US20090281961A1

US20090281961A1 - System and method using contract for risk transference

Info

Publication number: US20090281961A1
Application number: US12/437,868
Authority: US
Inventors: Derrell Hendrix
Original assignee: Derrell Hendrix
Current assignee: Karson Management (Bermuda) Ltd
Priority date: 2008-05-09
Filing date: 2009-05-08
Publication date: 2009-11-12
Also published as: US20090281962A1; US20130124434A1; US20090281842A1; US20130144806A1; US20090281960A1; US8219478B2; US20130096957A1; US8768733B2; US8155985B2

Abstract

Disclosed herein is a system and method for eliminating or transferring the non-economic risk of financial securities. The system and method serves to avoid non-economic losses in the first instance, and to counter the adverse capital impact of prior non-economic gap losses by providing capital relief consistent with a determined protected amount. A client sells to an investor its rights to payments from a fixed income securities (FIS) Portfolio that exceed an agreed threshold, or protection value. The investor purchases the rights to the payments from the client for an amount substantially equal to the difference between the protection value and a higher threshold, or implied value. The client and investor agree to a profit sharing arrangement for FIS Portfolio payments over the implied value. As security for the client's obligation to deliver either the FIS Portfolio or its proceeds to the investor after the FIS Portfolio returns reach the protection value, the client pledges the FIS Portfolio or other agreed upon assets, or some combination thereof.

Description

CROSS REFERENCE TO RELATED APPLICATIONS

This application claims the benefit of U.S. Provisional Application No. 61/052,035, filed May 9, 2008; U.S. Provisional Application No. 61/052,048, filed May 9, 2008; U.S. Provisional Application No. 61/052,067, filed May 9, 2008; and U.S. Provisional Application No. 61/052,053, filed May 9, 2008. This application is related to the following co-pending non-provisional U.S. patent applications: “SYSTEM AND METHOD USING SECURITIES ISSUANCE FOR RISK TRANSFERENCE,” filed May 8, 2009; “SYSTEM AND METHOD USING INSURANCE FOR RISK TRANSFERENCE,” filed May 8, 2009; and “SYSTEM AND METHOD USING ASSET SALE AND LOAN FOR RISK TRANSFERENCE,” filed May 8, 2009, all of which are hereby incorporated by reference in their entirety as if fully set forth herein.

FIELD OF THE INVENTION

The present invention relates generally to systems and methods for transferring/acquiring a defined risk/discount associated with a security or portfolio of securities. More specifically, the invention relates to systems and methods for transferring non-economic risk through the assignment of security proceeds via a contract.

