Business and Finance

Posts Tagged ‘Credit Risk’

Observers in the lending industry have estimated that there may be at least 50 million Americans who are not able to qualify for credit. These consumers are usually young, often members of the minority groups and unbanked…and they are faced with the long-standing dilemma of credit: how can I build my credit record if no one will give me any credit at all?

One of the answers offered by credit card companies is a variety of prepaid credit cards, designed for use by specific segments in the market. The prepaid credit cards are meant for that significant portion of the population that cannot meet the qualification criteria for regular credit cards, or who qualified before but have since lost their credit due to repeated defaults and other reasons.

Advantages of Prepaid Credit Cards For those who do not have enough credit history or have had it blemished, prepaid credit cards are an effective way to build or slowly rebuild credit. That may not happen immediately, but it is something to work on over time. The banks that issue prepaid credit cards are also prepared to extend normal credit the moment you are able to show that you have become a worthy credit risk.

For the moment, you may have to make do with prepaid credit cards. You can use prepaid credit cards as you would any other regular credit card to purchase airline tickets, reserve hotel rooms, or order items online.

Prepaid Credit Card for Students There is a special prepaid Visa credit card for students, which offers a lot of convenience not only for the students but also for their parents. These reloadable prepaid credit cards offer parents several options on how to reload. Parents can add money to reloadable prepaid credit cards by depositing money, by arranging an automatic transfer of funds from their account (a deposit account or their own credit card account), or by online transfer. Using the prepaid Visa credit card is no different from giving the regular allowance to their child, only they do so by electronic means and there is no more cash that changes hands.

The big advantage of the prepaid Visa credit card is that the student is limited to spend only as much money as there is in the card. The parent is thus able to control to some extent the spending behavior of their child. They can use the prepaid credit card anywhere that the credit card brand is accepted.

Prepaid Credit Cards as Gift Certificates Some prepaid credit cards function like gift certificates. You buy the prepaid credit card for a certain amount, and your recipient can purchase items with it at any of the brick-and-mortar stores or online merchants, and also for mail order items, that accept the particular credit card brand. Your recipient can use the prepaid credit card only up to the amount of money that you loaded on it. This particular version of prepaid credit cards is non-reloadable.

Like any gift certificate, recipients of prepaid credit cards can buy whatever it is they want at any time they want. Unlike a gift certificate that, when it gets lost is lost forever to the recipient, prepaid credit cards may be replaced if it gets lost or is stolen.

Prepaid Credit Cards for Travel There is a prepaid credit card designed for travel. These reloadable prepaid credit cards can be purchased in lieu of travelers’ checks or cash. In a way, it combines the best features of a credit card and a traveler’s check because of its convenience and security features. Should you lose the prepaid credit card while you are on travel, you can easily obtain an emergency replacement, both for the prepaid credit card and some cash.

Prepaid credit cards for travel are accepted all over the world, and also allow you to obtain currency from ATM machines. When you need to reload and you are already traveling you can arrange for the reload by phone or online. Apart from the fact that it is a prepaid credit card, you can use it exactly like a regular credit card. That also means you enjoy other benefits just like a regular card — reimbursements for lost luggage of up to $1,000 per cardholder if your luggage is lost; zero liability if your prepaid credit card is used fraudulently after you lose it or have it stolen from you; purchase security up to $500 per claim for any items you buy with prepaid credit cards, which subsequently gets stolen or damaged for certain reasons.

Generally, you can purchase prepaid credit cards of all the major credit card brands at their participating retailers. You don’t have to worry about not having acceptable credit because prepaid credit cards are made available without need of a credit report or a bank account. The only qualifications you need to have are that you have reached 18 years of age and that you must be able to present a valid identification issued by government.

Disadvantages of Prepaid Credit Cards There are a few things about prepaid credit cards that may not be as convenient as the regular credit cards. For one thing, you load only so much money onto it. You will need to keep track of the balance on the prepaid credit card because not all of the merchant terminals where you use the card may be able to help you determine it. However, there are procedures that tell you how to determine your balance, and you will these detailed on the back of the prepaid credit card and in the instructions accompanying it.

The process of reloading your prepaid credit card may be a little inconvenient to some. If you’re using cash, you would have to visit the participating outlet where you bought your reloadable prepaid credit cards. The more convenient way will be reloading online.

There are also the charges. Prepaid credit cards impose an application fee, the amount of which varies with the issuer, and there is also a service charge that you have to pay monthly. You also have to pay for transaction fees, charges when you transfer funds to top up the balance, when you replace your prepaid credit card, and many other fees. To be sure about the fees, you should read closely the fine print on the prepaid credit card account.

