Credit-linked notes

Under a guarantee agreement, the originator is able to recover an amount equal to the net realised losses on the reference pool of loans, including the costs incurred in the foreclosure and recovery process, in return for a periodic payment of a guarantee fee. This fee is calculated to make up any shortfall between the interest received on the credit-linked note collateral pool and the expenses and interest costs of the issuing SPV. Realised losses are applied in reverse sequential order to the notes, by can-... 

A credit-linked note (CLN) is a structured note that combines both a debt instrument and a credit derivative. The structured note includes an embedded credit derivative that isolates the credit risk of the reference asset in this way an investor in this type of structured note may be able to transform its credit risk exposure. The investor in this note makes a cash investment in a bondlike instrument and receives a return that is... 

Exhibit 21.12 illustrates the generic credit-linked note. 

Credit-linked notes (CLNs) are the simplest of all credit derivative instruments. They are funded assets issued by a bank or other entity and have credit risk to a second issuer (the Reference Issuer). These notes pay an enhanced coupon to the investor for taking on the added credit risk. These are typically issued our of repackaging vehicles or EMTN programmes. 

The issuer of the bonds under a traditional CDO or ABS structure or of credit-linked notes in a synthetic funded structure is a special purpose vehicle (SPY). The structure relies on the fact that such SPY is bankruptcy remote, that is, the entity is unlikely to become subject to bankruptcy proceedings or claims by other investors. For these purposes, the constitutional documents of the SPY usually prohibit any merger, or consolidation, the SPY is prohibited from engaging in business other than those directly related to the transaction and is restricted from incurring any additional debt. 

Unless embedded in fixed-income products, such as structured or credit-linked notes, the derivatives are off the balance sheet. This status endows them with tremendous flexibility and leverage, characteristics they... 

Credit-linked notes, or CLNs, are known as funded credit derivatives, because the protection seller pays the entire notional value of the contract up front. In contrast, credit default swaps pay only in case of default and are therefore referred to as unfunded. CLNs are often used by borrowers to hedge against credit risk and by investors to enhance their holdings yields. 

Credit-linked notes are hybrid securities, generally issued by an investment-grade entity, that combine a credit derivative with a vanilla bond. Like a vanilla bond, a standard CLN has a fixed maturity structure and pays regular coupons. Unlike bonds, all CLNs, standard or not, link then-returns to an underlying asset s credit-related performance, as well as to the performance of the issuing entity. The issuer, for instance, is usually permitted to decrease the principal amount if a credit event occurs. Say a credit card issuer wants to fond its credit card loan portfolio by issuing debt. To reduce its credit risk, it floats a 2-year credit-linked note. The note has a face value of 100 and pays a coupon of 7.50 percent, which is 200 basis points above the 2-year benchmark. If more than 10 percent of its cardholders are delinquent in making payments, however, the note s redemption payment will be reduced to 85 for every 100 of face value. The credit card issuer has in effect purchased a credit option that lowers its liability should it suffer a specified credit event—in this case, an above-expected incidence of bad debts. 

There are two basic forms of pooled commercial mortgage transactions the true sale and the synthetic structures. The true sale mechanism, as its name suggests, involves the sale of assets from the originator s balance sheet to an SPV, which are then used as security for the issue of notes to investors. Synthetic structures, by contrast, involve the creation of a credit derivative linked to the performance of a pool of loans. The loans themselves remain on the balance sheet of the originator but the credit risks associated with these loans are transferred through the credit derivative to investors. Synthetic structures can simplify the issuance process and avoid many of the complexities (and costs) associated with the sale of assets in many jurisdictions. 

The notes issued to investors are linked to the credit risk of the portfolio through the credit-default swap— which usually has the same term to maturity as the notes—and to the credit derivative counterparty. The... 

Individual projects were removed from the course, and replaced by In Class Designs (ICD). These ICDs were essentially open-book, open-note tests that students were required to complete individually. The ICDs were linked to each project and focused on a critical aspect of the project topic. Students were required to pass the ICD with at least a 65% in order to receive full credit on the related project submission. Those not meeting that criteria received only the ICD percentage of the associated project grade (e.g. a student earning a 50% on the ICD and an 80% on the group project would receive a 40% on the group project). 

---