Banking Law Investment Banks Loan Sales Liabilities & Securitization Discussion

Question Description

  • With regard to investment banks and loan sales and securitization;
  • In distributing an issuer’s securities, what could be the investment bank’s liability for the issuer’s wrongdoing. i.e. if the offering prospectus is false? (20 marks)

b) Explain in detail any one technique of loan sales used by banks mentioning its limitations and benefits to the parties concerned.

Principles of Banking Law Loan Sales & Securitization 9th May 2021 Ali Al Tareef Loan Sales & Securitization About the Lecturer ‫علي الطريف‬ Loan Sales & Securitization Our Commitments Loan Sales & Securitization Loan Sales & Securitization Loan Sales & Securitization Loan Sales & Securitization Loan Sales & Securitization 55% 45% Loan Sales & Securitization Legal techniques for transferring debts/contractual rights Selling loan assets Asset securitization Loan Sales & Securitization United Kingdom USA 25% . 15% Russia 25% 10% Brazil . 25% Ethiopia Loan Sales & Securitization Legal techniques for transferring debts/contractual rights Novation Assignment & its limitations Legal & equitable assignment

Trust Loan Sales & Securitization Selling loan assets Techniques for loan sales The sale agreement and its implications Loan Sales & Securitization Asset securitization Forms of securitization Transfer of loan assets Risk Regulation Loan Sales & Securitization Core banking activity of Lending results in a bank taking on different risks in different circumstances and can often reach a stage where it is saturated, illiquid or its capital becomes inadequate…. Loan Sales & Securitization Therefore, a bank would want to: Reduce Risks Meet Capital Adequacy requirements Generate liquidity in order to finance better projects Enhance returns Take advantage of the financial and commercial opportunities Leverage on its superior operating strengths Loan Sales & Securitization Legal forms and techniques for transferring debts / contractual rights 1. Novation: Making a new contract for an existing one, with the approval of all the parties concerned – with one party remaining constant in both the contracts.

This means the original contract ceases/lapses and a new contract is made. Example, A Bank has a loan agreement as lender to Mr P. It proposes to transfer the loan to B Bank, which is done through a new contract between B Bank and Mr P. 2. Assignment: A new contract may or may not be required, but certainly an agreement of Assignment has to be made between the Assignor and Assignee. The original contract between A Bank and Mr P should expressly permit Assignment. Loan Sales & Securitization original contract Loan Sales & Securitization 3. Legal and Equitable Assignment (also sub participation) In case of an Equitable Assignment or Sub Participation, the Assignor may retain some rights and will also have to be a claimant / defendant in a suit filed by the debtor / obligor or Assignee. T

he Assignor retains the right to sue the debtor / obligor on behalf of the Assignee as his trustee. The original agreement is untouched. 4. Risk Participation where a 3rd party bank/institution merely gives a guarantee but the original agreement is not affected. These are similar to credit derivatives (credit default swaps) effected at a fee. Features of a Loan Sale Agreement like any other contract, defines roles, responsibilities, rights, duties, liabilities, representations and warranties, indemnities and commercial terms. The buyer takes over the risks and liabilities concerned with the borrower and must do their own due diligence.

Seller must abide by his duty of confidentiality under the English Law. Roles of respective parties must be clear in terms of Rescheduling of debt and Set off. Loan Sales & Securitization TECHNIQUES FOR LOAN SALES  Three main techniques for loan sales:  Novation : Novation is the cancellation of the contract between the borrower and the selling bank and its substitution by a contract of the same nature between the borrower and the buying bank. All the parties must agree to a novation. Novation can subject the buyer to duties as well as pass to it the benefit of the borrower’s duty to pay. Loan Sales & Securitization TECHNIQUES FOR LOAN SALES  Three main techniques for loan sales:  Assignment: A lender (selling bank/ assignor) may assign (transfer) his rights to principal and interest payments under a loan agreement to a third party (buying bank/ assignee).By using the method of assignment, a bank may only sell its rights and it is generally not possible to transfer its obligations.

Lending contracts are relatively amenable to assignment since the lender’s duties are relatively limited. Loan Sales & Securitization TECHNIQUES FOR LOAN SALES  Three main techniques for loan sales:  Sub-participation: In a sub-participation, the buyer pays an amount to the selling bank, and in return the selling bank agrees to pay an amount to the buyer equal to a proportionate share of the payments of interest and principal received from the borrower on the underlying loan. The loan agreement between the seller and borrower is unaffected by the sub-participation agreement between the 2 banks.

The buyer has no claim whatsoever against the borrower. Thus if the borrower defaults, the buyer cannot sue it. The buyer is thus exposed to a double credit risk- of default by both the borrower and the selling bank. Loan Sales & Securitization TECHNIQUES FOR LOAN SALES  Three main techniques for loan sales:  Sub-participation: In a sub-participation, the buyer pays an amount to the selling bank, and in return the selling bank agrees to pay an amount to the buyer equal to a proportionate share of the payments of interest and principal received from the borrower on the underlying loan. The loan agreement between the seller and borrower is unaffected by the sub-participation agreement between the 2 banks. The buyer has no claim whatsoever against the borrower. Thus if the borrower defaults, the buyer cannot sue it. The buyer is thus exposed to a double credit risk- of default by both the borrower and the selling bank. Loan Sales & Securitization Asset Securitization: •Is the process of pooling and repackaging loans into securities (unitizing) which are then sold to investors through a Special Purpose Vehicle (SPV).

•It is the same as loan asset sales, but instead of doing it on a contract by contract basis, a larger portfolio is pooled together, broken down into investible units, offered to intending buyers, financial institutions, HNWIs or mutual/pension funds. •It’s a process of balance sheet management for banks. The securities are considered to be asset backed, which would include credit card receivables, mortgages, consumer loan portfolio etc •The bank continues to service the loans on behalf of the investors, or may assign that task to a specialist loan management company. A custodian holds the original loan documentation. •The Securities created may be externally rated, even a credit derivative (or insurance) contract may be entered into.

•No notice need to be given to original borrowers as the original lender continues to service the debts, the legal practice relates to an Equitable Assignment. •Risk – how much is transferred and when it is retained by the original lender bank Loan Sales & Securitization RISKS IN SECURITIZATION  Risks for the selling bank:  If novation is the technique used, the bank will have no further obligations or liabilities under the loans. However if assignment is used, it cannot absolve the bank from its obligations to make further advances. Hence transfer of loans by means of assignment means that the bank remains subject to some risk. The bank may continue to service the loans i.e. collect the principal and interest and pass them on to the issuer and is thus exposed to operational risk.

It might breach its duties as an agent of the issuer or it might be liable for misrepresentations made to the borrowers. Loan Sales & Securitization RISKS IN SECURITIZATION  Risks for the selling bank:  Risks for the issuer: Once the loans are transferred to the issuer, it has to bear the credit risks attached to the underlying transactions i.e. the risk of non-payment. The borrowers might bring cross-claims when payment is sought from them. These risks can be minimised by credit enhancement, by transfer of the loans at a discount or by overcollateralizing the issuer. The issuer may seek representations from the bank in the documentation concerning the quality of loans being transferred. In the event of a breach of these representations, the issuer can take action against the bank. Loan Sales & Securitization RISKS IN SECURITIZATION  Risks for the selling bank:  Risk to the investors: If the issuer fails, the position of the investors will depend on the structure of the securitization. If the securities are debt instruments, they will rank equally with other creditors. Follow @The BIBF For the latest updates on programmes and initiatives Loan Sales & Securitization Exercise 1 Loan Sales & Securitization Exercise 2 Loan Sales & Securitization Exercise 3

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