This glossary guides you to the meaning of over 500 words and phrases used in securitization industry.
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Asset Backed Commercial Paper (ABCP)
Is an application of the concept of securitisation to funding of trade receivables. Several originators wanting liquidity against their trade receivables sell these receivables to a conduit which then issues commercial paper, that is, short term paper of typically 90 days to 180 days maturity corresponding to the present value of such receivables. On maturity, the originator is supposed to collect the receivables and pass them over to the holders of the paper through the conduit. At times, the conduit is sponsored by a major bank which also provides liquidity support to the conduit to ensure timely redemption of the paper.
Asset Backed Financing
Refers generically to all forms of financing where the financier has a claim over specific assets of the borrower, whether with or without a general claim against the borrower.
Asset Backed Securities (ABS)
Is a security backed by receivables other than those arising out of real estate. Some examples are autos, credit cards, and royalties. It is common in securitisation markets to distinguish between ABS and mortgage-backed securities, viz., MBS. However, in markets outside the United States, the word ABS might cover all classes of securitised instruments, including those out of mortgages.
Generally refers to the underlying covenant in revolving assets securitisation and future flows securitisation that the repayment of principal (amortization) to the investors in a program will be accelerated upon the happening of certain events, normally events such as a fall in the degree of over-collateralisation, under-performance events, etc.
A method for finding out the amortisation of the principal invested in any periodic repayment. The method uses the implicit rate of return to find out the income earned during the period, and treats the balance as amortisation.
Act of God bonds
See catastrophe bonds below.
A legal word for receivables, right to claim.
Refers to US government agencies for promoting mortgage secondary markets. In market language, it may also refer to a a security issued by these organisations. These organizations include: the Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac), the Federal National Mortgage Association (FNMA or Fannie Mae), the Government National Mortgage Association (GNMA or Ginnie Mae).
In US parlance, refers to the mortgage -backed securities issued by agencies. Compare with private label securities.
Is the concept which assumes that newly issued mortgages tend to prepay slower than mortgages which are older or seasoned. This aging refers to the underlying collateral and not the securities created upon that collateral.
Alternative Risk Transfer
Refers to devices for managing insurable risk other than by seeking an insurance cover. For example, when a corporate wanting protection against natural calamities either sets up a captive insurance company or uses securitisation of risk to cover itself, it is using an alternative to traditional insurance, and hence the device is called alternative risk transfer (ART).
Is the periodic paydown of principal. This is a common feature of most fixed rate loans. Amortization schedule refers to a schedule showing the payment of principal and interest over time for a loan. Compare with bullet payment.
Is the Annual Percentage Rate of Interest. Refers to the intrinsic rate of return (IRR) in a mortgage or loan carrying specified payments over time.
Is the Annual Percentage Yield of Interest. This refers to the APR compounded on a yearly basis.
Adjustable Rate Mortgages
Is a mortgage loan which has a coupon or interest rate that is subject to change on predetermined reset dates, on the basis of variations in a reference rate. These loans use interest rate indices as the reference rate. Adjustable rate loans may have cap and floor features, meaning the maximum rate and the minimum rates after giving effect to variations. There may also be lifetime cap and floor features. Adjustable Rate Mortgages may be strictly amortizing though some have negative amortization features.
In relation to receivables, it means the legal action of transfer of receivables from one person to another. In relation to a mortgage, it would mean the transfer of a mortgage by the mortgagee (borrower and occupier) to another person.
Assignable mortgage/ Assumable Mortgage
Is a mortgage loan which can be assumed by a new buyer. Generally, the new owner must pass a credit approval process.
See weighted average maturity below.
Baby Bonds are bonds which have denominations less than $1,000 per bond.
In securitisation transactions, it is customary for the originator to continue to service the transaction, that is, collect receivables, follow them up, etc. However, the SPV is given the right, in certain predefined events or at the discretion of the SPV, to remove the servicer and have the transaction serviced by the back up servicer, that is, an entity other than the servicer.
BAN or Bond Anticipation Note
Is a short term security issued by a municipality. The security will be paid or redeemed by funds from a new issue. It is a cash management tool.
The law relating to bankruptcy of entities.
The properties of a bankrupt entity which are usually taken over by a Court-appointed administrator.
A key concern in securitisation transactions to ensure that the transfer of assets of the originator to the investors’ representative or SPV is not affected by bankruptcy or distress of the originator. This necessitates certain legal precautions in structuring the assignment of receivables, as also so constituting the SPV that it can neither be taken to liquidation by the shareholders of the originator, nor by those of the SPV itself. Further, the structure should also ensure that the SPV would not be treated as the subset of the originator by substantive consolidation. Such a structure is called bankruptcy remote structure.
Refers to a situation where an entity is unable to pay its debts. Normally the assets of a bankrupt entity are taken over by a Court-appointed administrator, and the entity is taken to winding up.
Similar to grantor trust where the only role of the trust is to hold title to the asset and the trustee has no interest in the asset. See also grantor trust, tax transparency.
Is a security which does not have the owner’s name on the certificate. Interest and principal are paid to the person presenting the attached coupons to the agents for payment.
Refers to charges which are imposed upon the redemption or liquidation of an investment or borrowing option. Sometimes, these charges are viewed as early withdrawal penalties. They are called back-end because they occur at the end of the investment process.
Is the standard to measure, monitor, price or evaluate a security or derivative. It could also refer to a rate used as the basis for adjustable rate loans or mortgages. For example, the treasury market is the benchmark for the corporate, mortgage backed, international and emerging credit markets.
The interest of the investors on whose behalf the trustee or the SPV holds securities/ receivables. In a securitisation deal, the receivables/ cash flows are legally held by the SPV or trust, for the benefit of the investors; hence the investors are beneficiaries and their interest is beneficial interest.
