Chapter Twenty-four

1. Chapter Twenty-four Managing Risk with Loan Sales and Securitization McGraw-Hill/Irwin

2. Basic Descriptions of Loan Sales • Loan sale • Pass-through securities • Collateralized Mortgage Obligations (CMOs) • Mortgage-Backed Bonds (MBBs) McGraw-Hill/Irwin

3. Loan Sales • Loan sales and asset securitization • Correspondent banking • Highly leveraged transaction (HLT) loan • Bank loan sale McGraw-Hill/Irwin

4. Types of Loan Sales Contracts • Two basic types: • Participations • Assignments McGraw-Hill/Irwin

5. The Loan Sale Market • Traditional Short-Term Segment • LDC Loan • HLT Loan Sale • The Buyers • vulture fund - a specialized fund that invests in distressed loans McGraw-Hill/Irwin

6. Buyers and Seller of HLTs • The Buyers • Investment banks, vulture funds, other domestic banks, foreign banks, insurance companies and pension funds, closed-end bank loan mutual funds, and nonfinancial corporations • The Sellers • major money center banks, small regional or community banks, foreign banks, and investment banks McGraw-Hill/Irwin

7. Secondary Market for Less Developed Country Debt (LDC) • Since mid 1980’s, many large commercial and investment banks in the New York and London began trading in LDCs • Mexico and Brazil crisis in late 1980’s • Asian crisis in 1997/1998 • economic crisis in southeast Asia, South America, and Russia in the late 1990’s • Brazil’s rapid economic recovery, Mexico’s upgraded credit rating, Russia’s debt restructuring early 2000’s • Trading takes place in the high-yield (or junk bond) departments of participating banks • Brady bond McGraw-Hill/Irwin

8. Factors Encouraging and Deterring Future Loan Sales Growth • Factors Encouraging Loan Sales • Generate current fee income • Reduce liquidity risk • Boost capital adequacy ratio • Reduce reserve requirements • Factors Discouraging Loan Sales • Access to the Commercial Paper Market • Legal concerns McGraw-Hill/Irwin

9. Pass-Through Security • The original use of securitization is a result of government-sponsored programs to enhance the liquidity of the residential mortgage market • GNMA (“Ginnie Mae”) • FNMA (“Fannie Mae”) • FHLMC (“Freddie Mac”) McGraw-Hill/Irwin

10. Collateralized Mortgage Obligation (CMO) • A CMO is repackaged cash flows from mortgages and pass-through securities • A multiclass pass-through created with a number of different bond holder classes differentiated by the order in which each is paid off • Class A,B, and C Bond buyers McGraw-Hill/Irwin

11. Mortgage -Backed Bond (MBB) • Differ from pass-throughs and CMOs in two key dimensions: • MBBs normally remain on the balance sheet • cash flows on the mortgages backing the bond are not necessarily directly connected interest and principal payments on the MBB • MBBs decrease the bank’s asset portfolio liquidity McGraw-Hill/Irwin

12. Securitization of Other Assets • The major use of pass-throughs, CMOs, and MBBs have led to the packaging of other loans such as: • automobile loans • credit card receivables (CARDs) • small business loans guaranteed by the Small Business Administration • commercial and industrial loans • student loans • mobile home loans • junk bonds • time share loans • adjustable rate mortgages McGraw-Hill/Irwin

13. Benefits versus Costs of Securitization Benefits Costs________ New funding source Public/private credit risk Increased liquidity Overcollateralization Enhanced ability to manage Valuation and packaging interest rate risk Savings to the issuer on: reserve requirements deposit insurance premium capital adequacy requirements McGraw-Hill/Irwin