Deck 25: Loan Sales

Question 1

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

Answer 1

False

Question 2

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.

Answer 2

False

Question 3

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

Answer 3

False

Question 4

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

Question 5

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

Question 6

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

Question 7

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

Question 8

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

Question 9

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

Question 10

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

Question 11

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

Question 12

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.

Question 13

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 14

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

Question 15

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

Question 16

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

Question 17

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

Question 18

FIs discourage borrowers from hedging their own risk of default.

Question 19

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

Question 20

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

Question 21

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 22

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

Question 23

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

Question 24

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

Question 25

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 26

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

Question 27

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

Question 28

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

Question 29

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

Question 30

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

Question 31

The buyer of a loan participation bears double monitoring costs.

Question 32

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 33

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 34

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

Question 35

Because a bad 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 36

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 37

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

Question 38

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

Question 39

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

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

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.

Question 42

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

Question 43

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.

Question 44

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.

Question 45

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.

Question 46

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.

Question 47

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

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

Question 48

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.

Question 49

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.

Question 50

Which of the following is NOT a reason for an 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.

Question 51

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.

Question 52

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.

Question 53

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.

Question 54

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

Question 55

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

Question 56

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.

Question 57

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 58

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 59

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.

Question 60

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.

Question 61

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.

Question 62

The principal objective in the creation of _____ is to maximize asset values by separating good loans from bad loans.

A)hedge funds
B)bad banks
C)vulture funds
D)structured banks

Question 63

The sellers of domestic loans and HLT loans include all of the following EXCEPT

A)major money center banks.
B)foreign banks.
C)U.S.government and its agencies.
D)non-financial companies.

Question 64

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.

Question 65

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.

Question 66

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 67

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 68

Vulture funds are

A)management consulting firms that employ turn-around specialists.
B)portfolios consisting of stakes in distressed companies.
C)mutual funds that grow by acquiring their competitors.
D)mutual funds that invest only in highly-leveraged transactions.

Question 69

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.

Question 70

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.

Question 71

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.

Question 72

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.

Question 73

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.

Question 74

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.

Question 75

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 76

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.

Question 77

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.

Question 78

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.

Question 79

The major buyers of U.S.domestic loans of non-distressed companies include all of the following EXCEPT

A)domestic banks.
B)foreign banks.
C)the Resolution Trust Corporation.
D)non-financial companies.

Question 80

If an FI embraces the concept of good bank/bad bank,

A)bad bank assets are passed on to the institutions correspondent bank that is required to accept the assets.
B)good bank assets are organized into a closed end mutual fund which then sells shares to raise funds for the bad bank.
C)the bad bank is a special purpose vehicle (SPV)that is organized to liquidate non-performing loans.
D)the bad bank assets are funded by FDIC insured deposits.