Bond Equivalent Yield (BEY)
Is the computation of a yield on the basis of a 365-day year.
Beneficial interest certificates
Certificates indicating the beneficial interest of investors in the SPV/ trust. These are different from bonds which are debt securities issued by the SPV. See also cash flow bonds.
Bank for International Settlements (BIS)
An international banking forum which sets standards for bank capital and risk management. The BIS has, inter alia, set model capital adequacy norms based on which bank regulators in individual countries fix the minimum capital requirements for banks and financial intermediaries. These proposals also include provisions relating to securitisation transactions.
A securitisation issue where no or scanty details are known about the collateral, that is, underlying assets. Normally this is the case where the SPV issues securities backed by receivables of multiple originators.
An instrument created by securitising the receivables from music tapes of a famous singer by that name. Perhaps the first instance of securitisation of intellectual property rights.
Refers to bonds created by converting sovereign debts of Argentina, Mexico and Venezuela into tradeable securities under a plan initiated by the US Government in 1989. Named after its author, Brady.
Is an organization which is created to serve as a vehicle to transport damaged loans or securities from an ailing financial institution. Often these nonperforming securities are package into securities or portfolios, which may be, acquired by turn-around specialists or vulture funds at significantly discounted prices. This activity can help improve the creditworthiness of the impaired financial institution because loans or securities in default are no longer held by that institution. This frees up regulatory capital for other purposes and removes impediments for complying with various regulatory bodies and banking laws. It should be noted that from a banking, brokerage or insurance perspective, illiquid or defaulted loans and securities have substantially higher regulatory capital haircuts relative to most other liquid securities. See Special Purpose Vehicle below.
Refer to categories for securities or derivatives. Some buckets refer to maturity classifications, such as, 3, 6, 12 month buckets. There are many other designations as well. The term can also refer to duration adjusted groups, option adjusted groups, and other predefined categories which represent a dominant, common feature.
Is a type of credit security which repays the entire principal on the maturity date. Prior to the maturity or prepayment of the bond, interest payments are to be made in accordance with the payment schedule. Normally, corporate bonds pay off in lump sum principal, that is, are bullet paying bonds, whereas many mortgages, leases etc. pay off on an amortization basis. See also amortisation above.
Is mortgage market phenomenon representing the tendency of mortgage pools to become less sensitive to interest rate as they tend to maturity. The older the pool, the more burnt out is the sensitivity to interest rate changes.
Is a contract whereby the purchaser, owner or holder is given the right but is not obligated to purchase the underlying security or commodity at a fixed strike price within a limited time frame. Compare with put option below.
The possibility that prepayments will increase above an anticipated rate, causing earlier-than-expected return of principal, usually occurring during a time of falling interest rates.
Is the ceiling, upper limit price, or interest rate which would be paid.
The amount of capital relative to the assets of a financial intermediary. Almost all banking regulators now require a certain minimum of capital against the risk-weighted assets of financial entities. Generally these requirements are set in accordance with concordat under the aegis of Bank for International Settlements.
In a securitisation transaction, the amount of cash deposit put by the originator to serve as a cushion for the investors; a device of credit enhancement. Generally, the collateral is retained out of the amount payable by the SPV for purchase of the receivables of the originator.
Cash flow bonds
Securitised instruments issued as bonds, instead of pass through or pay through certificates. Different examples are collateralised mortgage obligation bonds, collateralised loan obligation bonds, etc.
In insurance language, the risk of a major devastation of person or property, generally due to natural calamities. In securitisation language, it also means the risk of an unprecedented near-complete collapse of the originator’s cash flows, leading to a catastrophe for the investors.
Catastrophe bonds or Cat bonds
A securitised instrument based on insurance receivables out of catastrophe insurance.
CATS are Certificates of Accrual on Treasury Securities. In a generic sense, the sliced off interest payments or coupons are called strips or zeroes. At those times the discounted bond principal is referred to as the Corpus.
Collateralized Bond Obligation (CBO)
CBO is a Collateralized Bond Obligation. It is similar in structure to a CMO deal, indicating the receivables of an entity, normally banks, on account of bonds held by the bank, transferred to an SPV and securitised. Since the underlying receivables are from bonds, hence the name collateralised bond obligations.
CBOE is the Chicago Board Options Exchange
CBOT is the Chichago Board of Trade
Current Face Value
The current amount of principal outstanding on a security, which is calculated by multiplying the original face value by the most recent factor.
Refers to the Chapter 11 of US Bankruptcy Code which provides for certain protection to distressed companies, such as stay against suits or action against properties etc. Similar provisions exist in many other countries.
Creation of a security over certain assets of a borrower to secure a credit or a debt obligation. In securitisation structure, if the SPV issues bonds, it might create a charge on the receivables held by it.
Picking up selected high quality assets for the purpose of securitisation leaving behind low grade assets. Cherry picking of assets for securitisation is frowned up by creditors of the originator as also the shareholders. In some countries, cherry picking for securitisation is prohibited.
Choses in action
A legal expression for actionable claims or receivables.
A trust formed for non-business purposes. Specific to securitisations, charitable trusts are used as an intermediary owner of the SPV – that is, the SPV is owned by the trust; had the SPV been owned by the originator, the originator or the shareholders of the originator could either take the SPV to liquidation. By inducting the charitable trust as owner, the SPV becomes an orphan company.
Clean up buyback or call
An option with the originator in securitisation transactions where the originator can buy back the outstanding securitised instruments when the principal outstanding has been substantially amortised, leaving a small uneconomic amount to serviced. Normally, clean up call is exercised when the outstanding principal falls below 10% of the original.
Collateralized Loan Obligations (CLO)
Is similar in structure to the Collateralized Mortgage Obligation. See Collateralized Mortgage Obligation below for analogous terms -the only difference here being that the securities issued on behalf of the originating bank are backed by receivables from loans, rather than bonds.