BACKGROUND OF THE INVENTION

A significant number of banks, insurance companies, and other financial institutions maintain partial or full interests in structured finance and fixed income securities (FIS). These securities may include, for instance, those backed by mortgages, home equity loans, credit card receivables, auto loans, and collateralized loan obligations, as well as collateralized debt obligations (CDOs) and credit default swaps on fixed income securities and CDOs of fixed income securities (collectively, FIS Portfolios). To collect value from FIS a financial institution may treat FIS as an asset which it either intends to trade, or hold to maturity and collect principal and interest payments. Regardless of whether it seeks to keep, transfer, or acquire FIS, it is important that the financial institution be able to determine the value of FIS, if not for purposes of market pricing, then for the fact that the value of held FIS will affect a financial institution's balance sheet and possibly its income statement. In addition, the reported value of FIS may affect its credit rating or otherwise influence the amount of capital necessary to maintain a given FIS or FIS Portfolio. However, given characteristic market and regulatory conditions it may be difficult to appropriately value, finance, or trade FIS, regardless of the credit quality of its underlying assets or cash flows.
Changes by accounting standards boards, such as the Financial Accounting Standards Board (FASB), that govern the accounting profession will affect the perceived value of FIS by modifying the accounting standards used to determine the fair value of FIS. For example, under prior International Financial Reporting Standards, and with changes to U.S. General Accepted Accounting Principles, the value of FIS has been increasingly tied to fair value as determined by the transferability of the FIS. Under these prior accounting standards the fair value was determined by the price that would be received to sell the asset or to transfer a liability in an orderly transaction between market participants at the measurement date; however, this accounting treatment contrasted with the previous practice of many financial institutions, which involved estimating fair value using financial models that determine an expected value of FIS or FIS Portfolios. As seen in, for example, FASB Staff Position 157-4, the more recent accounting standard position has been to permit some flexibility in determining fair value in distressed market conditions or in situations where there has been a significant decrease in the volume and level of activity for the asset or liability being valued. Despite these changes, the prevailing standards continue to focus on determining the value of the asset or liability under current market conditions. As a result, the current market value of the FIS, as defined for accounting purposes, may be significantly lower than the expected value of the collection of principal and interest on the underlying securities.
In another instance, changes in market supply and demand for certain classes of securities can also affect the perceived value of given FIS. For example, difficulties surrounding the decline of securities backed by sub-prime mortgages have affected the values of FIS under fair value accounting standards. Factors such as a perceived lack of transparency, as well as the presence of securities issued by highly leveraged entities investing in FIS Portfolios (such as structured investment vehicles and conduits), have led investors to largely exit certain sectors of the FIS market. Despite attempts to increase transparency in accounting standards, the main sources of investor concern relate to an impaired ability to establish a current estimated market value for FIS, estimate future market value or maturity value for FIS, and estimate correlations between various FIS investments. As a result, investors are willing to pay less to acquire the securities affected by these concerns.
In addition to other factors, the changes to accounting standards and variations in investor demand represent forces that give rise to non-economic changes in the value of FIS. (e.g., changes that are not attributable to changes in market interest rates or default probabilities, but rather in market supply and demand characteristics). Because they are not generally based on changes in the level of interest rates (the interest rate curve) and the credit quality of the underlying securities (i.e., the expected amount of repayment of principal at maturity or upon default, as determined by qualitative analysis or by use of a model), these non-economic changes in value have significant accounting consequences and, if the securities are sold, real economic consequences for the holders of FIS and participants in FIS markets. In the current environment, the above factors have resulted in an increasing number of market participants having determined that the current market or liquidation value for FIS is often significantly below the expected or model-based value, resulting in the booking of substantial losses or reductions in capital resources. This, in turn, has prompted many financial institutions and other holders of interest in FIS to either sell assets (to avoid future risk of loss) or raise capital (in order to preserve or restore regulatory or rating agency capital ratios). Many financial institutions with access to the equity market have elected to raise fully-dilutive equity capital in order to shore up capital adequacy measures, rather than sell and realize non-economic losses on FIS Portfolios.
As a result, it would be advantageous to have a method for an arm's-length solution for eliminating or reducing non-economic risk that supports a higher-than liquidation value for FIS and FIS Portfolios, and satisfies financial institution auditors, rating agencies, regulators and analysts in terms of capital relief.

SUMMARY OF THE INVENTION

Disclosed herein are methods and systems, including computer program products, for eliminating or transferring the non-economic risk of financial securities. The systems and methods serve to avoid non-economic losses in the first instance, and to counter the adverse capital impact of prior non-economic gap losses by providing income and capital relief. In addition, the systems and methods described herein have the effect of transferring risk and countering the adverse profit-and-loss and capital impact of a non-economic component of marking to market in relation to illiquid securities or credit derivatives portfolios. More specifically, the systems and methods described herein provide for transferring risk up to an amount equal to the difference between (a) the current liquidation or fair market value of an individual security or a portfolio of securities and, (b) a value that is equal to the present value of expected future principal payments discounted at an appropriate discount rate (e.g., the swap rate for the corresponding maturity) of the security or the portfolio of securities (the “Gap” risk).
According to an embodiment of the system and method, a gap contract program is implemented with respect to a selected asset, such as FIS or a FIS Portfolio. At inception, two parties enter into a contractual agreement whereby the first party sells to a second party its rights to certain selected asset payments above an agreed threshold. More specifically, the first party assigns to a second party the right to receive a fixed periodic payment as well as the right to all or a portion of maturity or default recovery proceeds of the selected asset if the aggregate principal payment (APP) of the selected asset is above a stipulated protection value. In return, the second party provides to the first party capital that is substantially equal to the difference between the protection value and a higher reference value, or an “implied value,” agreed upon by the parties. The proceeds from the sale of the gap contract become the unrestricted, unencumbered property of the first party upon receipt. As security for the first party's obligation to deliver either the selected asset or its proceeds to the second party after the selected asset returns reach the protection value, the first party pledges the selected asset or other agreed upon assets, or some combination thereof.
The proceeds of the selected asset assigned to the second party may be divided into two components: gap payments and excess payments. Gap payments include those payments from the first party to the second party of selected asset APP in excess of the protection value, and up to the implied value. Excess payments from the client include those payments from the first party to the second party of all or a portion of the selected asset APP in excess of the implied value. No gap payments will be due where the APP of the selected asset is less than the protection value. Likewise, no excess payments are due where the APP of the selected asset is less than the implied value. The first party retains all of the APP not exceeding the protection value.
In another embodiment, the selected asset is held to the redemption date under the control of a trustee. The trustee directs cash received from principal repayments and/or recovery cash flows from the selected asset to be held until the expiration date. Although the expiration date of the contract is generally determined to be co-terminus with the maturity profile of the selected asset, the parties to the program may agree to other expiration dates. As added security, the selected asset or portions thereof are not allowed to be sold or assigned without the prior written consent of the second party. At the expiration date, the trustee will be charged with determining the APP of the selected asset and calculating the APP and determining the difference between it and the protection value and the implied value.
In another embodiment, the first party may terminate the contract prior to the expiration date by reducing the underlying security on a proportional basis, and by paying the second party an early expiration premium. The expiration premium may be determined according to criteria that ensure that the second party receives a minimum return on its investment.
In another embodiment, a processing system is relied upon to execute one or more of the steps of the above programs. The processing system includes a processor, one or more input devices (such as a keyboard or mouse) for inputting data into the system, and one or more displays for outputting information to the user. The processing system also includes a memory for storing data and instructions executable by the processor, and for storing an operating system. The memory may also include instructions for modeling the Gap risk in various securities and security portfolios, determining the aggregate principal payments of a security portfolio, and determining loan variables and interest rates, in addition to various other steps as required by the programs herein.
These and other aspects and advantages will become apparent to those of ordinary skill in the art by reading the following detailed description, with reference where appropriate to the accompanying drawings. Further, it should be understood that the foregoing summary is merely illustrative and is not intended to limit in any manner the scope or range of equivalents to which the appended claims are lawfully entitled.

