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Glossary
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Z
Principal and interest as in the principal and interest required
for periodic loan repayments.
Planned amortization class tranche. A REMIC security created to
receive selected cash flows from a pool of underlying mortgages
securing the REMIC. PAC tranches use a structure similar to a sinking
fund to establish a fixed principal payment schedule. Created together
with a companion or support tranche.
A CMO Z bond with some call and extension protection provided by
collars. Like other Z bonds, a PAC Z bond earns interest that is
accrued but not paid in cash for a defined time period. See Z tranche.
A security purchase transaction that is closed out or sold on or
before the settlement or expiration date. In a pair-off, the investor
commits to purchase a security. Then, prior to the predetermined
settlement date, the investor offsets that purchase with a sale
of the same security that is arranged to settle on or before the
settlement date for the purchase. Instead of paying for the purchased
security on the settlement date, the investor need only pay or receive
the difference between the purchase and sale prices. Pair-offs are
price speculations that are considered trading activities and may
be criticized by bank examiners if not handled as trading activities.
(1) The principal or maturity value of a non-amortizing, debt security.
(2) The current face of a mortgage-backed security.
See par line.
(3) The price at which the face value of a debt
security equals its selling price or 100.
(4) For stocks, the face or nominal amount of a
share.
The parity price at which the yield of a mortgage-backed bond equals
its net coupon rate. Because of the delay days, the par line is
not 100 but instead is somewhat lower. Par line is not constant
for different coupon rates at different delay days. However, it
is not a function of prepayment speeds.
See par for all securities except MBSs. See par line for MBSs.
See yield curve.
A change in interest rates that affects all of the different maturities
for an instrument by the same amount. For example, if there was
a parallel shift in U. S. Treasury rates in the amount of a 25 basis
point increase, every maturity from 30 days to 30 years would rise
by 25 basis points. The new yield curve, or graphical depiction
of the term structure of interest rates, would be 25 basis points
above the old yield curve at all points.
A lending term meaning at an equal rate or pace.
(1) For a mortgage-backed security, see par line.
(2) For a convertible security, see conversion
value.
See conversion value.
A duration measure calculated by changing one variable while all
other variable are held constant. The most common example Is key
rate duration where all variables are held constant except the yield
for a specific maturity point on the yield curve. Another application
of partial duration is the calculation of option-adjusted duration
by changing a variable such the OAS while holding all other variables
constant.
A document or a process in which a secured party gives up its collateral
interest in a portion of the property of the debtor that is pledged
to secure a loan. For example, if a real estate developer has pledged
10 lots as collateral for a loan, a partial release may be used
for each lot as it is sold. For personal property collateral, a
partial release may be entered into the public record by using a
standard form called a UCC-3.
An agreement between lenders to share a commitment to extend funds
(if any), the extension of funds, and the credit risk for one or
more credit facilities to a borrower. Almost always evidenced by
a written agreement.
See general partnership and limited partnership.
The original type of MBS structure. In a pass-through, investors
own a pro rata claim to the cash flows from the pool of underlying
mortgages. Each investor’s pro rata share of interest and
principal is remitted to the investor, "passed through,"
by an agent.
The net amount of interest paid to investors owning mortgage-backed
securities after all servicing and guarantee fees are deducted.
Options whose exercise is influenced by the historical trend in
interest rates in addition to the current level of interest rates.
The exercise of a path dependent option is influenced by whether
or not it is in the money as well as by how many times that option
has previously been that deep in the money. Loan prepayments are
path dependent. For example, if interest rates fall to 8 percent,
a borrower with an 11 percent loan is less likely to prepay his
loan than another borrower if rates have fallen to 8 percent and
returned to 11 percent several times since the first borrower obtained
his loan but only fallen to 8 percent once since the second borrower
obtained his loan.
A form of check that is written on an organization other than a
bank but is payable through banks. Credit union "checks"
are actually PTDs. PTDs are recognized as disbursements after they
clear, not when they are written. A PTD functions the same as a
warrant.
