Deck 26: Loan Sales

Question 1

When a portion of a loan is sold from a large bank to a small bank, it is often called a participation.

Answer 1

True

Question 2

The growth of the commercial paper market as well as the increased ability of banks to underwrite commercial paper has reduced the importance of short-term segment of the loan sales market.

Answer 2

True

Question 3

When an FI sells the loan of an individual corporation in the secondary market, the corporation's stock often decreases in value.

Answer 3

False

Question 4

Historically, correspondent banking relationships have been important in the sale of bank loans.

Question 5

A loan sale occurs when an FI originates a loan and sells the loan without recourse to an outside buyer.

Question 6

A distinction between distressed and non-distressed is usually made when selling highly leveraged transactions loans (HLTs).

Question 7

Most loans originated and sold in the short-term market are secured loans to below investment grade entities.

Question 8

Loan sales do not create a new type of security as with other methods to manage credit risk.

Question 9

Highly leveraged transaction (HLT) loans typically are used to finance new fixed assets of an ongoing firm.

Question 10

An FI that sells a loan with recourse retains ownership of the loan.

Question 11

When an FI sells a loan with recourse, a liability is created on the balance sheet.

Question 12

Highly leveraged transaction (HLT) loans are typically unsecured, short term and have fixed rates.

Question 13

Loan sales by an FI are another tool to manage credit risk of the FI.

Question 14

In the sale of a loan to an investor/buyer, there are fewer agency costs associated with loan participation contracts than with loan assignment contracts.

Question 15

Banks began selling short-term loans only since the passage of the Financial Services Modernization Act in 1999.

Question 16

The definition of a highly leveraged transaction is any transaction that involves a buyout, acquisition or recapitalization.

Question 17

FIs discourage borrowers from hedging their own risk of default.

Question 18

Most HLT loans are very heterogeneous with respect to the size of the issue, the interest payment date, interest indexing, and prepayment features.

Question 19

The loan sales market in which an FI originates and sells a short-term loan of a corporation can be considered a close substitute to the issuance of commercial paper.

Question 20

When an FI sells a loan without recourse, the credit risk of the loan is completely eliminated from the FIs balance sheet.

Question 21

Loans originated by domestic U.S.banks cannot be sold to foreign banks.

Question 22

Investment banks are the predominant buyers of HLT loans because they are more informed agents in this market than other investors.

Question 23

An originate-to-sell model when dealing with below investment grade companies is considered an attractive alternative for FIs, which have specialized credit monitoring skills, as compared with keeping the loans in their portfolio.

Question 24

Insurance companies and pension funds are important buyers of long-maturity loans.

Question 25

Some corporate customers that rely on bank loans may see the sale of one of its loan by the bank as an adverse event in the customer-bank relationship.

Question 26

A loan credit rating is the same as bond credit rating in that it is based solely on the financial soundness of the underlying corporation.

Question 27

Closed-end bank loan mutual funds are restricted to investing in loans only through the loan resale or secondary market.

Question 28

The move by regulators toward market value accounting of the loan portfolios will likely encourage sales of loans in the secondary markets.

Question 29

Most vulture funds are formed by the mutual fund industry as a way around SEC restrictions from participating in the FI-originated loan sales market.

Question 30

Mutual funds are prohibited from purchasing/participating in the FI loan sales market by the SEC.

Question 31

Selling loans without recourse is a way for FIs to remove loans from their balance sheet for the purpose of reducing the cost associated with reserve requirements.

Question 32

The traditional interbank loan sale market has been growing rapidly due to an increase in the number of mergers and acquisitions.

Question 33

Credit derivatives allow FIs to reduce credit risks without removing loan assets from their balance sheet.

Question 34

The buyer of a loan participation benefits because the only risk exposure is to the borrower.

Question 35

One way to boost the capital to assets ratio of an FI is through loan sales.

Question 36

Assignments of fixed-rate loans typically do not have difficulties in the calculation and transfer of accrued interest.

Question 37

Because a bad-bank bank has a difficult time gaining deposits for funding, it also has a difficult time devising an optimal strategy to manage and dispose of bad assets.

