Securitized Banking and the Run on Repo Appendix A

Appendix A: Glossary of Key Terms and Asset Classes This glossary provides definitions for all terms given in bold in the body of the paper and all asset classes listed in Table 1. For the latter group, we include the panel location of that variable in parenthesis following the definition (e.g: Table I – Panel A). AA-AAA ABS RMBS/CMBS: Residential mortgage-backed security (RMBS) or commercial mortgage-backed security (CMBS) with ratings between AA and AAA, inclusive. (Table I - Panel D) < AA ABS RMBS-CMBS: Residential mortgage-backed security (RMBS) or commercial mortgage-backed security (CMBS) with ratings between AA and AAA, inclusive. (Table I Panel D) AA-AAA CDO: Collateralized debt obligations (CDO) with ratings between AA and AAA, inclusive. (Table I - Panel D) AA-AAA CLO: Collateralized loan obligations (CDO) with ratings between AA and AAA, inclusive. (Table I - Panel D) A-AAA ABS Auto/CC/SL: Asset-backed securities (ABS) comprised of auto loans, credit-card receivables, or student loans, with ratings between A and AAA, inclusive. (Table I Panel D) ABX, ABX Index, ABX Index Spread: The ABX Index is a credit derivative that references 20 equally-weighted subprime RMBS tranches. There are also sub-indices linked to a basket of subprime bonds with specific ratings: AAA, AA, A BBB and BBB-. Each sub-index references the 20 subprime RMBS bonds with the rating level of the subindex. Every six months the indices are reconstituted based on a pre-identified set of rules, and a new vintage of the index and subindices are issued. In this paper, we focus on the BBB ABX tranche of the first vintage of the ABX in 2006, which is representative of the riskier levels of subprime securitization. We refer to this tranche of the 2006-1 issue simply as “ABX”. Asset-Backed Securities (ABS): An asset-backed security is a bond which is backed by the cash flows from a pool of specified assets in a special purpose vehicle rather than the general credit of a corporation. The asset pools may be residential mortgages, in which case it is a residential mortgage-backed security (RMBS), commercial mortgages – a commercial mortgage-backed security (CMBS), automobile loans, credit card receivables, student loans, aircraft leases, royalty payments, and many other asset classes. Australia RMBS AAA: AAA-rated RMBS backed by Australian mortgages. (Table I – Panel C) Auto AAA: AAA-rated ABS backed by auto loans. (Table 1 – Panel B) BBB+/A Corporates: Corporate bonds rated between BBB+ and A, inclusive. (Table I Panel D) Cards AAA: AAA-rated ABS backed by credit-card receivables. (Table I – Panel B) CMBS AAA: AAA-rated Commercial-mortgage-backed securities. (Table I – Panel B) Credit Default Swaps (CDS): A credit default swap is derivative contract in which one party agrees to pay the other a fixed periodic coupon for the specified life of the agreement. The other party makes no payments unless a specified credit event occurs. Credit events are typically defined to include a material default, bankruptcy or debt restructuring for a specified reference asset. If such a credit event occurs, the party makes a payment to the first party, and the swap then terminates. The size of the payment is usually linked to the decline in the reference asset's market value following the credit event. Collateralized Debt Obligations (CDOs): A CDO is a special purpose vehicle, which buys a portfolio of fixed income assets, and finances the purchase of the portfolio via issuing different tranches of risk in the capital markets. These tranches are senior tranches, rated Aaa/AAA, mezzanine tranches, rated Aa/AA to Ba/BB, and equity tranches (unrated). Of particular interest are ABS CDOs, which have underlying portfolios consisting of asset-backed securities (ABS), including residential mortgage-backed securities (RMBS) and commercial mortgage-backed securities (CMBS). Collateralized Loan Obligations (CLOs): A CLO is a securitization of commercial bank loans. Commercial Mortgage-backed Securities (CMBS): See asset-backed securities, above. Dutch RMBS AAA: AAA-rated RMBS backed by Dutch mortgages. (Table I – Panel C) European Auto AAA: AAA-rated ABS backed by European auto loans (Table I – Panel C) European Consumer Receivables AAA: AAA-rated ABS backed by European consumer receivables (Table I – Panel C) Haircut: The collateral pledged by borrowers towards the repo has a haircut or “initial margin” applied, which means the collateral is valued at less than market value. This haircut reflects the perceived underlying risk of the collateral