Time between when a payment is received and when the funds are deposited.
When employees hold their paychecks over a weekend and when vendors
process receipts only once a week, the payor benefits from the extra
time its investments earn interest. These beneficial payee processing
delays are limited to payments by check. Electronic payments (wire
transfers and ACH credits) produce no processing delay at all.
An entity responsible for paying bond principal and interest on
behalf of the debtor.
A type of insurance purchased by a builder that protects both the
bank and the owner by providing that the insurance company will
be responsible for payments due to laborers and other parties who
provided services for the building project.
The date that dividends, interest, or principal and interest payments
are due to be paid to the owner of record of a security.
A guaranty in which the signer is guarantying payment of the obligation
upon the borrower's failure to pay without the bank having to first
attempt to collect from the borrower or from any collateral.
A general intangible under which a debtor’s principal obligation
is a monetary obligation from a third party. A category of personal
property collateral defined by the 2000 revisions to Article 9 of
the Uniform Commercial Code.
See administrative float.
A type of systemic liquidity risk. The risk of funding problems
arising from the failure to receive funds due to the bank. A payments
system disruption need not result from an operational or computer
failure. If one party fails to make a required funds transfer, that
failure can trigger more defaults down the line. See systemic liquidity
risk.
See projected benefit obligation.
An informal expression used to indicate that a potential buyer's
offer to purchase a portion of a new issue is accepted subject to
the potential seller winning the bid to become the underwriter.
A U.S. Government agency that was created to insure guaranteed pension
benefits. PBGC has statutory authority to claim up to 30% of the
net assets of a firm that sponsors a pension plan when an underfunded
plan is terminated. Such a PBGC claim is granted the same priority
over the claims of other creditors as a tax lien.
A collateral interest in personal property collateral that has been
properly documented. See "security agreement" and "perfection".
The name for a procedure established by Article 9 of the Uniform
Commercial Code. Creditors must comply with this procedure in order
to establish the priority of their security interest in personal
property relative to the priority of security interests in the same
property that may be held by other creditors. (It may be used when
an interest in collateral is provided by the debtor or by a guarantor
or other third party.) Perfection does not normally constitute the
actual agreement between the secured party and the debtor. By itself,
perfection does not create a security interest and must therefore
be supported by a separate security agreement or pledge agreement.
There are several different procedures that can be used to achieve
perfection of a security interest in a debtor’s personal property.
The most common method is perfection by filing a financing statement.
See financing statements and security agreement.
A type of insurance purchased by a builder that protects both the
bank and the owner by providing that the insurance company will
be responsible for completing construction if the contractor fails
to do so.
The maximum amount by which an adjustable-rate security’s
coupon rate can change in any given period of time. Also called
reset cap. For most ARMs and floaters, the maximum periodic or reset
change is defined as an amount of change in each consecutive 12-month
period over the life of the security. Thus the term annual cap is
also used to describe most periodic caps.
A lender, which may be a financial institution, an insurance company,
or a pension fund, that finances real estate projects after construction
is completed. Also called end lender. See takeout commitments.
An informal phrase used to describe the amount of short-term liabilities
needed to offset a continuous or nearly continuous working capital
shortfall. Also used as a name for a borrower's need for year-round
working capital financing. This type of financing is usually needed
by rapidly growing and/or undercapitalized firms and is usually
provided by asset-based lenders.
Defined by law to be all property that is not real property. Further
classified in Article 9 of the Uniform Commercial Code into various
categories.
Personal property.
The most common form of environmental liability risk assessment.
A phase I audit consists of a thorough review of the past and present
ownership of the property as well as the past and present uses of
the property. These reviews include examinations of public records
regarding the property. Additional information is obtained from
both a physical inspection of the property and from interviews with
people who are familiar with the property. The goal of a phase I
audit is to determine the presence or the likely presence of hazardous
substances in the buildings, soil or ground water. Phase I audits
are noninvasive and do not include the collection or analysis of
samples. Accordingly, the findings of a phase I audit cannot be
conclusive. The audit merely determines whether further investigations
are needed.