BRIEF DESCRIPTION OF THE DRAWINGS

The invention is described below in connection with the following illustrative figures, wherein:

FIG. 1 is a schematic illustration of principal transactions of a gap contract program at inception, according to an embodiment;

FIG. 2 is a schematic illustration of principal transactions of a gap contract program over its term, according to an embodiment;

FIG. 3 is a schematic illustration of principal transactions of a gap contract program at an expiration (maturity) date, according to an embodiment;

FIG. 4 is a schematic illustration of principal transactions of a gap contract program at inception and showing a multi-tiered investment entity and interaction with an investment advisor entity, according to an embodiment;

FIG. 5 is a schematic illustration of principal transactions of a gap contract program over its term and showing a multi-tiered investment entity and interaction with an investment advisor entity, according to an embodiment;

FIG. 6 is a schematic illustration of principal transactions of a gap contract program at a maturity (redemption) date and showing a multi-tiered investment entity and interaction with an investment advisor entity, according to an embodiment;

FIG. 7 is a schematic diagram of a processing system for implementing portions of the gap contract program including gap risk modeling and determination of program variables, according to an embodiment;

FIG. 8 is a chart illustrating for an asset owner the value collected from a protected portfolio—with and without a gap contract program in place—for various aggregate principal payment scenarios, according to an embodiment; and

FIG. 9 is a chart illustrating for an asset owner the benefit analysis for a given protected portfolio—with and without implementing a gap contract program—including values due to the gap contract counterparty for various aggregate principal payment scenarios, according to an embodiment.

