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A PIK of the ABCDS of arcane credit derivative terminology

By Stacy-Marie Ishmael Published: June 29 2007 03:00 | Last updated: June 29 2007 03:00

Subprime or subprime mortgages. These are residential mortgages issued to high-risk borrowers, such as those with a history of late payments or bankruptcy. A rash of defaults in the sector has shaken credit markets in recent weeks. ABS or asset-backed security. A financial security which uses any asset, including loans, leases, credit card debt, company receivables or royalties, as collateral. MBS or mortgage-backed security. This is a type of asset-backed security that uses a single mortgage, or a pool of them, as collateral. Investors receive payments derived from the interest and principal of the underlying mortgages. CMBS or commercial mortgage backed securities. These are securities backed by mortgages on commercial properties, such as hotels or real estate. RMBS or residential mortgage backed securities. These securities are backed by mortgages on residential properties. RMBS represent by far the largest section of the European asset-backed market. CDS or credit default swaps. These offer protection against the non-payment of unsecured corporate or sovereign debt. A typical CDS contract featuresone counterparty agreeingto "sell" protection to another. The "protected" party pays a fee each yearin exchange for a guarantee that if a bond goesinto default, the seller ofprotection will provide compensation. ABCDSs. This lengthy acronym represents credit default swaps based on asset-backed securities. They are a type of insurance against default on the underlying security. CASH CDO or collateral debt obligation. These are vehicles that invest in leveraged loans and high-yield bonds and asset-backed securities. These pools of assets are sliced up into parts or tranches that carry different risks and then sold onto investors. Synthetic CDOs. These are pools of debt instruments which include credit derivative swaps as well as cash bonds. These instruments are used in a variety of trading strategies to hedge risk and to give investors exposure to the credit markets without having to buy the underlying assets. CLO or collateralised loan obligation. These are complex financial instruments which repackage portfolios of loans and can offer investors better returns for a given credit rating than traditional fixed-income assets. CPDO or constant proportion debt obligation. A seriously complex financial instrument, invented last year by ABN Amro, the Dutch bank, and designed to pay the same high interest rate as a risky junk bond while offering the highest possible credit rating. CPDOs use mathematical strategy to make a highly leveraged bet on the creditworthiness of companies. Equity bridge or bridge equity. This is short-term financing to allow private equity firms or other buyers of corporate assets to complete deals before longer-term financing is secured. Cov-lite or covenant-lite loans. These are loan agreements which lack, or possess fewer, financial covenants, or stipulations which protect lenders. Cov-lite agreements also allow borrowers to incur additional indebtedness as financial performance improves. PIK, or payment-in-kind toggle. A clause in a syndicated loan agreement that allows a borrower to elect for interest to be capitalised. In lieu of payment in cash, this means the interest will in effect be paid for by incurring additional debt, often at a higher rate of interest. Sources: Allen & Overy, Blenheim Advisors, FT Reporters

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http://www.ft.com/cms/s/46fc99a6-25dd-11dc-b338-000b5df10621,dwp_uuid=1c5733... 9/24/2008