Prospects of Prepaid Credit Cards Prepaid credit cards do not provide credit; it is your money that you’re using. You are asked to pay other charges, so it is not for free. You are paying for the convenience and security of carrying plastic instead of large amounts of cash. People with bad credit will be able to act as if they had a regular credit card and enjoy the convenience of one.

Issuers of prepaid credit cards realize that it is a good way to monitor the credit behavior of the cardholder. A prepaid credit card would be a source of information that indicates to the credit bureaus and issuing lenders about how you as the individual cardholder use the card to pay your bills such as utilities. If these consumer data could be formatted in such a way as to provide the basis for a statistical model on probable future behavior in spending, then this could become the foundation for building a credit history.

You would benefit, because by using prepaid credit cards you are rebuilding your credit. The prepaid credit card issuers would benefit, too, because they would be making previously unproven customers bankable. More people could then qualify for regular credit, and that would mean tremendous incremental revenue for the lenders.

If you want to make good money with banks, or any institution, Government and agency bonds are where it is at. Simply because all Government bonds and agencies are AAA rated, and banks can buy millions of dollars of any bond without incurring any credit risk.

All banks own bonds of some sort, and they are buying them from brokers. Our primary bonds are:

U.S. Treasury obligations (T-bills, T-notes, T-bonds) Government Agency Debt (GNMA) Private Agency Debt (FNMA, FHLMC, FHLB and others) Mortgage Backed Securities (Pass throughs , CMO’s, ARM’s) Municipal Bonds Investment Grade Corporate Bonds
The institutions that have strict policy guidelines on the bonds that they can buy are Banks, Credit Unions and Municipalities.

The spreads on Treasuries make them difficult to sell or “mark up” more than a few “ticks” to most sophisticated banks and institutions. A tick is 1 point in price. Government bonds are quoted in 32nds.

An example of a treasury bond would be: Bid 101-16 Ask: 101-24. If your client wanted to buy $10,000 of this treasury bond, you would see the price to you at 101-24 (24/32). 24/32 = .75. So the price is really 101.75 or $10,175. Each point represents $10 for every $1000 par bond. For $10,000, each point is worth $100. All bonds trade at a minimum of 1000. Institutions normally buy $250,000 up to tens of millions per trade. So, our example of a $10,000 trade really isn’t realistic and would not be worth your time. A “tick” by the way, is if the price went up to 101-25.

Trading for a few “ticks” on $100,000 would make you very little. If you factor in ticket charges, you might make $100 on the trade. You only present treasuries if it’s non competitive, or if the client is investing at least $1,000,000, otherwise it won’t make you much. If your client deals with 3 other brokers on treasuries, you will all be fighting for very little money. It’s very easy to get a quick quote on treasuries. Every major dealer owns them, and they can be purchased quickly. You or your trader will contact a major brokerage firm (Merrill Lynch, UBS etc.) and buy them. Not much money yes, still, it is assets you are controlling, and it could be used as available money to swap out of into a better investment for the client.

Treasuries are very safe of course, that’s why they are bought. Only buying treasuries will diminish the rate of return of the entire portfolio, if that is their only or main investment vehicle. Treasuries offer flexibility though. The market values on them will normally hold up well over time. They are very liquid and can be traded instantly. You should sell them only as “time bucket” or maturity gap placing.

If you see the bank has nothing maturing in the first half of a year for instance, you can recommend treasuries there too. Remember, institutions are looking for best price, but also good advice. The medium sized banks ($50 million – $500 million assets) will value good planning and thoughtful recommendations over dealing with 10 brokers all day. The larger institutions are more complicated, and require more price awareness. They think they have the ideas covered and you may have to just be an order taker with them.

How To Sell Mortgage Backed Securities or CMO’s

Mortgage backed securities offer the best alternative to decreased loan demand. Pass throughs, CMO’s and adjustable rate MBS’s are paid to the bank just like a loan that the banks has made for a mortgage. If a person takes out a $250,000 mortgage, the customer is paying back the bank monthly with principle and interest. As you know, if you own a home, your initial payments are mostly INTEREST in the early years. A mortgage backed security, if it is a new issue will operate the same way.

Length of the outstanding mortgages, or current face of the mortgages are a factor. “Seasoned pools”, as they are called, are mortgage pools that have had several years of payment on them. They have more predictable payments and duration. They will normally pay better because of that. Seasoned pools are usually what banks are looking for. They are generally interested in better cash flow and predictable cash flow.

