Credit Risk and Exposure in Securitization and Transactions

178 Pages·1989·16.735 MB·English

by  T. H. Donaldson F.C.I.B. (auth.)

CREDIT RISK AND EXPOSURE IN
SECURITIZATION AND TRANSACTIONS
Also by T. H. Donaldson
HOW TO HANDLE PROBLEM LOANS
LENDING IN INTERNATIONAL COMMERCIAL BANKING
THE MEDIUM-TERM LOAN MARKET (with J. A. Donaldson)
THINKING ABOUT CREDIT
UNDERSTANDING CORPORATE CREDIT
Credit Risk and
Exposure in
Securitization and
Transactions
T. H. Donaldson, F.e.LB.
Palgrave Macmillan
ISBN 978-1-349-10363-8 ISBN 978-1-349-10361-4 (eBook)
DOI 10.1007/978-1-349-10361-4
© T. H. DonaIdson, F.C.I.B., 1989
Softcover reprint ofthe hardcover 1s t edition 1989 978-0-333-47050-3
All rights reserved. For information, write:
Scholarly and Reference Division,
St. Martin's Press, Inc., 175 Fifth Avenue, New York, N.Y. 10010
First published in the United States of America in 1989
ISBN 978-0-312-03094-0
Library of Congress Cataloging-in-Publication Data
DonaIdson, T. H. (Thomas Hay), 1936-
Credit risk and exposure in securitization and
transactions.
Includes index.
1. Bank loans. 2. Credit. 3. Risk management.
I. Title.
HG1641.D67 1989 332.1'753'0685 88-35566
ISBN 978-0-312-03094-0
Contents
List of Glossary Items viii
Acknowledgements x
1 INTRODUCTION 1
Glossary 1
Developments in substitutes and supplements for lending 2
The difference between borrower/counterparty risk and
transaction risk 4
The need to identify and understand the different risks 6
The purpose and structure of the book 8
PART I RECOGNIZING RISK
2 THE DIFFERENT TYPES OF RISK 13
Glossary 13
Risk v. exposure 14
Proxies for exposure 15
Broad categories of risk 17
How risks interact 27
3 UNDERSTANDING THE RISK 29
Glossary 29
The strength of the borrower 29
Does the transaction change the credit of the borrower? 31
Does the transaction change the probable size of loss? 34
Have we identified the true risks of the transaction? 37
Risk transferred still exists 40
Change in form may reduce protection 42
PART II DETAILS OF RISK
4 CREDIT AND RELATED RISK 47
Glossary 47
The risk of a loan or direct credit (lending risk) 48
v
VI Contents
Settlement risk 51
Clearance risk 55
Documentation risk 60
Operating risk 69
Secured, senior or subordinated 71
Put not thy trust ... 79
5 TRADING AND RELATED RISK 81
Glossary 81
Trading risk 82
Market making risk 87
Underwriting risk 88
Investment risk 92
Hedging risk 93
The interaction with credit risk 95
Illiquidity risk 98
Mismatch risk 100
All swings, no roundabouts risk 102
Insider trading/conflict of interest risk 103
PART III RISK IN INSTRUMENTS
6 LOANS AND LOAN SUBSTITUTES 107
Glossary 107
Traditional loans 108
Deposits and redeposits 110
Bonds and FRNs 111
NIFs, RUFs, and MOFs 115
Zero coupon and deep discounted bonds 119
Synthetic assets 121
Loans bought and sold 122
7 TRADING INSTRUMENTS 130
Glossary 130
Forward and spot exchange 130
Interest rate swaps 134
Currency swaps 135
Options, warrants and futures 138
Forward rate agreements (FRAs) 141
Caps, floors and collars 142
Hybrids 143
Contents VB
PART IV RISK/REWARD
8 CAPITAL ADEQUACY 147
Glossary 147
Introduction 147
Capital requirements for different risks 148
Loan equivalents 150
Return on capital, on assets and on risk 156
Prudential regulation-a blessing or a curse? 161
Only themselves to blame 164
Index 167
List of Glossary Items
Figures refer to the chapters in which words or phrases are expained.
Basle Committee 8
Borrower 1
Cap 7
Capital adequacy (ratio) 8
Cash flow 3
Clearance risk 4
Collar 7
Commercial bank 1
Contract risk 4
Contracts for differences 2
Cooke Committee 8
Counterparty 1
Credit risk 1
Currency swap 5
Daily settlement limit 4
Deep discount 6
Delivery v. payment (DVP) 4
(Dis)intermediation 1
Documentation risk 4
Due diligence 6
Exposure 2
Floating rate note (FRN) 5
Floor 7
Forward rate agreement 7
GlO 8
In the money 5
Interest rate swap 5
Investment bank 1
LIBID 2
LIBOR 2
LIMEAN 2
Loan equivalent 8
Mark to market 8
Market maker 6
Master agreement 4
Vlll
List of Glossary Items IX
Merchant bank 1
Multiple option facility (MOF) 6
Net working investment 3
Note issuance facility (NIF) 6
Off balance sheet 5
Operating risk 4
Revolving underwriting facility (RUF) 6
Risk 2
Securitization 1
Seniority 3
Settlement risk 2
Standby commitment 5
Subordinated debt 3
Trading risk 2
Underwriting risk 2
Upfront payment 1
Warrant 5
Yield curve 5
Zero coupon bond 6
Zero sum 3