Commercial Mortgage Backed Securities (CMBS)
Refers to Commercial Mortgage Backed Securities. A section of Mortgage Backed Securities , the word is used to distinguish these from Residential mortgage backed securities (RMBS). Commercial mortgages represent mortgage loans for commercial properties such as multi-family dwelling, shops, restaurants, showrooms, etc.
CME is the Chicago Mercantile Exchange.
Collateralized Mortgage Obligation (CMO)
Collateralized Mortgage Obligation Is a securitisation payment method where the cash inflows of the SPV are divided into several tranches, each tranche having different payback period and seniority profile. These tranches, which are often designated as A to Z pieces or securities, normally in the form of bonds. For example, the A bonds might be the senior most in terms of security, and might off faster than other bonds. The different tranches can be structured as per the objectives of the investors as to pay back period and the risk inherent. The common CMO structures are: Interest Only, Principal Only, Floater, Inverse Floater, Planned Amortization Class, Support, Scheduled, Sequential, Targeted Amortization Class, and Z or Accrual Bond. Often, many of these securities contain option characteristics. Related structures are Collateralized Bond Obligations and Collateralized Loan Obligations.
The risk that the cashflows collected by the originator gets co-mingled with that of the originator; hence, in bankruptcy, such cash would become the part of the bankruptcy estate of the originator and would not be available, for lack of traceability, to the SPV, even though it belongs to the SPV.
Is the generic term for a structure that integrates cashflows from the underlying collateral to be differentiated into several distinct cashflows streams, or different securities, each having different repayment and seniority structure. Some of these securities may experience greater stability whereas others may absorb more of the risky characteristics of the underlying assets. The purpose of the reconfiguration of the cashflows from underlying assets is to either carve out securities of different maturities, or to allow some to be subordinated to the others so as to improve the rating of the latter. Specific categories of these structures are Collateralized Bond Obligations, Collateralized Loan Obligations, and Collateralized Mortgage Obligations.
Is the underlying security, mortgage, or asset for the purposes of securitization or borrowing and lending activities. In respect of securitisation transactions, it means the underlying cashflows.
Collateral Trust Bond
Is a security issued by a corporation and is secured by other securities. This bond compares to Mortgage Backed Securities which are secured by real property or unsecured bonds. Depending on the underlying collateral and the terms of the issue, these bonds can offer somewhat better financing rates to the issuer.
Where the originator in a securitisation is also the servicer, the cash collected by the originator may at times co-mingle, or may deliberately be mixed up with that of the originator himself, leading to no clear identification of the cash collected on behalf of the SPV. This is called co-mingling.
A short term debt instrument, typically of 90 days to 364 day maturity, normally in form of a promissory note, issued at a discount on face value. Plain commercial paper is mostly unsecured, but a combination of securitisation and commercial paper has resulted into asset backed commercial paper.
A medium, or a legal vehicle. Specific to securitisations, this means an entity formed to hold receivables transferred by the originator on behalf of the investors. In pass through structures, an SPV is a mere conduit as it merely represents the collective property and cashflows of the investors. In case of asset-backed commercial paper it means the SPV which holds the receivables transferred by different originators, and issues commercial paper to raise money to buy the same.
Several possible meanings, but in the context of securitisations, normally refers to the action of a judicial authority in treating the SPV and the originator as the same entity by applying a legal concept called lifting or piercing the corporate veil. If consolidation is done by a Court, the transfer of assets by the originator to the SPV would become unfructuous. Securitisation structures aim at avoiding the possibility of a consolidation by Courts.
In accounting sense, could mean the consolidation of the accounts of the SPV with those of the originator. Again, this would mean the assets transferred by the originator would come back on the balance sheet of the originator.
Refers to a mortgage loan provision. It defines and allows an Adjustable Rate Mortgage (ARM) to be converted into a Fixed Rate Mortgage.
Is the contractual rate of interest on a credit instrument. It is the interest payable on a bond, normally expressed as a percentage of face value.
Refers to the party with whom a swap or options deal has been struck. In relation to securitisation, it means the party with whom the SPV has entered into, say, an interest rate swap and accordingly, counterparty risk refers to the risks as to performance of the swap counterparty.
Are formal conditions or clauses which are written into credit agreements. Often the document which contains these covenants and terms is called the indenture.
Refers to a contract between two parties where one party agrees, for a fee, to guarantee the total returns in a credit-based transaction, thus taking the credit risks in the transaction without either funding the transaction or taking it on its books. A technique to share the risks and rewards in credit transactions.
In the sense in which bank regulators use it, it means forms of financing clients of a financial institutions which are similar to a traditional credit.
Refers to one or more initiatives taken by the originator in a securitisation structure to enhance the security, credit or the rating of the securitised instrument, e.g., by providing a cash collateral, profit retention, third party guarantee, etc. Comparable to the various ways of securing a traditional credit transaction. Credit enhancement could be structural credit enhancement, originator credit enhancement or third party credit enhancement.
Direct credit substitute
A term used by bank regulators to indicate extent of credit risk undertaken by a financial intermediary in a credit substitute transaction. Generally, the extent of risk undertaken by the entity is directly reduced from the capital of the entity. See also capital adequacy above.
The date on which payments from a security to an investor are made.
Is the date from which interest accrues on a newly issued municipal security.
Refers to a relationship which obligates a borrower to pay interest and principal.
In accounting sense, means putting of the securitised assets off the balance sheet, and corresponding derecognition of liability. See also sale treatment.
Discretionary further advance
In securitisation transactions, refers to the possibility of the originator making further advances, at his discretion, to the obligors. Compare with mandatory further advance below.