The compensation or mark up potential is good in mortgage backed bonds. They are priced above treasuries because, although they are AAA rated, they are not absolute in their pay off and the payments fluctuate. Since they are usually 15-30 years in duration, they allow for price mark up. Where treasuries and straight agency debt allow for a few ticks to a .25, MBS’s can create spreads between buying and selling them up to a

Convertible bonds have been around since the centuries as shipping companies promised investors a fixed income return or a portion of the profit from a particular voyage. Convertible bonds offer something that a traditional fixed income investment can not – the ability to participate in the equity upside of the issuing company. The convertible bond is embedded with a conversion feature whereby investors are allowed to exchange their bond, in the future, for shares of the company’s stock – instead of receiving their principal. The exchange for stock is determined by today’s price and not the future price. So if the company that issued your convertible bond conquers the world (i.e. Google) you can exchange your bond for shares of a highly appreciated stock and keep the increase.

The problem however today is the availability of such instruments, the interest rate risk inherent in all fixed income instruments and the credit risk associated with a bond (think GM). Imagine however there was an innovative way by which you could invest in a convertible bond, where one previously did not exist, without the associated risks involved in buying such a bond. Let me explain more.

In order to understand the construction of a synthetic convertible bond we have to first understand the “internal pieces” of a traditional convertible bond. A traditional convertible bond could be thought of as a combination of a conventional corporate bond (with interest and a stated maturity) combined with an option for the investor to convert the bond into stock at their choosing. This convertibility option is where the convertible bond gets its’ equity value. As the price of the issuers’ equity (stock price) increases so does the value of the convertibility option. This is so because this option gains value from the ability to convert the bond into stock at a lower price. So we could essentially develop a convertible bond from a corporate bond with an attached call option. This however still presents the same problems with credit risk, availability of a corporate and interest rate risk. Let’s go a bit further.

Deconstructing even further we can turn to “bond theory” to understand how a corporate bond is constructed, from the standpoint of an investment banker. See, a corporate bond is nothing more than a promise to pay with the risk that the company will not be able to deliver on their promise. This is what we refer to as credit risk. The riskier the company the more return we expect from them in the form of a higher interest payment. This is also known as the “spread above Treasury” curve for some of you. Now, if we think in terms of what makes a Treasury different from a conventional corporate bond we can simplify the structure down into a Treasury plus some equivalent of a risk premium. Now this is a simplified format but stay with me. Here is a question – What happens if your company’s corporate bond fails to pay you the stated interest and principal as outlined in the prospectus? Well, unless you are GM or some other government backed company, then the company is ruled to be in default and the bondholders have the first claim to the assets of the company to repay. From an option standpoint that is another embedded option for the company; they can pay their interest and principal or “Put” the company to the bondholders. So the value of the credit risk is the value of the put option TO the company. So we can now look at a corporate bond as a Treasury with an embedded Put option from the company.

Now we have a fully deconstructed convertible bond (1) an embedded conversion feature or call option (2) a Treasury and (3) an embedded Put option. The embedded Put option has to make up the difference in static yield from the lower paying Treasury instrument. Since the company has the right to put the company’s assets to the bondholders in the case of a default, as an investor we are “short” a put option. Quick note – in the investing community when we sell a put option we receive a premium ($). By selling this put option we are creating the extra income stream that would have been produced from the higher yielding corporate bond.

This simply gives us the basic framework for developing a conceptual idea as to how a convertible bond can be constructed using readily available market instruments. The calls and puts should be available from most major brokerage houses and trade data readily available. Next we will start to focus on more in depth concepts of the synthetic convertible bond.

If your credit history is considered poor and you wish to apply for a loan, there are some lenders who will work with you to secure an unsecured loan. However, with an unsecured bad credit loan, the amount you borrow will be low, and the lender will first have to see just how bad your credit is before making a decision on an exact amount.

There are a couple of reasons why it is a good idea to apply for an unsecured loan if your credit is poor. The first is that you can apply for the loan that you need. Second, by making payments on time, your credit score will go up. When your credit score goes up, you become less of a credit risk. In order to apply for a bad credit unsecured loan, you must be 18 years old, be in a job for at least three months and have a good repayment record on your credit ratings for at least six months. The interest rate would depend on how much you borrow and the period you plan to pay it back over.

Bad credit unsecured loans are good for a couple of reasons. First, you have the opportunity to apply for the loan you need. Secondly, by making regular payments on your loan, you begin to repair your credit score proving to any future financial lenders that you are not posing a risk to them. In order to apply for a bad credit unsecured loan, you might be 18 years old, be in a job for at least three months and have a good repayment record on your credit rating for at least six months. The interest rate would depend on how much you borrow and the period you plan to pay it back over.