Deck 24: Managing Risk Off the Balance Sheet With Loan Sales and Securitization

Question 1

When a vulture fund acquires a distressed loan, the fund usually assists the distressed firm's managers in formulating a long-term plan for restoring profitability.

Answer 1

False

Question 2

Loans sold to correspondent banks are predominantly sales of distressed HLT loans.

Answer 2

False

Question 3

A CMO is a multiclass pass-through that helps investors choose the amount of prepayment risk they will face.

Answer 3

True

Question 4

A loan sold without recourse generates a contingent liability for the selling bank.

Question 5

In 2008, loan sales primarily consisted of sales of distressed loans.

Question 6

Because of the government backing, investors in GNMA pass-throughs are guaranteed to earn at least the T-bill rate on their investments.

Question 7

Most loan sales are now accomplished in about 10 days.

Question 8

An investor in a GNMA mortgage-backed security may be able to earn a return higher than the rate on a comparable maturity Treasury without taking on much, if any, default risk.

Question 9

A pass-through security is best characterized as

A) a multiclass mortgage-backed bond.
B) a security with a pro rata claim to the underlying pool of assets.
C) a bond backed by real estate.
D) a part of a loan assignment.
E) a part of a loan participation.

Question 10

The sale or transfer of assets at less than fair value that occurs at a time when the seller is insolvent is termed fraudulent conveyance.

Question 11

In selling loans, FIs act as an asset _____ and in creating CMOs, FIs act as an asset _____.

A) transformer; broker
B) transformer; transformer
C) broker; broker
D) broker; transformer

Question 12

More than 90% of loan sales are via assignments.

Question 13

Advantages of Brady bonds over LDC loans include improved liquidity and higher coupon rates.

Question 14

Which one of the following types of transactions leaves the assets on the balance sheet?

A) Loan sale without recourse
B) GNMA pass-throughs backed by mortgages placed in trust
C) CMOs issued using mortgage pool as collateral
D) Mortgage-backed bonds issued
E) None of the above

Question 15

Advantages of loan sales and securitization typically include all but which one of the following?

A) Reduction in credit risk
B) Reduction in interest rate risk
C) Increase in liquidity of the balance sheet
D) Reduction in regulatory tax burden
E) Increase in net interest income

Question 16

An advantage of securitization and loan sales over interest rate swaps as a risk-management tool is that securitization, by removing loans from the balance sheet, reduces the regulatory tax imposed by existing regulations.

Question 17

Under current reserve requirements, bank loan sales with recourse are considered a liability and are subject to reserve requirements.

Question 18

A mortgage pass-through security is a bond issue backed by a group of mortgages that pays fixed semi-annual coupon payments where the principle is repaid only at maturity.

Question 19

The buyer of a loan in a participation has a double-risk exposure: one to the borrower and one to the selling bank.

Question 20

Vulture funds specialize in buying distressed loans.

Question 21

Important buyers of loans include all but which one of the following?

A) Foreign banks
B) Insurance companies
C) Closed-end bank loan mutual funds
D) Vulture funds
E) Credit unions

Question 22

Loan sales are likely to continue because
I) they can increase near term reported earnings.
II) they reduce the amount of capital required.
III) more corporate borrowers have access to the commercial paper market.

A) I and II only
B) II and III only
C) I and III only
D) II only
E) I, II, and III

Question 23

Fraudulent conveyance proceedings are

A) charges that a loan was improperly sold according to the conditions of the original loan agreement.
B) charges of improprieties in HLTs.
C) evidence of moral hazard on the part of the loan buyer.
D) illegal methods to boost borrower's earnings to increase probability of loan acceptance.
E) the primary cause of the subprime mortgage crisis.

Question 24

How much capital is required to back the mortgages if the minimum risk-based capital requirement is 8%?