Question 38

The buyer of a loan participation bears double monitoring costs.

Question 39

The primary sellers of domestic loans are medium-sized regional banks.

Question 40

Floating-rate loan assignments typically occur on the loan repricing date as an effort to minimize confusion regarding the calculation and transfer of accrued interest.

Question 41

Although a loan sale strategy for an FI may reduce or eliminate credit risk, the strategy does not affect the FI's liquidity risk.

Question 42

Which of the following observations is NOT correct?

A)Most loans are sold with recourse.
B)Loan sales are a primitive substitute for securitization.
C)Selling of a loan creates a secondary market for loans.
D)Ownership of the loan is always transferred to the loan purchaser.
E)Loan sales do not involve the creation of new types of securities.

Question 43

Which of the following is true concerning loans sold with recourse?

A)Most loans are sold with recourse.
B)The buyer cannot put the loan back to the selling FI.
C)The FI has no explicit liability if the loan eventually goes bad.
D)The FI that originated the loan retains a contingent credit risk liability.
E)The loan sale is technically removed from the balance sheet.

Question 44

Which of the following statements regarding assignments are true?

A)Buying a share in a loan syndication with some contractual control and rights over the borrower.
B)All rights are transferred on sale, meaning the loan buyer now holds a direct claim on the borrower.
C)Transfer to U.S.domestic loans is normally associated with a Uniform Commercial Code filing.
D)all of the above statements are true.
E)none of the above statements are true.

Question 45

Banks and FIs rely on which of the following contractual mechanisms to control the credit risks of lending?

A)requiring higher interest rate spreads and fees on loans to more risky borrowers.
B)restricting or rationing loans to more risky borrowers
C)requiring enhanced seniority for the bank over assets of risky borrowers
D)diversifying across different types of risky borrowers
E)all of the above are utilized.

Question 46

Which of the following is NOT a contractual mechanism used by FIs to control credit risks?

A)Diversifying across different types of risky borrowers.
B)Requiring higher interest rate spreads for higher risk borrowers.
C)Requiring more collateral for the bank over the assets of more risky borrowers.
D)Making lending decisions only in centralized locations.
E)Placing more restrictive covenants on the actions of more risky borrowers.

Question 47

Research has shown that current-year income for an FI is rarely affected by the decision to sell loans from their balance sheet.

Question 48

Besides reducing credit risks, an FI has an incentive to sell loans it originates for all of the following reasons EXCEPT to:

A)geographically diversify.
B)decrease core deposits.
C)lower reserve requirements.
D)lower capital requirements.
E)generate reinvestment income.

Question 49

What are the two basic types of loan sale contracts or mechanisms by which loans can be transferred between seller and buyer?

A)Participations and assignments.
B)Participations and originations.
C)Syndications and originations.
D)Transfers and assignments.
E)Exercise and transfers.

Question 50

The Resolution Trust Corporation (RTC), a government agency formed to manage failed S&Ls in the early 1990s, followed a Good Bank/Bad Bank concept in the sale of loans.

Question 51

Which of the following is NOT a key characteristic of loans sold in the short-term loan sale market?

A)Issued as a secured loan.
B)Loans to investment grade borrowers or better.
C)Issued with a fixed rate.
D)Sold in units of $1 million and up.
E)Issued for 90 days or less.

Question 52

As FIs consolidate and expand their range of financial services, customer relationships with commercial entities are likely to become more important.

Question 53

Which of the following is NOT true of a loan that is sold without recourse?

A)The loan is removed from the FI's balance sheet.
B)The FI has no explicit liability if the loan eventually goes bad.
C)The FI that originated the loan bears all the credit risk.
D)The buyer can put the loan back to the selling FI.
E)None of the options.

Question 54

Which of the following is NOT a reason for a FI to sell loans with recourse?

A)To reduce capital requirements.
B)To avoid credit risk exposure.
C)To control interest rate risk exposure.
D)To avoid regulatory scrutiny.
E)To make it possible to lend large amounts to an individual borrower.

Question 55

A loan made to finance a merger and acquisition that usually results in a high leverage ratio for the borrower is a

A)loan sold without recourse.
B)highly leveraged transaction loan.
C)loan sold with recourse.
D)loan assignment transaction.
E)loan participation transaction.

