TUTORIAL 12 - SELLING LOAN ASSETS

1. Briefly explain what is meant by ‘selling loan assets’.

Selling loan assets’ is banking jargon. It involves a bank (the seller) transferring part
or all of its interest in a loan to another party (the buyer).Loans are a bank's assets.
Therefore the use of the term 'asset sale'.Loan sales arise in various contexts.First,
there is the 'participation syndicate'. Where a bank enters a 'bilateral loan' & then
immediately sells off parts of the loan to other banks. Second, many loan sales have
been motivated by a need for banks to remove items from their balance sheet.Portfolio
management, meeting capital adequacy requirements & reducing exposure to certain
borrowers have been different aspects of this. Third, there is now an active market in
‘distressed debt’. Borrowers are in default, & the debts are sold at a discount to those
who might be willing to assume the risk because there is a ‘favorable prospect’ for
them in any ultimate rescheduling of the debt. To an extent, the developing market in
bank loans is dissolving the boundaries between credit & capital markets. Since loans
are more readily saleable, there can be parallels with securities.

2. What are the various techniques of loan sales practiced by banks? Briefly explain each
of them.

Novation: is the extinguishment of a contract between the borrower, B, & the seller,
Bank X, & its 'substitution' by a contract of the 'same nature' between B & the buyer
bank Y. ALL parties must agree to a novation. Novation extinguishes the borrower’s
original payment obligation, it threatens any security which the selling bank has taken.
That must also be novated, or the security held by a security trustee in favour of any
buyer of the loan.

Assignment: as a technique of selling loan assets will be an assignment in equity.

Loan sales typically relate to part only of a loan. Banks are sometimes reluctant to
notify a borrower of an assignment for commercial reasons, since it may be taken as a
sign of the bank's weakness, a slight on the borrower or a vote of no confidence in it.

● Notice has distinct legal advantages, such as preserving priorities & cutting off
further cross-claims and defences.

● There may also be practical advantages such as reducing the risk of the selling bank
 being pressured to provide new money on a rescheduling.

● However, with syndicated loans, where an agent bank is appointed, there is no risk
that the borrower, if not notified, will get a good discharge by paying the wrong bank
all payments must go to the agent bank.

● Some borrowers are sufficiently powerful to have assignments limited. They want
to know who their banking partners are & wish to be in a position to track their
exposure to particular parties. Thus they may insist on a clause m the loan agreement
which requires their consent, or requires their consent although this is not to be
unreasonably refused. Generally under these clauses, consent will not be necessary
with assignments to affiliates, or if the borrower is in default.

Sub-participation:

● A fundamental distinction is between a ‘sub-participation’ (SP) and a ‘risk

participation’ (RP). In a SP, the buyer pays an amount to the selling bank, and in
return the selling bank agrees to pay an amount to the buyer, usually geared to
payments by the borrower on the underlying loan. Because the buyer bank is
providing funds to the selling bank, this is sometimes called a FUNDED SUB-
PARTICIPATION.

● In a RP, the third party bank, in return for a FEE, simply gives the lending bank a
GUARANTEE in relation to the failure of the borrower to pay on the underlying loan.
Nothing more will be said of RP here.

3. B has a facility of RM10 million from Bank X. Bank X informs B that it wants to
cancel the facility and transfer the facility to Bank Y who is willing to take over the
facility. Assess the legal implication of Bank X’s arrangement.

This arrangement is known as Novation. It is the extinguishment of a contract

between the borrower, B, & the seller, Bank X, & its 'substitution' by a contract of the
'same nature' between B & the buyer bank Y. ALL parties must agree to a novation.

Novation extinguishes the borrower’s original payment obligation, it threatens any

security which the selling bank has taken. That must also be novated, or the security
 held by a security trustee in favour of any buyer of the loan.

An important practice has developed whereby some loan agreements incorporate at

the outset the borrower’s agreement to novate in favour of anyone introduced by the
original bank. A form of novation certificate can be included in the loan agreement,
which also provides that novation takes effect when a certificate is signed by the seller
& buyer & by the party designated as the borrower's agent for this purpose.

The result is that the borrower need not know that the loan agreement has been
novated. Most likely, however, it will have access to the register of novation
certificates - knowledge post hoc.

4. Integrity Bank (IB) has provided a RM50 million facility to B. Later Bank Y and
Bank Z purchased, in equal proportion, the said RM50 million facility from IB.
Assess the legal impact of the above banking practice.

The legal impact of the loan sales includes:

After selling the loan to Bank Y and Z, the seller, IB is making no representation and
has no responsibility regarding the loan agreement such as in terms of the validity,
enforceability of the loan agreement.

It may also be made explicit that the third party, which is Bank Y and Z, must
undertake their own independent investigation of the financial condition of the B (the
borrower) which cannot rely on the seller (IB).

In some cases, however, the seller, IB has to give some representations & warranties
assuring Bank Y and Z about what is being sold.

Thus with an assignment, the seller (IB) may represent that Bank Y and Z will obtain
good title, free of any security interests or claims and IB will be in compliance with
obligations under the loan agreement and that the loan is not subject to any set-off,
defense or counterclaim due to an act or omission of IB.
5. Bank X approved and transferred a RM20 million facility to B. Subsequently Bank X
made arrangements to assign a portion of the RM20 million facility, that is RM10
million out of the RM20 million facility, to Bank Y, who willingly bought it. Evaluate
the legal position of B as the borrower in the above transaction.

There is no risk that the B, if not notified, will get a good discharge by paying the
wrong bank -all payments must go to the agent bank.

Some borrowers are sufficiently powerful to have assignments limited. They want to
know who their banking partners are & wish to be in a position to track their exposure
to particular parties. Thus they may insist on a clause m the loan agreement which
requires their consent, or requires their consent although this is not to be unreasonably
refused. Generally under these clauses, consent will not be necessary with
assignments to affiliates, or if the borrower is in default.