A) $75.0 million
B) $37.5 million
C) $12.0 million
D) $3.0 million
E) $6.0 million $150,000,000 x 0.50 x 0.08 = $6,000,000; mortgages carry a 50% risk weight

Question 25

If a mortgage pass-through experiences smaller prepayments than expected early on in the life of the security, the result will be that pass-through holders will receive _______ than expected cash flows early on and _______ than expected cash flows later on.

A) greater; less
B) greater; greater
C) less; greater
D) less; less
E) less; no different

Question 26

You own a mortgage-backed security and you will receive fixed semiannual interest payments and no principle payments as long as prepayments remain within a given range. If prepayments move outside the range, you will receive prepayments. You must be holding a ______________________.

A) class C or lower sequential pay CMO
B) PAC CMO
C) PO security
D) pass-through security
E) CDO

Question 27

If the mortgages are securitized and deposits are reduced, how much will the bank save in the first year's reserve requirements and deposit insurance premiums in total?

A) $144,460,800
B) $160,512,000
C) $165,476,200
D) $178,332,500
E) $181,249,300 150-6 = 144M deposits available to finance mortgages requires [(150,000,000 - 6,000,000) / (1 - 0.1)] = 160M deposits. Reserve requirements are 160M x 0.1 = 16M; Deposit insurance premiums = (160,000,000 x 0.0032) = 512,000; total = $160,512,000

Question 28

A form of trust that can issue multiple class debt securities without having to pay taxes on the interest paid is called a

A) CMO.
B) REMIC.
C) MBB.
D) PIP.
E) GNMA.

Question 29

Characteristics of loan participations include:
I) the loan participant is not a primary creditor on the loan.
II) the original lender can change some loan terms without the participant's permission.
III) participations are without recourse.

A) I only
B) II only
C) II and III only
D) I and II only
E) I, II, and III

Question 30

In a three-class sequential pay CMO, if we consider Class B holders as having average prepayment risk, then Class A holders have _____________ prepayment risk and Class C holders have _____________ prepayment risk.

A) above average; below average
B) below average; below average
C) below average; above average
D) above average; above average

Question 31

Banks were willing to swap LDC loans for Brady bonds because:

A) Brady bonds carried higher interest rates than the loans.
B) the bonds had variable interest rates.
C) the bonds were marketable and the loans were not.
D) the bonds were uncollateralized.
E) none of the above

Question 32

If mortgage interest rates fall and prepayments occur, the holder of a GNMA pass-through selling at a _____ will have a _____.
I) discount; capital gain
II) premium; capital loss
III) discount; capital loss
IV) premium; capital gain

A) I only
B) I and III only
C) I and II only
D) II and IV only
E) III and IV only

Question 33

A three-class sequential pay CMO has an initial principle balance of $50 million per class. In the first month, interest payments of $5 million and principle payments of $2 million are received. In the second month, Class A holders receive interest on _____ principle and Class B holders receive interest on _____ principle.

A) $30 million; $30 million
B) $28 million; $28 million
C) $27 million; $27 million
D) $28 million; $30 million
E) $30 million; $28 million

Question 34

The act of buying a share in a loan syndication with limited contractual control and rights over the borrower is called a

A) correspondent loan.
B) loan assignment.
C) HLT loan.
D) loan participation.
E) distressed loan.

Question 35

In a loan participation, which of the following is/are true?
I) The loan buyer has no part in the original underlying credit agreement, even after purchase of the loan.
II) If the selling bank fails, the loan buyer's claim against the selling bank may be treated as unsecured.
III) In the event the selling bank fails, the original borrower's deposits may be used to reduce the loan amount without any proceeds going to the loan buyer.

A) I only
B) II only
C) II and III only
D) I and II only
E) I, II, and III

Question 36

A loan that finances a merger or acquisition that results in a high-leverage ratio for the borrower is called a

A) correspondent loan.
B) CMO.
C) HLT loan.
D) low-recourse loan.
E) distressed loan.

