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The Loan Sales Market

  • Gary B. Gorton
  • Joseph G. Haubrich

Secondary loan participations, or loan sales, are a recent innovation in banking. In a secondary loan participation, or loan sale, a bank makes a loan and then sells the cash stream from the loan without explicit contractual recourse, guarantee, insurance, or other credit enhancement, to a third party. Between the late 1970s and early 1988 this market grew from insignificant amounts to about $240 billion. In fact, in roughly the last four years the loans sales market has grown by 784 percent. The development of the loan sales market is momentous. Bank loans hitherto were nonmarketable securities which could only be removed from the balance sheet by creating a contingent liability or by legally transferring the debtor-creditor relationship. Neither happened in significant volume. Whatever unique services were provided by banks, their production apparently required the bank to hold loans until maturity. Consequently, the recent practice of loan sales raises fundamental questions about the uniqueness of banks relative to markets as mechanisms for allocating capital. In particular, are banks continuing to perform unique services, such as enforcing loan covenants, or are these activities now performed by other economic agents, in markets? If banks are still performing these activities, what incentives to perform do they face if the loans can be sold without recourse? This paper describes the evolution of the loans sales market and explains the legal, accounting, regulatory and economic issues raised by its growth. We present the available quantitative evidence on the growth of the loan sales market, the identity of buyers and sellers, the types of loans sold, the characteristics of the participation contracts, and the prices of loans which were sold. Qualitatively, loan participations are distinguished contractually from other bank asset contracts, and the prices of loans both legally and economically. The various contracts are defined and their legal implications discussed. A set of stylized facts about loan sales contracts, based on a sample of blank secondary loan participation contracts (and associated contracts with the underlying borrower), collected from money center banks, is presented. Finally, we briefly consider possible explanations for how loans can be sold when this was not possible (in significant amounts) previously.

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Paper provided by Wharton School Rodney L. White Center for Financial Research in its series Rodney L. White Center for Financial Research Working Papers with number 35-88.

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Handle: RePEc:fth:pennfi:35-88
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