank. Risk exposure is greater under loan participations than under loan assignments since participations have a A double-risk @ exposure. The buyer of the loan participation is exposed to the credit risk of the originating bank (still controlling the loan) as well as the credit risk exposure of the borrower. originating bank (still controlling the loan) as well as the credit risk exposure of the borrower....
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This note was uploaded on 02/28/2012 for the course FINE 442 taught by Professor Larbihammami during the Spring '12 term at McGill.

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Chap024 - Chapter 24 - Managing Risk off the Balance Sheet...

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