and protects the lender against a change in its value. Haircuts are different for different asset classes and ratings. HEL BBB: BBB-rated ABS backed by Home-equity loans with BBB ratings (Table 1Panel A) HELOC AAA: AAA-rated ABS backed by Home-equity lines-of-credit (Table I- Panel A) HG SF CDO (High-grade structured-finance CDOs): High-grade structured-finance CDOs buy collateral consisting of the AAA and AA-rated tranches of securitized bonds. (Table 1 – Panel B) Home-equity loans (HEL): A home equity loan is a line of credit under which a home owner can borrower using the home equity as collateral. Home-equity lines-of-credit (HELOC): A HELOC differs from a home equity loan in that the borrower does not borrower the full amount of the loan at the outset, but can draw down the line of credit over a specified period of time with a maximum amount. LIB-OIS: The spread between the LIBOR and the OIS. LIBOR: The London Interbank Offered Rate (LIBOR) is a series of interest rates, of different maturities and currencies, at which banks offer to lend fund to each other. These rates are calculated by the British Bankers’ Association as the averages of quotes contributed by a panel of banks and announced at 11:00 Am local time in England. This is called the rate “fixing.” Quotes are ranked and the top and bottom quartiles are discarded. LIBOR is fixed for 15 different maturities, from overnight to one year, and in ten international currencies. Similar fixing arrangements exist in many markets around the world. See Gyntelberg and Wooldridge (2008). Mezzanine SF CDO: A Mezzanine structure-finance CDO refers to a collateralized debt obligation where the underlying portfolio consists of tranches of different asset-backed securities that are rated between BBB and A, inclusive. (Table I – Panel B) Monoline Insurers, Monoline Insurance Companies (“monolines”): Insurance companies that are restricted by regulation to one line of the business, the business of issuing financial guarantees on bonds, that is insurance against the loss due to default of specified bonds. The first such company was AMBAC Financial Group Inc., formed in 1971, followed by MBIA formed in 1983. In 1989 a law in New York limited the sale of financial insurance products by those companies solely to bond insurance, making them “monolines.” Mortgage Originators: Financial firms that underwrite and fund residential and possibly commercial, mortgages. OIS: See Overnight Index Swap (Table I – Panel E). Overnight Index Swap (OIS): An Overnight Indexed Swap (OIS) is a fixed/floating interest rate swap where the floating leg of the swap is tied to a published index of a daily overnight rate reference. The term ranges from one week to two years (sometimes more). At maturity, the two parties agree to exchange the difference between the interest accrued at the agreed fixed rate and interest accrued through geometric averaging of the floating index rate on the agreed notional amount. This means that the floating rate calculation replicates the accrual on an amount (principal plus interest) rolled at the index rate every business day over the term of the swap. If cash can be borrowed by the swap receiver on the same maturity as the swap and at the same rate and lent back every day in the market at the index rate, the cash payoff at maturity will exactly match the swap payout: the OIS acts as a perfect hedge for a cash instrument. Since indices are generally constructed on the basis of the average of actual transactions, the index is generally achievable by borrowers and lenders. Economically, receiving the fixed rate in an OIS is like lending cash. Paying the fixed rate in an OIS is like borrowing cash. Settlement occurs net on the earliest practical date. There is no exchange of principal. The index rate used is typically the weighted average rate for overnight transactions as published by the central bank (e.g., the effective fed funds rate). Repo-Haircut Index: The equal-weighted average haircut for all nine of the asset classes in Panel D of Table I. Haircuts of 100% (= no trade) are included in this average. (Table I, Panel D) Repo-Rate Index: During the time that all asset classes have active repo markets in 2007 and early 2008, this index is identical to the equal-weighted average repo rate for all nine the asset classes in Panel D of Table I. As haircuts rise to 100% for any given asset class (= no trade) on date t, we drop that class from the index and compute the index change for period t using only the classes that traded in both period t-1 and period t. (Table I, Panel