Relative to securitisations, refers the interest rate used for computing the purchase price of receivables or the rate for computing present value of a sum payable in future.
A phenomenon in financial markets where the users of financial resources seek direct access to the providers of such resources, by avoiding the intermediary institution or banks.
In context of credit card securitisation, refers to a trust which would acquire receivables of a particular originator and would be co-terminus with the particular issuance. Compare with a master trust below.
Deferred purchase price
A device of credit enhancement where a part of the purchase price for the receivable payable by the SPV to the originator is retained by the SPV to serve as a cash collateral.
DRIP or DRIPS
Refer to Dividend Reinvestment Programs whereby an investor acquires additional shares of the corporation by having the dividends automatically reinvested.
Debt to income ratio
As an important tool to evaluate consumer loans, this ratio measures the monthly required repayment under a borrowing to the monthly income of the borrower. Depending upon the definition of the analyst, the income could mean the cashflows left after mandatory deductions at source, other loan repayments, etc.
An assignment of receivables that does not complete the legal requirements for an assignment, for example, a formal stamped instrument, or a notice to obligors, etc. English common law recognises equitable assignment as creating an equity between the assignor and the assignee, though it cannot have any standing in relation to either the obligor or any third parties.
The criteria for selection of receivables which are to be assigned by the originator to the SPV. These are normally contained in the receivables sale agreement with a provision that a breach of the criteria would amount to breach of warranties by the originator, obliging the originator to buy-back the receivables.
Is a term which broadly categorizes countries in the midst of developing their financial markets and economic infrastructures.
Is an option whose characteristics are implied but not explicitly specified. For example, the option to prepay a mortgage loan.
Same as legal mortgage.
Is an option whose strike and expiration are clearly stated. There is a direct payment for this specific option contract. In the case of an implied option or embedded option, the price adjustment is reflected in the instrument such as a mortgage.
A mortgage which has not been completed in accordance with legal requirements – say, stamping, filing or registration. English common law permits recognition of interest of a mortgagee even if the mortgage is not duly completed in law. However, perfect legal claim in priority over rights of all others can be obtained only by a legal mortgage.
The possibility that prepayments will be slower than an anticipated rate, causing later-than-expected return of principal. This usually occurs during times of rising interest rates.
Is a fund held by a third-party custodian.
Refers to the excess of the income inherent in the portfolio of receivables, over and above the SPV’s discounting rate and the expenses of the transaction. Represents the profit of the originator in the securitisation transaction.
Equipment Trust Certificate
Is a security which is collateralized by ownership of specific equipment, often capital in nature. Normally used in aviation revenues securitisation, this would involve the ownership of the asset, e.g., aircraft, being transferred to the SPV which would issue certificates indicating beneficial ownership of the asset. The asset is leased out by the SPV to the aviation company normally under a full payout dry lease.
Is a term to indicate an increase in the duration of mortgage backed and related securities. Generally, it is a consequence of slower-than-expected prepayments.
In banking parlance, means the arrangement with a borrower to provide a particular kind of credit support to the borrower.
The decimal value, calculated monthly, that represents the proportion of the original principal amount outstanding at a given time.
The making of further advances to an obligor of a receivable; if the receivable has already been securitised, making of further advances creates complications on account of priority of claim over the underlying security. See also discretionery further advances; mandatory further advances.
Nick name for US agency for trading in mortgage pass throughs, see Federal National Mortgage Association.
Fixed allocation percentage
In credit card securitisations, refers to the fixed proportion in which principal collected every period will be allocated to amortise the outstanding investment of the investors, and the amount retained by the originator.
Floating allocation percentage
See under principal allocation percentage.
The earlier US accounting standard on securitisation which was superseded by FASB 125 on January 1, 1997.
Is the Accounting Standard issued by the US Financial Accounting Standards Board on securitisation accounting.
Financial assets investment securitisation trust. A US tax provision treats the FASIT as a tax transparent entity if it satisfies certain conditions.
Final Distribution Date or Maturity Date
The latest possible date on which an MBS receives payment. The actual final payment of any MBS will likely occur earlier, and could occur much earlier than the final distribution date or maturity.
Refers to charges which are imposed upon the purchase or acquisition of an investment position. Many times these charges are on a sliding scale. Sometimes, these charges are viewed as impediments for early withdrawals. They are called front-end because they occur at the beginning of the investment process.
Federal Home Loan Mortgage Corporation
A US govt. agency created in 1970 to promote secondary market in conventional residential mortgages.
An instrument carrying a floating rate of return.
The minimum rate of interest payable on an adjustable-rate mortgage.
First loss risk
Refers to extent of credit enhancement in a securitisation transaction which is several times the historical loss, so as to make the investors virtually protected against risk of losses, other than catastrophe risk.
Nick name for Federal Home Mortgage Corporation.
Federal National Mortgage Association
A body created in 1938, but now privately owned and quoted on New York SE, for promoting mid priced residential mortgages.
The exercise of an owner or secured creditor’s rights over an asset to liquidate the amounts payable under a defaulted loan or credit contract. For example, in context of mortgages, the seizure of the mortgaged property; in case of leases, the repossession of leased property. Sometimes, could also refer to the prepayment of a mortgage or lease.
Refers to the condition whereby interest rate or exchange rates are free to change. Normally the basis of variation is provided.
FRCMO is a Collateralized Mortgage Obligation carrying a floating rate.
Fixed rate mortgage
A mortgage loan with an interest rate and payments that do not change over the life of the loan. Contrast with adjustable rate mortgage.
Floating rate note
A debt instrument carrying a floating rate of return. In context of securitisation, refers to the bonds issued by SPV carrying a floating rate.
Funded risk participation
See sub-participation below.
Future receivables securitisation
Refers to securitisation of receivables that do not exist; that will arise over time.
The UK accounting standard on accounting for substance of transactions; has a specific section dealing with securitisation.