An environmental liability risk assessment. A phase II audit is
usually conducted only when the phase I audit or other information
about the property or about the activities conducted on the property
indicate that there is a possibility of contamination. In the phase
II audit, qualified individuals collect ground and water samples,
test storage tanks, and/or collect building materials samples. Drilling
may be conducted to obtain subsurface soil samples. Samples are
then tested and analyzed.
Simple; not complex. Sometimes used to differentiate pass-through
MBS pools from CMO structures. More often used to mean sequential-pay
REMICs, the simplest REMIC structure.
A REMIC security created to receive selected cash flows from a pool
of underlying mortgages securing the REMIC. PAC tranches use a structure
similar to a sinking fund to establish a fixed principal payment
schedule. Created together with a companion or support tranche.
PAC tranches are intended to have low call and low extension risk.
Sometimes called controlled amortization bonds.
Land that has been divided into lots described in a plat plan that
is filed in the real estate records of a political entity.
An informal term for 1/64. Half of 1/32, the smallest increment
commonly used to quote the price of an agency security. For example,
a quoted price of 101 and 5/32 plus is equivalent to 101 and 11/64ths.
or
See principal-only strip.
See basis point.
A county, city, town, or other municipal corporation, a public authority,
and generally any publicly owned entity that is an instrumentality
of a state or of a municipal corporation.
For mortgage-backed securities, a pool is a group of mortgage loans
backing an individual security issue.
See factor.
A collection of financial assets belonging to a single owner. For
example, the municipal bond portfolio. Risk in portfolios is reduced
by diversification.
The act of holding a financial instrument, one or more portfolios
of financial instruments, or one’s entire balance sheet in
a way that exposes the holder to profits or losses from future changes
in market prices. Positions may be taken with the intent to profit
from expected future market changes (trading activities); may result
from inventories of financial assets maintained for sale to customers
(dealing activities); or may be the result of the net exposure from
transactions (residual positions resulting from trading activities,
dealing activities, or customer accommodations).
Banks take positions in one of two ways: (1) In
their trading accounts, banks (mainly large banks) may take positions
with one or more financial instruments in the expectation of profiting
from future rate changes. (2) More typically, banks hold or take
balance sheet positions. The cumulative interest rate risk exposure
from customer deposits, loans, and other activities creates a net
residual position that the bank may or may not hedge. Choosing not
to hedge is positioning. Alternatively, banks may create a position
or add to a residual position in the expectation of profiting from
them.
A particular type of instability in the duration of an instrument.
Positive convexity means that as yields rise, duration declines.
Graphically, this is seen as a price/yield curve for which the price
at very low and very high yields exceeds the price indicated by
a straight, tangent line. For an instrument with positive convexity,
duration overstates the interest rate sensitivity. If convexity
is low, that is, if the price/yield relationship is close to a straight
line, duration is stable. If convexity is high, duration is unstable.
The greater an instrument's convexity, the less accurate duration
will be.
See correlation.
(1) The name for a particular relationship between changes in the
price of a debt security and changes in prevailing interest rates.
When a security has positive duration, its price increases in response
to a decrease in prevailing market rates. Almost all securities
have positive duration. Note that the term "duration"
as used in this definition refers to modified duration. See convexity,
modified duration, and negative duration.
(2) For a financial institution, a situation in
which the total duration of its assets is longer than the total
duration of its liabilities. In such cases, the duration of equity
is positive. In other words, an entity with long-term assets funded
by short-term liabilities will have a positive duration of equity.
A financial institution that has a positive duration of equity may
also be described as having a negative gap or as being liability
sensitive. The theoretical equity value, but not necessarily the
stock price, of a financial institution with a positive duration
of equity will decrease if interest rates rise and increase if interest
rates decline. Note that the term "duration" as used in
this definition refers to modified duration. See convexity, modified
duration, and negative duration.
A term referring to an asset-sensitive condition. A mismatch in
which interest-sensitive assets exceed interest-sensitive liabilities.
