FINAN 531 FINAL

What legislation authorizes federal agencies to sell delinquent and defaulted loan assets?

1996 Federal Debt Collection Improvements Act.

What was the amount of Mortgage-Backed Securities outstanding as of 2015?

220,785,000,000

When an SPV creates asset-backed securities, do they retain the ownership of the original assets?

A Special Purpose Vehicle (SPV) purchases the assets (newly originated loans) from the originating bank for cash generated from the sale of asset-backed securities. The SPV sells the newly created asset-backed securities (credit derivatives) to investors such as insurance companies and pension funds, earning a fee for the services. However, the underlying loans in the asset pool belong to the ultimate investors in the asset-backed securities. All cash flows from the loans are passed through the SPV and allocated according to the terms of the ABS contract to the ultimate investors. Thus, the SPV acts as a conduit, selling the asset-backed securities to investors and passing the cashback to the originating bank. So, yes?

What is the packaging of loans into asset pools and then selling portions of the pool to investors known as?

Asset securitization: the packaging and selling of loans and other assets backed by securities.

Which agencies are NOT directly involved in the creation of mortgage-backed securities?

FHA or Farmers Home Association

Which is the oldest mortgage-backed security sponsoring agency?

Federal National Mortgage Association (FNMA) or "Fannie Mae" created in 1938

What does GNMA do?

Government National Mortgage Association (or "Ginnie Mae") Provides timing insurance to investors in mortgage-backed securities.

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

Highly Leveraged Transaction (HLT): A loan made to finance a merger and acquisition. If a loan is sold without recourse, not only is it removed from the FI's balance sheet but also the FI has no explicit liability if the loan eventually goes bad.

What does full amortization of a thirty-year loan mean?

It means that the annual and monthly cash flows on the mortgages portfolio reflect repayments of both principal and interest. Most fixed-rate mortgages are fully amortized. So for a 30-year loan for a mortgagee means that unless they refinance, prepay, or buy a new house their monthly payments will be the same for 30 years. If someone owns that mortgage and the mortgagee do not refinance, prepay, or buy a new house then the mortgage holder can expect a consistent income from the mortgage.

What is the most unique risk of fixed income securities?

Prepayment risk

Know what is NOT true of a loan that is sold without recourse?

Recourse: the ability to put an asset back to the seller if the credit quality of that asset deteriorates. NO recourse means that if the loan the FI sells goes bad, the buyer of the loan must bear the full risk of the loss. The buyer cannot put the bad loan back to the seller.

What are some causes of residential mortgage prepayment risk?

Refinancing and Housing Turnover

What type of loans are securitized most often?

Residential Mortgages

What is the more traditional form of an off-balance-sheet subsidiary for removing loans from a bank's balance sheet called?

Special Purpose Vehicle (SPV)

In 2008 who placed FHMA and FHLMC under conservatorship?

The FHFA (Federal Housing Finance Agency)

Virtually all HLT loans have the following characteristics:

They are term loans (TLs). They are secured by assets of the borrowing firm. They have a long maturity (often 3-6 years). They have floating rates tied to LIBOR. The prime rate or a CD rate (normally 200-275 basis points above these rates). They have strong covenant protection.

Besides reducing credit risks, a bank has incentives to sell loans for all of the following reasons EXCEPT... (know why they might not want to sell, basically).

To DECREASE core deposits.

What is a vulture fund?

Vulture fund: a specialized hedge fund that invests in distressed loans (often with an agenda that may not include helping the distressed firm to survive).

Define an HLT loan as adopted by US bank regulators in 1989 when given examples.

What constitutes an HLT loan has often caused disputes. However, in October 1989, the three U.S. federal bank regulators adopted a definition of an HLT loan as one that (1) involves a buyout, acquisition, or recapitalization and (2) doubles the company's liabilities and results in a leverage ratio higher than 50 percent, results in a leverage ratio higher than 75 percent, or is designated as an HLT by a syndication agent.

Does FNMA hold the mortgages it purchases on its balance sheet?

YES. FNMA actually helps create pass-throughs by buying and holding mortgages on its balance sheet.

When a FI sells a loan without recourse, is the credit risk eliminated from the FI's balance sheet?

YES. If a loan is sold without recourse, not only is it removed from the FI's balance sheet but also the FI has no explicit liability if the loan eventually goes bad.

Do buyers of a loan participation bear double monitoring costs?

YES. Participation in a loan: buying a share in loan syndication with limited contractual control and rights over the borrower. The economic implication of these features is that the buyer of the loan participation has a double risk exposure: risk exposure to the borrower and risk exposure to the loan selling FI. As a result of these exposures, the buyer bears a double monitoring cost as well.

Are investment banks predominant buyers of HLT loans?

Yes

Are loan sales by an FI another tool to manage the credit risk of the FI?

Yes

Historically, do correspondent banking relationships have an important part in the sale of loans?

Yes, a large part of correspondent banking involves small banks making loans that are too big for them to hold on their balance sheets. For lending concentration, risk, or capital adequacy reasons—and selling parts of these loans to large banks with whom they have a long-term deposit-lending correspondent relationship. This market has existed for many years, it grew slowly until the early 1980s, when it entered a period of spectacular growth, largely due to expansion in highly leveraged transaction (HLT) loans to finance leveraged buyouts (LBOs) and mergers and acquisitions (M&As).

Do credit derivatives allow FI's to reduce credit risk without removing loan assets from their balance sheet?

Yes. Credit derivatives (including forwards, options, and swaps) allow FIs to hedge their credit risk. They can be used to hedge the credit risk on individual loans or bonds or portfolios of loans and bonds.