Jim Reber: Investment terms decoded, part II

Let’s define the latest bond jargon.

By Jim Reber, ICBA Securities


As we proceed into the second quarter of 2021 and I’ve happily been building out presentations to a number of community banking groups, it occurs to me that the past year has spawned another generation of products, strategies and terms that hadn’t previously been much used, or, in some cases didn’t even exist.

Participants in the fixed-income market … are quite fond of creating acronyms and nicknames to define these new terms. In some cases, they’re clever, logical and easy to recall. In other cases, they’re curious.

Participants in the fixed-income market, including underwriters, broker-dealers and analysts, are quite fond of creating acronyms and nicknames to define these new terms. In some cases, they’re clever, logical and easy to recall. In other cases, they’re curious.

Several years ago, this column featured some of the more popular and relevant acronyms and nicknames in play at the time. Given the space limitations, we didn’t get to visit all of these terms, and since that time, we’ve got more material to discuss anyway. So, as a service to community bankers who wonder what some of the lingo being passed around actually means, let’s play another round of the word association game.

BAM

Could be: Exclamation by celebrity chef Emeril Lagasse as he “kicks things up a notch.”

Reality: An acronym for Bloomberg Agency MBS prepayment model. Most community banks have significant investments in mortgage backed securities (MBS). The offering sheets made available by selling brokers will include a table that estimates the yields and average lives given a range of prepayment “speeds,” which are derived from a large number of variables. These include horizon rates, borrowers’ credit scores, geography and servicer, among many others. BAM is one of the more widely used models for these projections.

Bullets

Could be: Metal projectiles that are expelled out of the barrel of a firearm.

Reality: Debt instruments that contain no call features. These are only partially embraced by investors because they have lower yields than those that can be called away. However, bullets also have a greater ability to appreciate in price given a drop in market rates. About 5% of typical community bank’s investment portfolio is comprised of bullets.

CAR

Could be: A colloquial synonym for automobile, a popular means of transportation for the past 120 years or more.

Reality: An acronym for capital at risk, one of the more important measurements of interest rate exposure. This calculation quantifies the dollar and percentage change to capital in changing rate environments, typically plus 3% and 4%.

CPR

Could be: Cardiopulmonary resuscitation, an emergency procedure to restore one’s heartbeat.

Reality: An acronym for conditional prepayment rate, the means by which models like BAM (see above) are quantified in yield tables. CPR assumes a certain number of prepayments occur in a given forecast yield environment and displays these amounts as an annual rate.

Friction

Could be: Resistance to motion of one object moving relative to another.

Curious about more jargon?

Jim Reber covered more bond terminology in a previous column. Read part 1.

Reality: Qualitative features of certain MBS pools that can limit the borrowers’ ability to refinance. Prepayment friction can occur when the average principal balances in a pool are lower than conventional loans (e.g., maximum $125,000) or when the properties are in states that impose onerous taxes in a refi (e.g., New York or Florida).

Rev

Could be: A verb meaning to increase the speed of a motor by accelerating while the clutch is disengaged.

Reality: As an adjective, it’s short for Revenue, a type of municipal bond. Munis are repaid via two main tax streams. For General Obligation (GO) bonds, ad valorem property taxes are usually the source. For Revs, income from some specified service or activity (e.g., utilities, parking, tolls) are designated for debt service.

SOFR

Could be: A New Yorker’s pronunciation for a long, upholstered piece of furniture used for seating.

Reality: An acronym for Secured Overnight Financing Rate. It looks like 2021 will be the year that the preferred index for interest rate swaps in the U.S. will finally transition away from the London Interbank Offered Rate, or LIBOR, and into SOFR, with an assist from banking regulators. There is usually a degree of correlation between SOFR and LIBOR.

TAP

Could be: Pressurized valve that dispenses malt beverages.

Reality: A Federal Home Loan Bank program to issue a series of bullets (see above) in a specified window of time without the need to submit new registrations for each. The result is that a given TAP issue will have a larger total size with likely improved liquidity.

Close

Could be: The final distribution of all of the proceeds of a bond issue to end investors.

Reality: The end of this column.

Education on Tap

2021 Bond Academy registration opens

ICBA Securities and its exclusively endorsed broker, Vining Sparks, present the ICBA Bond Academy April 19–22. This virtual event teaches portfolio management fundamentals and offers up to eight hours of CPE credit. To register for this complimentary program, visit icbasecurities.com

Webinar series continues

ICBA Securities and Vining Sparks present the next webinar in the 2021 Community Banking Matters series on April 13 at 10 a.m. Central. Rick Redmond will discuss LIBOR Update: Are You Ready? Visit viningsparks.com to register for either event. One hour of CPE credit is offered for each.


Jim Reber, CPA, CFA (jreber@icbasecurities.com), is president and CEO of ICBA Securities, ICBA’s institutional, fixed-income broker-dealer for community banks

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