Question 37

If the bank can originate and securitize this amount of mortgages with the same terms four times over the next year (including the existing mortgages) and the bank earns a servicing fee each month equal to 3.5% of the monthly payments, what will be the bank's monthly fee income 12 months from now?

A) $110,456
B) $116,432
C) $122,673
D) $129,301
E) $133,444 4 x 923,576 x 0.035 = $129,301

Question 38

A four-class CMO has Class A, Class B, Class C, and the residual Class Z securities outstanding. Which class has the longest duration?

A) Class A
B) Class B
C) Class C
D) Class Z
E) All have the same duration

Question 39

Which one of the following forms of securitization is usually "double securitization?"

A) Mortgage-backed bonds
B) CMO
C) Pass-through
D) Loan sale

Question 40

For a loan sold with recourse,

A) the loan seller has no further obligation at all to the loan buyer.
B) the loan seller removes the assets from the balance sheet and does not report a contingent liability in the footnotes.
C) the loan buyer cannot collect from the loan seller in the event of borrower default.
D) no reserve requirement is imposed.
E) none of the above

Question 41

How does a mortgage pass-through differ from a CMO?

Question 42

What are the major factors that are likely to contribute to continued growth in the loan sale market?

Question 43

What is the total amount of net fee revenue generated from the mortgages over the year?

Question 44

What are the major differences in the traditional and HLT segments of the loan sale market with respect to the types of loans sold?

Question 45

The typical duration of a Class B CMO is

A) 1.5 to 3 years.
B) 3 to 5 years.
C) 5 to 7 years.
D) 7 to 10 years.
E) 18 to 20 years.

Question 46

Why are most loan sales on an assignment basis rather than a participation basis?

Question 47

How does a PAC CMO differ from a sequential pay CMO?

Question 48

The sum of the market values of all the classes of a CMO is greater than the total value of the GNMA pass-throughs backing the CMO because

A) the CMO has less credit risk than the pass-through.
B) CMO investors can choose their degree of prepayment protection.
C) the government guarantees CMOs' performance.
D) CMOs have a more favorable tax status than pass-throughs.
E) CMO investors have no prepayment risk.

Question 49

A three-class (Class A, B, and C) sequential pay CMO starts with an $80 million principle amount in each class. The mortgages in the pool have a 7% interest rate. The CMO classes receive monthly payments. During the first month $1 million in interest is received from mortgage holders and $1.5 million in principle. What principle amounts are outstanding for each class during the second month? How will this affect the total payment each class receives? Explain.

Question 50

What loans, other than mortgages, are currently being securitized?

Question 51

With a GNMA pass-through, the investor bears ________ of the prepayment risk, with a noncallable mortgage-backed bond the investor bears _________ of the prepayment risk, and with a CMO the investor bears ______________ of the prepayment risk.

A) some; all; none
B) all; some; none
C) all; none; some
D) none; some; all
E) none; some; none

Question 52

Why are MBBs the least used form of mortgage securitization?

Question 53

The FDIC is concerned about issuance of mortgage-backed bonds (MBBs) because

A) the FDIC is concerned about investors' prepayment risk.
B) MBBs increase deposit insurance premiums.
C) the process takes loans off the balance sheet and replaces them with liabilities.
D) the process reduces the amount of assets available to back insured deposits.
E) none of the above

Question 54

The bank keeps a capital-to-asset ratio of 8%. If the bank does not securitize the mortgages, they will be fully funded with demand deposits that have a reserve requirement of 10%. The demand deposits also have a deposit insurance premium of 0.20 cents per $100 of deposits. If the bank securitizes the mortgages, how much less capital will the bank require? If the savings from not having the required reserves and the deposit insurance premiums could be invested at 5%, what is the dollar opportunity cost of not securitizing?

Question 55

Explain the payment pattern on a GNMA pass-through and a new Class B CMO when interest rates fall. Which has more predictable payments, and why would an investor care?

Question 56

Why has securitization progressed most rapidly for home mortgages?