See tax transparency below.
A securitisation transaction is said to have been given a financing treatment when it is treated as a financial transaction either for legal, tax or accounting purposes. Compare with true sale treatment below.
Generally Accepted Accounting Principles. Compare with RAP.
Guaranteed Investment Contract
A contract guaranteeing a minimum rate of return on investments. In pay through securitisation, the SPV would need to re-invest temporary surpluses or surpluses to re-configure the cash flows. It would normally enter into a guaranteed investment contract with a bank to ensure it is not affected by movements in interest rates.
Slang for Government National Mortgage Association.
Government National Mortgage Association
A body created by the US Govt. engaged in providing secondary markets in mortgage instruments. The creator of the first issue of securitised pass throughs in 1970.
Is a 15 year maturity, fixed rate pass-through security issued by the Federal Home Loan Mortgage Corporation.
General Obligation Bonds
Are securities issued by municipalities. The source of revenue to pay the interest and principal is taxes. These securities are also known as full faith and credit issues because they depend on the municipality’s capacity to tax. These issues are often considered to be more stable than Revenue Bonds.
Gold (MBS) Program
Is the Federal Home Loan Mortgage Corporation (FHLMC) program that extended the interest and principal payment guarantee. It also reduced the interest delay to 14 days.
Graduated Payment Mortgage
Is a mortgage which frequently has relatively low payments in its early life. These relatively low payments are often insufficient to amortize the principal. Therefore with the passage of time the payment schedule is stepped-up to paydown the early negative amortization, service the interest requirement, and paydown the total principal balance.
A US tax-transparent trust that is a passive non-business entity, normally used in pass through securitisation; it cannot issue multiple class securities having payment streams different from those of the underlying receivables, but can create senior and subordinated securities.
Is a mortgage backed securities term which indicates mortgages which are not seasoned yet. Typically, a mortgage that is less than 30 months old is considered green.
In context of capital adequacy requirements, means the extent of marginal capital needed for a particular asset. For example, the haircut for a regular loan given by bank is 8%; in case of lower risk-weighted assets, the haircut is lesser.
Home equity loans
A loan granted based on the “equity” a home owner has built into his owned house, i.e., the excess of the market value of the house over the loans already taken. Typically, the home equity lender takes a secondary charge over the house if already mortgaged to a primary lender.
They are Catastrophe Bonds issued to pass on hurricane insurance risk to investors. In exchange, these investors may receive potentially greater-than-market rates of return.
Implicit rate of return
The rate of return inherent in an investment paying back in periodic instalments – the rate is derived mathematically so as to give a constant periodic rate on outstanding investment during any period, and fully pay back the principal invested at the end of the period.
Is a security whose value is predicated on a discounted interest rate structure. Typically, this is a CMO type derivative product. Prepayment activity is a dominant evaluation factor, since prepayment will affect interest payments. Compare with principal only which does not face interest rate or prepayment risk.
Is either the coupon or floating rate attached to a credit instrument or lending operation.
Interest Rate Risk
Is the risk associated with changes in general interest rate levels or yield curves. This compares to Prepayment Risk.
Interest rate swap
A single currency swap where parties agree to swap a fixed rate of interest for a floating rate of interest, or different bases for a floating rate of interest.
A company treated as such for regulatory purposes. Most countries’ laws provide for a specific regulation applicable to such companies. For example, US Investment Company Act, 1940. An SPV is not treated as investment company under the 1940 Act if it satisfies certain conditions set out in rule 3a-7.
See Embedded Option.
In context of securitisations, refers to the SPV which issues the securities to the investors.
Jump Bonds are issues which are conditioned on an event or series of events. When the event – such as breaking a prepayment collar – occurs, it triggers a predetermined movement to another payment arrangement. This type of bond occurs in collateralized obligation structures.
Bonds which are subordinated to senior bonds.
Refer to non-investment grade debt securities. Sometimes, these issues are called high yield securities. These securities have credit ratings below Baa/BBB-.
A mortgage which has been perfected as per requirements of the relevant law, for example, stamping, filing, registration, etc. Also called English mortgage.
A provision under UK Accounting standard FRS 5 requiring the amount of securitised assets being netted off by the amount raised by selling them off, instead of removing the assets from the balance sheet. If the maximum loss the originator can suffer is capped, the securitisation qualifies for a linked presentation.
In context of asset-backed commercial paper, refers to the facility granted by a bank to meet the short-term funds requirement of a conduit when it is unable to roll over the paper so as to redeem maturing paper. Normally the facility is available only for non-defaulted receivables, or else such a facility will be treated as a credit substitute.
Limited Liability Company (LLC)
A US corporate structure which provides for limited liability, but with a provision that the members of company cannot transfer their shareholding without consent of 100% of their members; each member has a right to participate in management. Similar concept exists in German law (GmbH) and some other jurisdictions.
Lifting or piercing the corporate veil
See under consolidation above.
The right of recourse limited to a particular amount or a particular security. For example, in a securitisation transaction, the right of recourse being limited to the over-collateralisation or cash collateral placed by the originator is a case of a limited recourse.
Loan to value ratio (LTV)
In case of asset-based lending, means the amount of loan as a percent of the value of the asset on which the loan is secured.
Mortgage Backed Securities (MBS)
Is a broad term which encompasses securities carved out of receivables out of mortgage funding. MBS are further classified into residential mortgage-backed securities and commercial mortgage-backed securities. The generic term also includes private label and agency securities, pass-throughs, or derivatives such as Collateralized Mortgage Obligations. It can refer to the Over-the-Counter options on mortgage backed securities as well. These mortgage backed securities are viewed as either plain vanilla or exotic.
Multiple class securities
A securitisation transaction where the SPV issues several classes of securities such as senior and junior securities.