A form of auditing account balances in which the account debtor
is requested to respond to either confirm or dispute the balance.
One of two forms of direct verification.
See yield curve slope.
An investigation of the appropriate public records, conducted shortly
after the closing of a secured transaction, to verify that the creditor’s
security interest in the collateral was properly recorded and that
it received the priority intended. See lien search.
A process by which the issuer of a check gives written permission
to have the check written and charged against his or her account
on a predetermined basis.
A conference held with potential bank bidders to explain a request
for proposal and answer questions.
An investigation of the appropriate public records, conducted shortly
before the closing of a secured transaction, to determine the likely
priority that will be received for the creditor’s security
interest in the proposed collateral. See lien search.
A legal term used in bankruptcy to describe a transaction deemed
to have occurred under circumstances favorable to the creditor that
benefited from the transaction. This provision is intended to protect
unsecured creditors. Under the U.S. Bankruptcy Code, the preference
period for most creditors is 90 days prior the date of the debtor's
petition filing. The exception is a one year preference period applicable
to creditors deemed to be an "insider" with respect to
the bankrupt debtor. Collateral interests obtained by a creditor
during the preference period are undone by the bankruptcy. See insiders.
See preference.
A type of equity or capital representing shares of ownership in
a corporation. May or may not receive distributions of corporate
income in the form of dividends. Has a higher priority claim to
corporate earnings or assets than common stock but lower priority
than corporate debt. A corporation may issue more than one class
of preferred stock with differing priority status such as first
or second preferred. Often preferred stock issues have a defined
dividend payment rate as long as there are sufficient corporate
earnings to distribute.
(1) The amount by which the price for a security is greater than
its par amount.
(2) The amount that must be paid above the par
amount for an issuer to call or refund an issue before its maturity.
(3) The amount paid to purchase an option.
(4) The cost of an insurance policy.
(5) In banking, the segment of an interest rate
that is offered or paid by one issuer representing the difference
between the rate offered or paid by that issuer and the rate that
other issuers of the same type offer or pay for similar issues.
For example, the extra or higher interest rate that a distressed
bank must pay above rates offered by other banks in order to attract
funds.
Expenses that are capitalized as assets on a firm's financial statements
because they will be charged against activities in the near future
rather than past activities. Also called prepaid expenses, prepaid
assets or prepaid items. For example, if insurance premiums for
the next six months are paid today, the amount paid may be shown
as a pre- paid asset. The asset in that example would then be reduced
to zero over the following six months by recognizing one-sixth of
the amount as an expense in each of next six months. Insurance,
taxes, and subscriptions are common prepaid expenses.
A reasonable and supportable forecast of loan prepayments. In the
case of a mortgage-backed security, it is the forecast of principal
amortization caused by loan prepayments. A single prepayment estimate
is associated with each projected interest rate environment. Estimates
are used to forecast expected lives. Investors typically examine
data for a range of prepayment estimates applicable to a range of
preselected rate changes.
(1) noun — A term used to describe loan or bond principal
payments that are made in excess of the scheduled principal payments
and before maturity. Any amount paid to reduce the principal before
the due date or in excess of the required principal amortization.
Prepayments may be voluntary or involuntary. For example, most residential
mortgage loan contracts permit the homeowner to voluntarily prepay
his or her loan at any time. Involuntary prepayments are liquidations
resulting from foreclosures, condemnations, or casualty.
2) verb — The action of making excess or
early payments.
A fee that must be paid to the lender if the borrower prepays a
loan within a defined time period. Many consumer loans, especially
residential mortgage loans, do not have prepayment penalties.
A representation that reflects the rate at which prepayments are
received or forecasted to be received for a mortgage loan, a pool
of mortgage loans, or an MBS. May be expressed as a PSA or CPR speed.
The risk that prepayments will speed or slow and therefore change
the yield and/or life of the security.
