This loan commitment would match the size and

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loan commitment. This loan commitment would match the size and maturity of the commercial paper issue—for example, a $100 million ceiling and 45-day maturity. If, on maturity, the commercial paper issuer had insufficient funds to repay the com- mercial paper holders, the issuer has the right to take down the $100 million loan commitment and to use these funds to meet repayments on the commercial paper. Often, the up-front fees on such loan commitments are less than those on SLCs; therefore, many firms issuing commercial paper prefer to use loan commitments. Finally, remember that U.S. banks are not the only issuers of SLCs. Not surpris- ing, property-casualty insurers have an increasingly important business line of performance bonds and financial guarantees. The growth in these lines for prop- erty-casualty insurers has come at the expense of U.S. banks. Moreover, foreign banks increasingly are taking a share of the U.S. market in SLCs. The reason for the loss in this business line by U.S. banks is that to sell guarantees such as SLCs credibly, the seller must have a better credit rating than the customer. In recent years, few U.S. banks or their parent holding companies have had AA ratings or better. Other domestic FIs and foreign banks, on the other hand, have more often had AA ratings or better. High credit ratings not only make the guarantor more attractive from the buyer’s perspective, but also make the guarantor more com- petitive because its cost of funds is lower than that of less creditworthy FIs. Loans Sold Loans sold (item 4 in Table 2B–2) are loans that a bank originated and then sold to other investors that may be returned (sold with recourse ) to the originating institution in the future if the credit quality of the loans deteriorates. Banks and other FIs increasingly originate loans on their balance sheets, but rather than holding the loans to maturity, they quickly sell them to outside investors. These outside investors include other banks, insurance companies, mutual funds, or even corporations. In acting as loan originators and loan sellers, banks are operating more as loan brokers than as traditional asset transformers. When an outside party buys a loan with absolutely no recourse to the seller of the loan should the loan eventually go bad, loan sales have no OBS contin- gent liability implications for banks. Specifically, no recourse means that if the loan the bank sells should go bad, the buyer of the loan must bear the full risk of loss. In particular, the buyer cannot go back to the seller or originating bank to seek payment on the bad loan. Suppose that the loan is sold with recourse. Then, loan sales present a long-term off-balance-sheet or contingent credit risk to the seller. Essentially, the buyer of the loan holds an option to put the loan back to the seller, which the buyer can exercise should the credit quality of the purchased loans sold Loans originated by the bank and then sold to other investors that can be returned to the originating institution.
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