Mega or Megas
Is a Fannie Mae program. It allows investors to combine new or old FHLMC securities into these larger instruments. Megas have principal amounts equal to or greater than $5 million. The subpools used for Mega construction can be either fixed or adjustable rate securities.
Mandatory further advance
In case of securitised receivables, the need for the originator to make further advances to the obligor which is committed under the underlying agreement. Compare with discretionary further advances.
A funding which is matched in repayment pattern with the recovery pattern of an asset. Securitisation, for the originator is an example of matched funding.
Is a 15 year maturity, fixed rate security issued by the Government National Mortgage Association (GNMA).
Mortgage indemnity guarantee policy – see under pool policy.
An insurer writing only a single line of insurance contracts, viz., credit insurance, which is similar to a financial guarantee. Securitisation transactions make use of monoline insurance contracts as credit enhancements.
Is the lending party in a mortgage transaction.
Is the borrowing party in a mortgage transaction
Is a creation of security interest, normally over real property, in order to secure a loan or debt obligation. See also legal mortgage, equitable mortgage above.
Medium Term Notes (MTN)
A debt security typically having a maturity period of 1 to 5 years.
Is the valuation process which provides an indication of reasonable prices for positions on a daily basis or some other proscribed time frame. In accounting parlance, it would mean valuing securities/loans at their market values.
In context of credit card securitisations or other revolving asset securitisations, refers to a trust which on an ongoing basis would continue acquiring receivables and issuing securities based thereon. Compare with a discrete trust.
An undertaking obtained from the persons dealing with an SPV that said person shall not file a petition for bankruptcy of the SPV until the investors in the SPV have been paid off. A feature required to ensure that the SPV is bankruptcy remote.
A term in English law meaning the substitution of one party to a contract by another, with the consent of the other contracting party. For example, A and B have a contract, and now A wants to transfer his rights and obligations under the contract with the sanction of C – this is a case of novation. Novation is required where A wants to transfer both the rights and obligations under the contract. Compare with assignment which is normally only of rights under a contract, and does not require the sanction of the other contracting party. Also see sub-participation, subrogation.
The debtor from whom the originator has right to receivables.
Originator Credit Enhancement
Refers to Credit enhancement provided by the originator, such as cash collateral, over-collateralisation, etc.
Off balance sheet
A debt or asset which does not show up on the balance sheet of the entity that originated the asset or debt. In a securitisation transaction, if the transaction qualifies for a sale treatment, the assets transferred by the originator are off the balance sheet of the originator, and so is the amount received on account of such transfer.
The entity assigning receivables in a securitisation transaction.
A company which has no identifiable shareholder/ owners – e.g., an SPV owned by a charitable trust. If the trust is a public charitable trust, there is no identifiable beneficial owner of the SPV.
A method of credit enhancement in a securitisation transaction where the originator transfers an extra collateral to the SPV to serve as security in the event of delinquencies, etc.
P & I
P & I are principal and income payments or principal and interest. Compare with principal only, interest only.
Planned Amortization Class
Is a security which is structured to have a reasonable life expectancy provided the prepayment speeds stay within the defined ranges. The scheduled interest and principal payments tend to be more stable for these tranches relative to the other parts of the deal.
PAC POs are Principal Only issues which are predicated on a predetermined PAC prepayment schedule, range, or collar.
Principal allocation percentage
In revolving asset securitisations, refers to the proportion of collections allocated to amortising the investment. See fixed allocation percentage or floating allocation percentage.
A European concept where banks participating in a jointly-funded loan account would be given certificates of participation evidencing their partial interest in the loan – the certificates would be normally transferable. A precursor to the concept of securitisation. See also sub-participation.
Occurs when an investor receives a portion of the profits, appreciation, or increased cash flow. This term tends to occur in the fixed income or real estate markets. In banking parlance, this term is also applied to the participation of several lenders in a syndicated loan, that is, a loan shared by several lenders.
Refers to the securitisation structure where the SPV makes payments, or rather, passes payments to the investors, on the same periods, and subject to the same fluctuations, as are there in the actual receivables. That is to say, amount collected every month is passed through to investors, after deducting fees and expenses. Compare with pay through.
Is a mortgage back securities term which refers to a tranche currently paying both interest and principal.
A securitisation structure where the payments to the investors are routed through the SPV who does not strictly pay the investors only when the receivables are collected by it, but keeps paying on the stipulated dates irrespective of the collection dates. In order to allow for smoothed payment to investors by removing the fluctuations in its collections, the SPV uses a guaranteed investment contract or credit enhancements or both.
Piercing the corporate veil
See under consolidation.
A German traditional secondary market mortgage product. Similar to the US concept of pass throughs.
Is a type of risk often associated with mortgages. It occurs from the time an application is accepted to the sale of the asset. Some analysts partition this process into two parts: production and inventory. Production starts at the time of the application and continues until the closing of the mortgage. Inventory risk starts at the closing and continues until the product is hedged or sold. Different hedging techniques are suggested for the two partitions.
Private label securities
See private pass throughs.
Principal only (PO)
Is the principal only derivative of a credit structure. Typically, it is found in CMO deals.
Is the combining of different loans into standardized or predefined units for trading purposes. This activity increases the homogenization of the underlying collateral. A key benefit of pooling is a diverse, generic security.
An insurance policy that covers losses sustained on a pool of mortgage loans. Also called MIG policy.
Refers to a cost which may be charged against a borrower in the event of a prepayment.
Is the potential loss due to prepayment by an obligor. The SPV may either pass through the prepaid amounts to investors thus resulting into faster payment of principal than expected, and reduced income over time, or if the SPV were to reinvest this money, the reinvestment may not produce rate of return as in the underlying receivables. Hence, prepayment is viewed as a risk in securitisation, though sometimes, prepayment penalties may more than undo the damage.