The sale of bonds used to obtain funds that are then placed in escrow
to back bonds previously issued. The first issue typically comprises
bonds that were originally issued at high, fixed coupon rates and
that could not be called when rates subsequently fell. Since they
could not be called, the issuer’s alternative method for reducing
its interest cost for the debt is to issue new, lower cost debt
and to use the proceeds of the new bonds to purchase Treasury securities.
The interest received from the Treasury securities pays the interest
due for the pre-refunded bonds until they can be called or until
they mature. The original set of bonds is said to be pre-refunded
by the second set of bonds. Those pre-refunded bonds have very little
credit risk since the cash for their debt service comes from the
Treasury securities and does not depend on the issuer. See refunding
escrow deposits.
A process by which a check is presented for payment at the drawee’s
bank.
The amount paid for a security. The price of a security is usually
expressed as a percentage of its par value. For mortgage-related
securities, the price is usually expressed as a percentage of the
current face value. A price greater than 100 percent is a premium
price while a price less than 100 percent is a discount price. See
current face, discount, par, and premium.
The risk that the market value of an asset or liability will change
adversely. One of nine risks defined by the OCC. The OCC defines
price risk as the risk to earnings or capital arising from adverse
changes in the value of portfolios of financial instruments. Since
such adverse changes generally result from changes in prevailing
interest rates, price risk is essentially the same as interest rate
risk. The Federal Reserve includes this risk in its definition of
market risk. See interest rate risk and market risk.
The issuance (sale) of new securities. As distinguished from the
secondary market.
For a bank, assets considered to be the primary source of extra
liquidity. Primary reserves are usually defined to be cash on hand,
balances on deposit with the Federal Reserve Bank, and balances
due from correspondent banks (e.g., cash and due from banks).
The remaining balance owed on a loan by a borrower or on a security
by its issuer, exclusive of any accrued interest.
A form of stripped mortgage-backed security that only passes principal
payments received from the underlying mortgage loans to the security
owners. May be a REMIC tranche.
Costs that arise from amendments to defined benefit pension plans
that retroactively increase benefits. In rare cases, retroactive
amendments that decrease benefits can create negative prior service
costs. Under FAS 87 rules, these costs are not added to the minimum
pension liability reported on the balance sheets for sponsors of
underfunded defined benefit pension plans. Instead, the costs are
amortized over the projected remaining service lives for the employees
expected to receive benefits. The amortization increases the reported
benefit expense of the sponsoring firm. The unamortized portion
of this off-balance sheet liability is disclosed as "unrecognized
prior service costs" in a footnote to the financial statements.
Instead of being sold to the general public after completion of
an SEC registration, some bonds are sold privately, without a registration,
to one or a few investors. When a bond issue is underwritten in
this way, it is called a private placement.
Mortgage-backed securities not issued by or guaranteed by a U.S
government agency or U.S. government sponsored enterprise. The mortgage
loans comprising private pools are generally loans that do not meet
GNMA, FNMA, or FHLMC requirements. Private pools may be structured
as fixed-rate pass-through securities, floating-rate pass-through
securities, or CMOs. Also known as whole loan pools.
or
Financial information, often just balance sheets, prepared by adjusting
a recent financial report to show the effect of recent or planned
changes. Projected financial statements.
Money or property received when collateral is sold, exchanged, or
collected.
Goods that become part of a product or mass of goods. An example
is the flour used to bake bread.
The internal processing time that an organization takes to prepare
a receipt for a deposit or an invoice for payment.
Property that is created from other property.
Entities sometimes used by doctors, lawyers, and other professionals.
These entities can provide favorable tax treatment and administrative
advantages and can therefore be advantageous to the professionals
who use them. In most respects, other than taxes, they are indistinguishable
from all other corporations.
Progress payments are payments made by the purchaser in stages as
the seller acquires or builds the property to be sold. A written
purchase agreement or contract establishes the seller's rights to
claim payments before the property is delivered to the buyer. When
the Federal government is making progress payments, the purchase
contracts usually include standard clauses that affect secured lenders.
These clauses provide that title to all materials, inventory, fixtures,
and equipment that are chargeable to the government contract vests
in the government.