Question 56

The unique features of participations in loans are:

A)the buyer is not a party to the underlying credit agreement so that the initial contract between loan seller and borrower remains in place after the sale.
B)The loan buyer can exercise only partial control over changes in the loan contract's terms.
C)The holder can vote only on material changes to the loan contract, such as the interest rate or collateral backing.
D)all of the above are features.
E)none of the above are features.

Question 57

As of 2010, the Department of Housing and Urban Development (HUD) no longer sells loans that were used to purchase multifamily apartment properties.

Question 58

Banks are able to incrementally remove risk from their balance sheets, allowing for business growth by selling non-performing loans to institutional investors.

Question 59

The European Commission has warned banks they could face heightened capital requirements if they continue to hold non-performing loans following proposed revisions ot the capital requirements regulation.

Question 60

Which of the following refers to a period when a borrower is unable to meet a payment obligation to lenders and other creditors?

A)Window.
B)Financial distress.
C)Foreclosure.
D)Recession.
E)Assignment.

Question 61

HLT loans typically have all of the following characteristics except which of the following?

A)They have a short maturity of less than three months.
B)They are secured by assets of the borrowing firm.
C)They have floating rates tied to LIBOR or some other short-term index.
D)They have strong covenant protection.
E)They are term loans.

Question 62

The definition of a highly leveraged transaction (HLT) loan as adopted by U.S.bank regulators in 1989 includes

A)doubling the borrower's liabilities which results in a leverage ratio higher than 50 percent.
B)involving a buyout, acquisition, or recapitalization.
C)results in a leverage ratio higher than 75 percent.
D)All of the options.
E)doubling the borrower's liabilities which results in a leverage ratio higher than 50 percent and involving a buyout, acquisition, or recapitalization.

Question 63

A type of company that specializes in distressed loans is

A)a bank loan mutual fund.
B)a domestic bank.
C)a foreign bank.
D)an investment bank.
E)a vulture fund.

Question 64

Which observation is true of vulture funds?

A)Their decisions based on developing and maintaining long-term relationships.
B)Their sole agenda is to helping the distressed firm to survive.
C)Their investments are always passive.
D)They are relationship based, not transaction driven.
E)In a restructuring, they are looking for a return on capital invested.

Question 65

A type of company that recently has moved from only purchasing loans on the secondary market into primary loan syndication is

A)a bank loan mutual fund.
B)a domestic bank.
C)a foreign bank.
D)an investment bank.
E)a vulture fund.

Question 66

Why do spreads on HLT loans behave more like investment-grade bonds than like high-yield bonds?

A)They tend to be more junior in bankruptcy.
B)They tend to have greater collateral backing than do high-yield bonds.
C)Because no bank makes a market in this debt.
D)Because securities firms do not make a market in this debt.
E)They tend to have no covenant protection.

Question 67

The traditional interbank loan sale market has been shrinking for which of the following reasons?

A)The barriers to nationwide banking have been largely removed through legislation.
B)Concerns about counterparty risk and moral hazard have increased.
C)The traditional correspondent banking relationships are slowly breaking down.
D)All of the options.
E)Concerns about counterparty risk and moral hazard have increased, and the traditional correspondent banking relationships are slowly breaking down.

Question 68

Which of the following transactions does NOT meet the legal definition of a highly leveraged transaction (HLT)?

A)A buyout that increases debt from $100 million to $150 million resulting in a 55 percent leverage ratio.
B)A recapitalization that increases debt from $100 million to $250 million resulting in a 55 percent leverage ratio.
C)An acquisition that increases debt from $100 million to $250 million resulting in a 65 percent leverage ratio.
D)An acquisition that increases debt from $100 million to $150 million resulting in an 80 percent leverage ratio.
E)An acquisition that results in an 80 percent leverage ratio.

Question 69

Loan participations

A)are riskier than loan assignments.
B)are less risky than loan assignments.
C)are always sold without recourse.
D)are always sold with partial recourse.
E)are made in smaller denominations than are loan assignments.