Private Pass Throughs
In US jargon, these are mortgage backed issues securitized by non-agency financial institutions. This compares to FNMA, Freddie Mac and GNMA securities.
Is an payment by a borrower in advance of the scheduled payment date. Prepayment is normally an embedded option in loan contracts, particularly so in case of consumer loans.
The extraction of the originator’s spread in the securitisation transaction, that is, the excess of the underlying rate of return in the receivables over the discount rate at which the SPV acquires the same. If the originator receives the whole of this profit upfront, he is said to have extracted the profit immediately. If he collects the profit by way of servicing fees, then the profit is extracted over time. If the originator transfers the receivables at their carrying value and agrees to extract the profit at the end of the transaction by way of residuary income, then the profit extraction takes place at the end of the term.
Various devices by which the profit extraction by originator takes place otherwise than upfront.
Is the Public Securities Association. It is an association of banks, brokers, and dealers who underwrite or sell bonds. These bonds include: U.S. treasuries, agencies, municipals, and mortgage backed securities. In particular, this organization sets standards and practices for the mortgage backed market. Among these standards are the PSA Prepayment Models and assumptions.
A measure of the rate of prepayment of mortgage loans developed by the PSA. This model represents an assumed rate of prepayment each month of the then-outstanding principal balance of a pool of new mortgage loans. A 100 percent PSA assumes prepayment rates of 0.2 percent per annum of the then unpaid principal balance of mortgage loans in the first month after origination and an increase of an additional 0.2 percent per annum in each month thereafter (for example, 0.4 percent per annum in the second month) until the 30th month. Beginning in the 30th month and in each month thereafter, 100 percent PSA assumes a constant annual prepayment rate (CPR) of 6 percent. Multiples are calculated from this prepayment rate; for example, 150 percent PSA assumes annual prepayment rates will be 0.3 percent in month one, 0.6 percent in month two, reaching 9 percent in month 30, and remaining constant at 9 percent thereafter. A zero percent PSA assumes no prepayments.
An option with the holder of a security to sell the security to the issuer or to the person who wrote the put option. Compare with call option.
A term under FASB 125 setting conditions for an SPV to qualify under the standard – transfers of assets to qualifying entities will qualify for sale treatment.
Revenue Anticipation Note
Is a security issued by a municipality against expected revenues. It has a maximum maturity of one year and is used as a cash management tool.
Regulatory accounting practices. Refers to the regulations generally of banking regulators in treating securitisation as off-balance-sheet for the purposes of capital adequacy. There are certain differences between off balance sheet treatment as between GAAP and RAP.
Revolving assets securitisation
Securitisation of assets which have very short payback periods, such as credit cards, so that, when the receivables are paid off, the amount is utilised for replenishment by acquiring fresh receivables rather than for amortisation of the investment.
Re-configuration of cash flows
In a pay through transaction, the SPV does not pay to the investors on the same intervals or subject to the same fluctuations as the underlying receivables. For example, receivables might have monthly pay-ins, but the SPV might be paying on quarterly basis. This is called re-configuration of cash flows.
The ability of an investor/ purchaser to seek payment against an investment to the originator of the investment. For example, in a securitisation transaction, the right of the investor to seek payment from the originator, or in case of a negotiable instrument, the right to seek payment from the endorser of the instrument. See also limited recourse.
Is the amount of capital available for trading or position taking purposes by financial institutions, computed after netting of the amounts required to be deducted as per capital adequacy guidelines.
Generally refers to the action of a judiciary in ignoring the legal form of a transaction and treating it as what the Court regards is the true nature of the agreement. In the context of securitisation, it refers to the treatment of a securitisation not as true sale but as financing transaction.
Real Estate Investment Trust (REIT)
Is a special structure which holds real properties. These properties can be apartments, shopping malls, office buildings or other acceptable real assets. The trust must distribute 95 percent of its income to the shareholders in order to qualify for special tax treatment.
Real Estate Mortgage Investment Conduit
Is a vehicle to minimize double taxation of income from a pooling of mortgages. A certain US tax provision grants tax transparency to such conduits, even though the conduit can issue multi-class securities.
In revolving asset securitisations, refers to the use of the cash receipts to acquire fresh receivables in lieu of those paid off, instead of for amortising the principal outstanding.
An option with the originator to buy back the receivables transferred by it. A re-purchase option will mostly re-characterise the securitisation transaction as a financing transaction.
If the originator agrees to a profit retention in a securitisation transaction, the retained profit will be subject to all the risks and rewards of the structure, and will be paid over to the originator on the termination of the transaction. This is called residuary income.
Are debt securities which have a defined source of anticipated funds to pay both the principal and the interest. These funds come from an activity, project, or revenue source which is not related to a municipality’s capacity to enact taxes. These bonds are sometimes viewed as more risky than General Obligation (GOs) Bonds.
Is a Targeted Amortization Class (TAC) tranche which has a long average life. This tends to provide some degree of protection against extension risk. However, rapid prepayments, which are greater than those stated in the TAC speed schedule, can quickly reduce the expected average life of the Reverse TAC.
Receivables sale agreement
The agreement under which the originator sells the receivables to the SPV.
A rule of the SEC in USA granting exemption to SPV from being regulated under the Investment Company Act, 1940.
Securities Act of 1933
Is the US Law which covers new issues of securities. It requires full-disclosure of material information related to the offering. Some securities such as U.S. Treasuries are exempt from the provisions.
In accounting standards for securitisation, recognition of a securitisation transaction as a sale of receivables would lead to recognition of upfront income (or losses) on the assignment, de-recognition of the assets and the corresponding liability. Compare with financing treatment.
Structural credit enhancement
A technique of credit enhancement by creation of senior and junior securities, thereby enhancing the credit rating of the senior securities.
