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FRM Part I · FRM Exam Part I · Banks

Under the originate-to-distribute (OTD) model, a bank makes loans and then sells them to a special purpose vehicle that issues securities. Which of the following is the most direct effect of this model on the originating bank?

Under originate-to-distribute, the bank sells loans to a securitization vehicle, so most credit risk leaves its balance sheet. This frees funding and regulatory capital for further lending. Holding all default risk to maturity describes the older originate-to-hold model, not distribution.

  1. ACredit risk on the sold loans is largely moved off the bank's balance sheet, freeing funding and regulatory capitalCorrect
  2. BThe bank retains all default risk and so must hold more capital against the loans
  3. CThe bank's liquidity needs rise because loans are held until maturity
  4. DThe bank loses its ability to earn any fee income from the loans

Explanation

Selling loans to an SPV that funds itself by issuing securities transfers most credit risk and removes the assets from the bank's balance sheet, so funding and capital are released for new lending. Retaining all default risk and holding to maturity describes the originate-to-hold model. The bank can still earn origination and servicing fees.

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