Repurchase agreements are widely-used in some fixed income investment sectors. For example, repurchase agreements are common in the U.S. Treasury and mortgage-backed securities (MBS) markets. A repurchase agreement is a contract between parties to transfer an interest in securities (a “sale”) along with a simultaneous agreement to repurchase the interest in the same (or similar) securities at a future date. The consideration paid for such an agreement typically reflects short term money market rates. The price difference between the sale and the repurchase is referred to as the “repurchase amount”. In a typical two-party repurchase transaction, the securities which are involved in the repurchase are typically fixed income securities such as U.S. government securities (such as U.S. Treasury bills) or other bonds. Details of repurchase agreements which involve the repurchase of these types of securities are provided in “Securities Lending and Repurchase Agreements”, 1997, Fabozzi Ed., Frank J. Fabozzi Associates, the contents of which are incorporated herein by reference for all purposes.
These repurchase agreements provide an efficient form of financing for investors interested in improving returns on capital and returns on equity. Unfortunately, repurchase agreements have generally been limited to use with certain types of securities which are liquid and have a relatively low risk. U.S. Treasury bills are a preferred form of collateral in these transactions. Further, U.S. bankruptcy laws provide additional protection to parties to repurchase transactions which involve securities.
Bank loans are a type of investment which has been increasing in popularity. The secondary market for floating-rate corporate bank loans has steadily grown over the past decade. For example, Standard & Poor's Portfolio Management Data (PMD) products track the new issue volume for leveraged loans. New issue volumes reached over $250 billion in 1998. The Loan Pricing Corporation (a Reuters company) estimated in 2001 that the total active syndicated volume (including both investment and non-investment grade loans) is around $2.8 trillion.
Investments in bank loans can have return profiles that are very skewed to the downside with not much upside beyond the base case. For example, for a single B-rated loan at par that pays Libor+3.00%, the best case scenario is that there is no default or credit deterioration. In the best case, the total return will be Libor+3.00%. There are, unfortunately, a number of potentially-worse scenarios. For example, a spread may widen in which the mark-to-market pricing of the loan is depressed and the loan holder may be forced to sell. Or, the loan may enter into default in which case there may be a partial (or even a full) loss of capital. In general, bank loans have a capped upside because they are usually callable or prepayable.
It would be desirable to provide transactions which allow bank loans to be readily transferred to increase their liquidity. It would further be desirable to provide techniques which allow bank loan investors to reduce the risk associated with their investments in bank loans. It would further be desirable to address deficiencies in prior art bank loan transactions.