Loan Sales and Other Credit Risk
Management Techniques
Chapter 27
Financial Institutions Management, 3/e
By Anthony Saunders
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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 and A’s.
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Bank Loan Sale Market
• May be sold with or without recourse.
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Types of loan sales
• Emerging market
• Domestic
» Traditional short term
» HLT Loan sales
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Traditional Short Term
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Key characteristics
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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
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Key characteristics
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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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Types of Loan Sales Contracts
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Participations
• Limited contractual control.
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Assignments
• Currently form bulk of the market (90% +).
• All rights transferred on sale of loan.
• Normally associated with Uniform Commercial
Code filing.
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The Buyers and Sellers
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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.
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The Sellers
Major money center banks, U.S. government
and its agencies.
 Good Bank - Bad Bank:
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• 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
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Foreign banks
• ING is a major market maker (HLTs).
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Investment Banks
• Bear Stearns. Generally large HLTs.
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Government agencies (HUD for example)
• Increased due to Federal Debt Improvements
Act, 1996.
• Largest sales to date, RTC.
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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.
• Glass-Steagall
» Loan sales are a substitute for underwriting.
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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.
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Factors Encouraging Loan Sales Growth
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BIS Capital Requirements
Market Value Accounting
Asset Brokerage and Loan Trading
Government loan sales
Credit rating of loans offered for sale
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