The actuarial present value of the pension benefits earned to date.
In contrast to the ABO, measurement of the projected benefit obligation
incorporates assumptions for future compensation rates for pay-related
benefit plans. The PBO must be disclosed in a footnote to the financial
statements.
Projected financial statements showing predicted income, cash flow,
and/or balance sheets. Unlike pro forma statements, projections
typically cover multiple time periods — sometimes as many
as five future years.
A written contract between a borrower/debtor and a lender/creditor
in which the borrower agrees to repay a loan granted by the lender.
The contract specifies the amount of the loan and the terms of repayment.
Trading activity that is conducted purely for the anticipated profit
of the trading entity. The term is used to distinguish such trades
from trading that is conducted for customers, for market-making,
or for hedging. Also called strategic trading.
Name used to identify a business that is not a separate legal entity
but instead is operated by an individual.
A document that describes the details and financial support for
a new bond or stock issue offering. A prospectus is required by
the Securities and Exchange Commission.
Parties in a credit derivatives transaction. See credit derivatives,
credit swap, credit option and credit linked note.
The name used in some states, (e.g., Pennsylvania) for the public
official responsible for receiving and maintaining public notices
of liens such as financing statements. Usually a county official.
See soft call protection.
Liquidity held for liquidity contingency risk or as a safety cushion.
Also called standby liquidity.
See Bond Market Association and PSA model. .
One of two standard models for describing the rate at which prepayments
have been, are, or are expected to be received for mortgages and
mortgage-backed securities. The model assumes that borrowers are
far less likely to refinance a new mortgage than they are to refinance
an older mortgage. Thus the PSA model builds in an assumption of
a 30-month phasein or ramp-up of prepayments. After a mortgage or
a pool of mortgages is 30 months old, a speed of 100 percent PSA
is equal to 6 percent CPR. Similarly, a speed of 200 percent PSA
is equal to 12 percent CPR and 50 percent PSA is equal to 3 percent
CPR. During the initial 30-month ramp-up, the PSA model assumes
much slower speeds. For the first month, 100 percent PSA equals
0.20 percent CPR. In the second month, 100 percent PSA equals 0.40
percent CPR. This level rate of increase continues throughout the
30-month period. PSA is the standard prepayment model of the Bond
Market Association, formerly the Public Securities Association.
The letters PSA were once an acronym for the former organization
name but now stand for "prepayment speed assumptions."
See payable-through-draft.
The records maintained by a filing authority that record the ownership
and/or security interests held in property. Under Article 9 of the
Uniform Commercial Code (UCC), creditors can perfect interests in
a debtor’s personal property by recording a lien in the public
records. Some states require such UCC filings to be made in a central,
state-wide location. Other states require UCC filings to be made
in public records maintained locally in each county. Both ownership
and liens in real property are usually recorded in public records
maintained by each county.
Former name for the Bond Market Association.
A central warehouse that accepts, stores, and delivers goods for
multiple businesses. Often, public warehouses are bonded. Importers
often use bonded public warehouses located in or near points of
entry to delay payment of duties. Food is often kept in public warehouses,
including grain elevators. Public warehouses issue collateral receipts
or warehouse receipts and can be used for controlling inventory
pledged to secure loans. See warehouse receipts.
A security interest in a debtor's property that is created when
the creditor's extension of credit to the debtor is used by the
debtor to acquire the property that is used to secure the transaction.
A contract that gives its holder the right to sell an underlying
security, commodity, or currency on or before a certain date. The
sale option is for a predetermined price called the strike price.
Options are often used in hedging. See American option and European
option.
A loan granted to a member financial institution by a Federal Home
Loan Bank. The put feature in a puttable advance enables the borrower
to prepay the advance, in whole or in part, in the event that prevailing
rates decline. Borrowers benefit when using this type of borrowing
to fund loans or investments that prepay when prevailing interest
rates fall.
A pay fixed/receive floating swap that grants the holder the option
to cancel the swap before its maturity.
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