D) Repurchase Agreements (repo), Reverse Repurchase Agreements (reverse repo): A sale and repurchase agreement, known as a “repo” for short, is a sale of a security combined with an agreement to repurchase the same security at a specified price at the end of the contract. Economically, a repo is a secured or collateralized loan, that is, a loan of cash against a security as collateral. From the point of view of the borrower of the cash (who is putting up the security as collateral), it is a reverse repurchase agreement, or “reverse repo.” Residential Mortgage-backed Security (RMBS): See asset-backed securities, above. Securitization: The process of financing by segregating specified cash flows, from loans originated by a firm (the “sponsor”) and selling claims specifically linked to these specified cash flows. This is accomplished by setting up another company, called a special purpose vehicle (SPV) or special purpose entity, and then selling the specified cash flows to this company, which purchases the rights to the cash flows by issuing (rated) securities into the capital market. The sponsor services the cash flows, that is, makes sure that the cash flows are arriving, etc. The SPV is not an operating company in the usual sense. It is more of a robot company in that it is a set of rules. It has no employees or physical location. Securitized Banking: Refers in this paper to the nexus of securitization and repurchase markets where “depositors” are able to engage in (reverse) repo by depositing money in exchange for securitized bonds as collateral. Securitized Bonds: A general term referring to any traded and rated tranche of an ABS, RMBS, CMBS, CDO, or CLO. Special Purpose Vehicle (SPV): An SPV or special purpose entity (SPE) is a legal entity which has been set up for a specific, limited, purpose by another entity, the sponsoring firm. An SPV can take the form of a corporation, trust, partnership, or a limited liability company. The SPV may be a subsidiary of the sponsoring firm, or it may be an “orphan” SPV, one that is not consolidated with the sponsoring firm for tax, accounting, or legal purposes (or may be consolidated for some purposes but not others). An SPV can only carry out some specific purpose, or circumscribed activity, or a series of such transactions. An essential feature of an SPV is that it be “bankruptcy remote,” that is, that the SPV never be able to become legally bankrupt. The most straightforward way to achieve this would be for the SPV to waive its right to file a voluntary bankruptcy petition, but this is legally unenforceable. The only way to completely eliminate the risk of either voluntary or involuntary bankruptcy is to create the SPV in a legal form that is ineligible to be a debtor under the U.S. Bankruptcy Code. Structured Finance: A broad term used to describe securitized bonds, but also more generally any bond with an embedded derivative. Student AAA: AAA-rated ABS backed by student loans. (Table I – Panel B) Tranche: A tranche (French for “cut”) refers to a slice of an portfolio ordered by seniority, e.g., a senior tranche or AAA tranche is more senior than a junior tranche or BBB-rated tranche. Triparty Repo: A sale and repurchase agreement that is intermediated by a custodian bank of international clearing organization. The intermediary manages the transaction including marking-to-market of the collateral. Parties to the transaction agree to an eligible collateral profile which determines what bonds can be used as collateral. The intermediary bears intra-day risk; see Task Force on Tri-Party Infrastructure (2010). UK Cards AAA: AAA-rated ABS backed by UK credit-card receivables (Table I – Panel C) UK RMBS AAA: AAA-rated RMBS backed by UK mortgages. (Table I – Panel C) Unpriced ABS/MBS, All Subprime: All tranches of ABS, MBS and all subprime securitized bonds which do not have public pricing posted on Bloomberg or Reuters (two news services used by traders) (Table I - Panel D) Unpriced CDO/CLO: All tranches of CDO and CLO securitized bonds which do not have public pricing posted on Bloomberg or Reuters (two news services used by traders) (Table I Panel D) VIX: The VIX index is a measure of the volatility of the S&P index, produced by and traded on the Chicago Board of Trade. The new version of the index introduced in 2003, is based on the options prices of the broader S&P 500 index. Its square approximates the conditional riskneutral expectation of the annualized return variance over the next 30 calendar days and thus the corresponding variance swap rate. See Carr and Wu (2006). (Table I – Panel E)