Your roadmap through the jargon jungle

Published on 24/02/2008 20:53

A WELTER of confusing acronyms and esoteric-sounding financial terms have rained down from the banking world in the past six months as the sector has been rocked by jitters and mega-writedowns.

The bottom line is the sector looks in its most vulnerable state for a couple of decades because of more complex loans and investments, with equally complex names. For those who need some help in this area, here is a roadmap through the new financial jungle:

SUBPRIME: through sheer repetition probably the new term on the banking block that a previously bewildered public feel most at home with. It is the single biggest cause of write-downs in the sector, some mind-blowingly high, such as $24 billion (12.2bn) at Citigroup and $22bn at Merrill Lynch.

Subprime was a crisis brought on by mortgage-lending in the US to people with poor credit histories, often were at quite penal rates. Last summer after US interest rates had gone up 17 times in 18 months, it sparked a rash of defaults and repossessions. As many of these mortgages had been sold on to other banks, panic set in with banks worried about lending to each other because of possible hidden problems in their balance sheets related to subprime.

LIBOR: London Inter-bank Offered Rate – the rate at which banks are prepared to lend to each other. This soared last summer because banks distrusted the state of each other's balance sheets in the slipstream of subprime.

ALT-As: mortgages in the US that are of higher quality than subprime loans but that also come with a health warning. They are often referred to as "non-conforming mortgages".

Typically, Alt-A mortgage loans might not have the full documentation supporting an application, perhaps with sketchier than normal employment details or less comprehensive income statements. On the plus side, Alt-A applicants will not tend to have as poor credit ratings as people falling into the subprime category.

CDOs: collateralised debt obligation. Packages of bonds and loans of different maturities and credit quality designed to appeal to the different "risk appetites" of investors. CDOs range from low-risk and investment-grade to highly speculative, in other words, risky.

As the years have passed, investors and credit rating agencies have both been judged to have lost track of the risks involved. Subprime mortgages were often an integral part of collateralised debt obligations. To give an idea of how they took off in popularity with banks in the good times, worldwide CDO issuance was $249bn in 2005 and $489bn in 2006.

MONOLINES: the first thing to understand about monolines is that they are not monolines. They were in the 1970s, when they existed purely to insure bonds by US municipal authorities to fund, say, a new road or power station.

That market is still worth $1.4 trillion. But the trouble began about five years ago when, instead of just insuring interest and capital payments on these safe bonds, they moved on to insuring CDOs (see above), altogether more risky.

When the credit rating agencies recently worked out that the monolines were also now vulnerable to subprime write-downs as well as the banks, some of them were downgraded. causing them financial problems. The monolines exposure to subprime lending is estimated at $125bn.

SIVs: structured investment vehicles. Bank funds that make a "turn" – or profit – by exploiting the differences between the interest rates on long-term and short-term financial assets. SIVs raise cash by issuing short-term debt and invest the proceeds in longer-dated higher-yielding assets, including US mortgages. Oops.

They have been stretched increasingly to fund themselves normally due to the global credit crisis.

ABCP: asset-backed commercial paper. It is a relatively short-term investment vehicle, maturing between 90 and 180 days. Normally issued by the banks themselves and secured against physical assets, they are convenient for short-term financing.

HEDGE FUNDS: probably among the most free-wheeling investor vehicles around, often run by former investment bankers who felt their multi-million salary packages were insufficiently lucrative. Hedge funds invest in a wide range of securities, everything from equities and emerging markets to currencies, commodities and complex derivatives contracts. The growth of hedge funds has been explosive in the past decade, initially partly due to the three-year downturn in stock markets from 2000-2 that diminished the attractiveness of "straight" equity investment.

There are now estimated to be about 9,000 of such funds, double the amount in 2000. Most dangerously, hedge funds use massive borrowings to amplify their bets. They tend to charge a 2 per cent management fee and a 20 per cent performance fee.

DERIVATIVES: financial contracts whose values are determined by the underlying value of the share price, currency, commodity or financial index they are based on. Typified by high-risk, high-reward, hedge funds they became a bit more mundane in recent years as even local councils and pension funds wanted some of their investment in such areas.

NINJA LOAN: probably the most- exciting sounding of the new banking jargon, but is really white-water rafting in financial terms for lenders and borrowers.The acronym stands for "no income, no job or assets". Ninjas were fuelled by the property-price boom in healthier times. As lenders softened their lending criteria, borrowers took out loans they knew they could not really afford. Both sides were really using inexorably rising house prices as a tacit backstop if the borrower defaulted on the loan. The credit crisis, consumer debt and slowing house prices severely undermined Ninjas and they are now very rarely given.

EBITDA: underlying earnings before interest, tax, depreciation and amortisation. As it strips out the obvious variables in financial performance, the City believes Ebitda gives a better picture of the basic health of a company than headline profits that can be flattered or made to look unduly bad by one-off hits. Some City wags, however, say that in tough trading conditions, for example the dotcom boom/bust at the turn of the millennium, Ebitda really stood for "Earnings Before I Tricked Da Auditor".