Are instruments which are engineered to receive principal payments using stipulated payment schedules. Generally, the term is used for bonds other than Planned Amortization Class (PAC) and Targeted Amortization Class (TAC) issues.
Is a mortgage industry term that describes the aging process underlying collateral. It refers to mortgages, which are at least 30 months old and are expected to have relatively stable prepayment rates. Contrast with green.
Is the process of homogenizing and packaging financial instruments into a new fungible one. Acquisition, classification, collateralization, composition, pooling and distribution are functions within this process.
In the context of securitisations, used to refer to underlying security.
Is a class of securities which have high or the highest claim against a borrower or assets of the borrower. Often they are secured or collateralized, or have a prior claim against the assets.
The fees payable to the servicer for servicing the transaction.
In a securitisation transaction, refers to the entity that would continue to collect the receivables, enforcement of receivables, etc. Normally, the originator is also the servicer. See also back-up servicer.
The right of the obligor to deduct an amount that the originator owes to him, from the amount he owes to the originator. A right of set-off is considered to be a defect in the receivables being assigned. Normally, the receivables sale agreement would contain a warranty that there is not right of set-off with the obligor.
Structured finance or Products
A generic term for financial instruments which are devised for funding on the basis of identifiable assets rather than the credit standing of the entity concerned. Includes securitisation, but besides, also includes various forms of lending where the cashflows of the entity are trapped at source to pay off the lender.
Stripped Mortgage Backed Securities
Are securities which are constructed from MBS pass-throughs. Essentially, these securities strip the cash flow stream into a separate interest only (IO) and principal only (PO) securities.
An account in which profit retention by the originator takes place.
An SPV organised as a company.
Special Purpose Entity
Same as Special Purpose Vehicle.
Special Purpose Vehicle (SPV)
Is an organization constructed with a limited purpose or life. Frequently, these Special Purpose Vehicles serve as conduits or pass through organizations or corporations. In relation to securitisation, it means the entity which would hold the legal rights over the assets transferred by the originator.
Same as stripped mortgage backed securities.
See under consolidation.
Is a class of securities which have lower priority or claim against a borrower. Typically, these are unsecured obligations. They are also called Junior notes and bonds. This compares to Senior securities.
A technique used mostly by bankers to allow several other banks to share the risks and the returns of a financial transactions, including the funding of the transaction. The principal contract between the originating bank and the borrower remains unaffected, the sub-participation a contract between the participating banks and the originating bank. If the sub-participants also provide funding to the originating bank, it is funded risk participation. If the sub-participant bank undertake the credit risk but do not fund the transaction, it is unfunded risk participation. See also participation.
See back-up servicer.
Are a class of securities that absorb many of the risks of the Planned Amortization Class structure.
Is a security that acts like a support instrument to Planned Amortization Class (PAC) and Targeted Amortization Class (TAC) bonds. Yields on these double-duty securities can fluctuate greatly depending on the actual prepayment history. Very high prepayments against the underlying PACs and TACs can quickly boost Super PO yields.
Is a bond engineered to counterbalance or uphold Planned Amortization Class, Targeted Amortization Class or other superior bonds in a deal. Also, referred to as a Companion Bond.
Targeted Amortization Class (TAC)
Is a credit market derivative. It was initially structured as a CMO tranche for MBS deals. It tends to be subordinate to Planned Amortization Class bonds but superior in terms of stability to other Scheduled bonds and Sequentials.
Tax Anticipation Note (TAN)
Is a security issued by a municipality against expected tax collections. It has a maximum maturity of one year. It is used for cash management purposes.
Third party credit enhancement
A credit enhancement provided in a securitisation transaction by third party guarantees, such as bank letter of credit, or monoline insurance contracts, etc.
Is the piece, portion or slice of a deal or structured financing. The so called “A to Z” securities of a CMO offering of a partitioned MBS portfolio. It can also refer to segments which are offered domestically and internationally. Tranches have distinctive features which for economic or legal purposes must be financially engineered or structured in order to conform to prevailing requirements.
True sale treatment
The treatment for legal or accounting or sale purposes to a securitisation transaction where it is treated as a true sale of receivables and not as financing transaction. See also sale treatment, re-characterisation.
Tax transparent entity
An entity which is not taxed either in representative capacity or in its own capacity as a tax paying entity, but the tax is levied on the participants in the entity based on their share of income in the entity. See also grantor trusts.
The security that secures the receivables; e.g., in a mortgage securitisation, the charge over the property is an underlying security.
Unwinding of transfers
A bankruptcy code provision that allows a Court to annul the transfers of assets made a certain time, say 6 months, prior to bankruptcy.
Unfunded risk participation
See under sub-participation.
Weighted Average Coupon (WAC)
The weighted average of the interest rates on the mortgage loans underlying an MBS.
Weighted-Average Life (WAL)
The average amount of time that will elapse from the date of a security’s issuance until each dollar of principal is repaid to the investor. The weighted-average life of an MBS is only an assumption. The average amount of time that each dollar of principal is actually outstanding is influenced by, among other factors, the rate at which principal, both scheduled and unscheduled, is paid on the mortgage loans underlying the MBS.
Weighted-Average Maturity (WAM)
The weighted average of the remaining terms to maturity (expressed in months) of the mortgage loans underlying the MBS.
The rate of return on an investment over a given time, expressed as an annual percentage rate. Yield is affected by the price paid for the investment as well as the timing of principal repayments.
The annual percentage rate of return on an investment, assuming it is held to maturity.
Zero Coupon Bonds
Bonds not carrying any coupon rate.
Are bonds in the Z tranche that accrue or accrete interest similar to the plain Z bond. However, the Z PAC repays principal as well. This principal repayment is defined and conditioned by a prepayment schedule or collar.