Issuer-borrower loan

Under the secured loan structure, the trustee might find it necessary under certain circumstances to enforce the fixed and floating charges. Such circumstances could include unremedied events of default under the issuer-borrower loan, or if third-party creditors were to attempt to put the company into administration. In this case, the trustee would seek to have an administrative receiver appointed on behalf of the secured creditors. However, the process could disrupt the receipt and payment of cash flows. The ratings of the notes are based on timely payment of interest (and sometimes principal) so the transaction will include some form of liquidity support, which is typically sized to enable the issuer to cover one year s debt service. 

As noted, a bond may contain an embedded option which permits the issuer to call or retire all or part of the issue before the maturity date. The bondholder, in effect, is the writer of the call option. From the bondholder s perspective, there are three disadvantages of the embedded call option. First, relative to bond that is option-free, the call option introduces uncertainty into the cash flow pattern. Second, since the issuer is more likely to call the bond when interest rates have fallen, if the bond is called, then the bondholder must reinvest the proceeds received at the lower interest rates. Third, a callable bond s upside potential is reduced because the bond price will not rise above the price at which the issuer can call the bond. Collectively, these three disadvantages are referred to as call risk. MBS and ABS that are securitized by loans where the borrower has the option to prepay are exposed to similar risks. This is called prepayment risk, which is discussed in Chapter 11. 

The issuer of the original debt or borrower of the original loan, known as the reference entity, need not be a party to the credit risk transfer and in fact is usually not even aware of the transaction, thus allowing the client relationship between the lending bank and the borrower to be maintained. 

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