Question 70

A type of FI that predominantly buys HLT loans because these loans require the kinds of investment analysis skills used in other parts of the FI's business is

A)a bank loan mutual fund.
B)a domestic bank.
C)a foreign bank.
D)an investment bank.
E)a vulture fund.

Question 71

Which of the following is NOT true of loan assignments?

A)All rights are transferred on sale.
B)The loan buyer holds a direct claim on the borrower.
C)Transfer of U.S.domestic loans is normally associated with a Uniform Commercial Code filing.
D)Ownership rights are generally much clearer in a loan sale by assignment.
E)Contract terms are unrestrictive from the seller's perspective.

Question 72

Which of the following transactions meets the legal definition of a highly leveraged transaction (HLT)?

A)A buyout that increases debt from $100 million to $150 million resulting in a 25 percent leverage ratio.
B)An investment project that increases debt from $100 million to $250 million resulting in a 55 percent leverage ratio.
C)An acquisition that increases debt from $100 million to $250 million resulting in a 65 percent leverage ratio.
D)An acquisition that increases debt from $100 million to $150 million resulting in a 70 percent leverage ratio.
E)An investment project that results in an 80 percent leverage ratio.

Question 73

Currently, this basic type of loan sale contracts comprises the bulk of loan sales trading.

A)Participations.
B)Originations.
C)Syndications.
D)Assignments.
E)Transfers.

Question 74

Loan assignments make up more than 90 percent of the U.S.domestic loan sale market because

A)they have lower capital requirements than other types of loan sales.
B)they are riskier than are other types of loan sales.
C)monitoring costs are reduced since all rights are transferred upon sale.
D)regulators prefer these transactions to loan participations.
E)there is no secondary market in loan participations.

Question 75

Which of the following rely on non-distressed HLT loan purchases as a means of diversifying without the high cost of developing costly nationwide banking networks?

A)Bank loan mutual funds.
B)Credit unions.
C)Foreign banks.
D)Investment banks.
E)Vulture funds.

Question 76

Loan assignments

A)are common in loan syndications.
B)do not have buyer restrictions.
C)comprise less than 30 percent of the U.S.loan sales market.
D)involve extremely high monitoring costs.
E)expose the buyer to a double risk and involve double monitoring costs.

Question 77

In a loan participation

A)the holder (buyer) is not a party to the underlying credit agreement, so the initial contract between the loan seller and the borrower remains in place after the sale.
B)the holder (buyer) is a party to the underlying credit agreement, so the initial contract between the loan seller and the borrower remains in place after the sale.
C)the holder (buyer) can vote only on material changes to the loan contract such as changes in interest rate or collateral backing the loan.
D)the holder (buyer) is not a party to the underlying credit agreement, so the initial contract between the loan seller and the borrower remains in place after the sale and the holder (buyer) can vote only on material changes to the loan contract such as changes in interest rate or collateral backing the loan.
E)the holder (buyer) is a party to the underlying credit agreement, so the initial contract between the loan seller and the borrower remains in place after the sale and the holder (buyer) can vote only on material changes to the loan contract such as changes in interest rate or collateral backing the loan.

Question 78

Loan participations are typically sold to correspondent banks because

A)they are insiders and can be trusted.
B)they offer the best prices.
C)the ongoing relationship offers the greatest monitoring opportunities.
D)it is a regulatory requirement.
E)correspondent banks are captive customers.

Question 79

A buyer of a loan participation is exposed to

A)risk exposure to the original borrower defaulting.
B)risk exposure to the failure of the selling bank.
C)moral hazard problems because the borrower is no longer monitored by the seller.
D)risk exposure to the original borrower defaulting and risk exposure to the failure of the selling bank.
E)risk exposure to the original borrower defaulting and moral hazard problems because the borrower is no longer monitored by the seller.

Question 80

Identify the correct observation.

A)Most loan sales are completed in less than 30 days.
B)Up to 50 percent of loan sales eventually fail to be completed at all.
C)There is no incentive to renege on a loan sales contract.
D)The tendency to renege on a loan sales contract decrease as market prices move away from those originally agreed.
E)Contractual problems, trading frictions, and costs rarely affect loan sales.