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Hint
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Answer
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• Debt as a proportion of total liabilities
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Leverage
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• Money lent to a bank by an individual or other entity that is redeemable at will • In the US, this debt has preference in the bankruptcy process over other creditors in the liability stack |
Deposits
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• Lowest tier in the liability stack • Represents ownership share/residual claim on assets after other creditors have been fulfilled • First to absorb capital losses |
Common Equity
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• Above equity in capital stack, but junior to everyone else; fixed dividend payments
• Two types of fixed dividend payments, cum and non-cum. For cum-dividend payments, if a dividend payment is missed, they accumulate and must be paid before common equity holders can receive dividends; for non-cum, they simply are forgotten
• Top 4 banks have this, but none of the mag 7 do; mostly non-cum, as this is friendlier from a regulatory perspective and closer to common equity |
Preferred Equity
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• A transaction in which one entity exchanges a security for a cash loan on an overnight basis (i.e., security is collateral for the cash), with the promise to rebuy the security the next day.
• Entity loaning cash for the security receives both a haircut (i.e., cash is overcollateralized by the asset value), as well as an interest rate on loaned amount.
• E.g., hedge fund exchanges asset for cash to increase leverage; while term is overnight, in practice almost all of this lending is rolled over; short term nature and high LTV ratio (high collateral value) makes this low-risk for cash lender in this transaction |
Repo
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• Short term, unsecured debt (less than 270 days); zero coupon; issued by highly rated banks and corps; MMMFs are/were large buyers of this (Lehman default disrupted the market)
• Senior unsecured debt in the capital structure; pari-passu with other senior unsecured bonds |
Commercial Paper
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• Packaging of assets into an SPV, where cash flows can then be passed on to claims sold to investors; generally in tranches with different risk ratings based on priority of claim to the underlying assets
• Addresses need for “safe” assets; provides diversification of default risk of underlying assets; bankruptcy remote |
Securitization
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• Value (of asset or company) according to balance sheet
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Book Value
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• Value of a company (or asset) based on the price in the market
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Market Value
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• A mismatch between the liquidity of assets and liabilities with claims to those assets; a common example would be the fact that depositors of a bank have the right to withdraw those deposits at any moment (i.e. very liquid), but assets on a bank’s balance sheet are often less liquid, creating a mismatch
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Liquidity Transformation
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• When many depositors try to withdraw deposits from a bank at once, leading to concerns over the bank’s ability to pay out deposits, leading to more attempted withdrawals and the potential for a vicious cycle
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Bank Run
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• Sensitivity of an asset price to change in interest rate (long-dated bond has a higher value of this than short-dated bond) • Aka, the average of when the cash flows of an asset will arrive |
Duration
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• Second derivative of sensitivity to interest rates; as interest rates rise, bonds are less sensitive to changes in interest rates, meaning that they are positive in regard to this concept
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Convexity
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• Risk that changes in interest rate will impact asset value; fixed-rate bond faces risk that interest rates rise and the price falls
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Interest Rate Risk
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• Risk of borrower not paying back payments as expected (e.g., late payments)
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Credit Risk
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• Risk that bank or other lending entity will need to write off losses due to borrower failing to make payments
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Default Risk
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• Capital that fulfills obligations as set by regulatory authorities; generally absorbs losses in times of financial stress
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Regulatory Capital
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• Common stock net of treasury stock, retained earnings, AOCI, goodwill, intangibles
• Exception: banks with assets <250bn were given option for one time election to omit AOCI from this category, essentially eliminating AFS volatility from regulatory consideration for these institutions |
CET1
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• Assets on balance sheet marked at historical cost; ostensibly intended to be held long term
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HTM
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• Securities on balance sheet at mark-to-market prices
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AFS
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