Credit Risk Management Practice Exam

Which method allows the distribution of risk through multiple investors in loan origination?

1. Syndication

2. CLO funding

3. Over-collateralization

4. Cash waterfall

The correct answer is: Syndication

The method that allows the distribution of risk through multiple investors in loan origination is syndication. In a syndication, a lead lender works with a group of other lenders to share the risk associated with a large loan. This structure is beneficial for both the borrowers and the lenders; it enables borrowers to access larger amounts of capital than individual lenders would typically provide, while allowing lenders to diversify their portfolios by participating in only a portion of a loan. Syndication helps mitigate the risks associated with concentrated exposures; by spreading the loan across multiple investors, the impact of any single default is diluted. Hence, lenders are more likely to engage in larger transactions without significantly increasing their individual risk levels. In contrast, CLO funding refers to collateralized loan obligations, which is more about pooling a variety of loans and then selling them as securities, rather than directly indicating a lending relationship. Over-collateralization is a technique used to enhance credit quality in asset-backed securities but does not distribute risk through investors in the primary loan origination context. A cash waterfall involves the method of distributing cash flows from a loan (or portfolio of loans) among different classes of investors, which primarily addresses the order of payment rather than the direct spreading of risk in origination.