DETAILED DESCRIPTION

While the present invention is capable of being embodied in various forms, for simplicity and illustrative purposes, the principles of the invention are described by referring to several embodiments thereof. It is understood, however, that the present disclosure is to be considered as an exemplification of the claimed subject matter, and is not intended to limit the appended claims to the specific embodiments illustrated. It will be apparent to one of ordinary skill in the art that the invention may be practiced without limitation to these specific details. In other instances, well-known methods and structures have not been described in detail so as not to unnecessarily obscure the invention.
In general, programs described below allow for a first entity, such as a financial institution, to avoid Gap losses in the first instance, and to mitigate profit and loss and the adverse capital impact of historical Gap losses. Tangible results of the program include the receipt of tier one capital by generating a profit and the receipt of capital relief by restoring the valuation difference between the reported or fair market value of an asset at the inception of the program, and the implied value.
As further described below, a gap contract program is implemented with regard to an asset, such as an FIS or FIS Portfolio, between two entities. Prior to implementation of the program, it may be determined that that one or more of a first party's assets are undervalued with respect to its perceived and modeled true economic value. Additionally or alternatively, the first party may desire to protect one or more assets against future losses in value due to market or non-economic factors. In order to increase profits, reduce risk and obtain capital relief in relation to the difference between the book value of the asset and its economic value, and to obtain other benefits, the first party may enter into an agreement with a second party to implement the gap contract program with regard to one or more selected assets (the “Protected Asset”). The first party may be a bank, insurance company, financial institution, or any other owner of financial assets. The Protected Asset may be a single asset, a FIS or FIS Portfolio, or any other principal bearing asset or combination thereof, including a portfolio of multiple assets.
At inception, the first party offers a contract (the “Gap Contract”) to assign to another entity portions of Protected Asset proceeds above a certain value (the “Protection Value”). According to an agreement, the second party purchases the contract for an amount that is substantially equal to the difference between the Protection Value and a higher reference value (the “Implied Value”). The face value of the gap contract may be determined with respect to the determined Gap between the current liquidation value of the Protected Asset and its estimated or modeled ultimate economic value (i.e., the present value of expected future principal payments discounted at an appropriate discount rate of the Protected Asset, or a percentage thereof). The second party purchasing the Gap Contract may be an investment firm or any purchaser of securities, including one or more individual investors. Through the initial transaction, the first party realizes immediate capital relief equal to the face value of the Gap Contract and may realize an immediate profit equal to or approximating the same amount.
The proceeds from the Protected Asset assigned to the second party under the contract may be divided into two components: “Gap Payments” and “Excess Payments.” Gap Payments include those payments from the first party to the second party encompassing the APP of the Protected Asset in excess of the Protection Value and up to the Implied Value. Excess Payments include those payments from the first party to the second party of all—or a portion—of the APP in excess of the Implied Value (i.e., profit sharing). No Gap Payments will be due where the APP of the selected asset is less than the Protected Value. Likewise, no Excess Payments are due where the APP of the Protected Asset is less than the Implied Value. The first party retains all of the APP not exceeding the Protection Value. Accordingly, through the implementation of the program the first party experiences relief from at least a portion of the Gap risk associated with losses in the value of the Protected Asset. Any losses experienced by the first party—in excess of those previously realized prior to the implementation of the program—are reduced by an amount up to the face value of the Gap Contract. Through the purchase of the contract, the second party effectively takes on the risk of losses below the Implied Value, up to an amount equal to the face value of the contract (i.e., losses between the Protected value and the Implied Value).
The Protected Value may be calculated in relation to the current transferability or book value of the selected asset, and may be substantially equal to this value. The Implied Value is greater than the Protected Value and may be calculated based on the expected amount of repayment of principal at maturity or upon default of the selected asset, as determined by qualitative analysis of the selected asset or by use of a risk analysis and economic valuation model. Alternatively, the Implied Value may be determined as a certain percentage of the expected economic value of the Protected Asset.
The expiration date of the program is generally co-terminus with the maturity date of the Protected Asset, with an earlier expiration provided for upon default. Alternatively, where the Gap Contract provides for the transfer of the selected asset to the second party, the expiration date of the program may be defined as either the date that the total proceeds from the selected asset reach the protected value, or the maturity/default date of the selected asset.
Prior to inception, the parties may make trust arrangements for the management of the Protected Asset, such as by establishing a trustee (the “Security Trustee”) to hold the Protected Asset for the term of the program. The Security Trustee directs cash received from principal repayments and recovery cash flows from the Protected Asset to be held until the maturity date. As added security, the Protected Asset or portions thereof are not allowed to be sold or assigned without the prior written consent of the second party. At the maturity date, the Security Trustee is charged with calculating the APP of the Protected Asset and determining the difference between it and Protected Value and the Implied Value.
According to the terms of the program, and as compensation for taking on Gap risk associated with the Protected Asset, the Gap Contract may provide for a fixed periodic payment (the “Gap Contract Coupon”) to the second party over the term of the program. The Gap Contract Coupon generally has a base component that may be tied to a major interest rate index modified by a fixed or variable amount, and which is paid in proportion to the face value of the Gap Contract. For example, the base component may be equal to the 3 or 6 month Libor, Federal Reserve, or Prime Interest Rate, plus and additional 0.5% to 2.5%, or therebetween. In addition, this Gap Contract Coupon may have a bonus component that may be determined according to a risk assessment of the Protected Asset and the Gap Contract in general.
To secure its obligations to provide periodic payments and to assign the proceeds of the selected asset or the asset itself, the first party may pledge security (the “Contract Security”). The Contract Security may be the Protected Asset itself, or may be another asset or group of assets that are agreed upon by the parties, and which may be margined periodically. Over the term of the program, the Contract Security is held in trust by the first party, or by a third party trustee, such as the Security Trustee.
The program may also provide for early termination of the Gap Contract by the first party. The first party may be permitted to cancel the Gap Contract in whole or in part at any time by paying the second party a termination premium, which may be agreed upon by the parties and which may be determined such that the second party receives a minimum return on its investment, or such that the second party can fulfill any necessary obligations to third party investors. Where the Protected Asset comprises a portfolio of assets, the first party may cancel the Gap Contract in part prior to the maturity date through a proportional reduction in exposure of the assets in the portfolio.
To raise capital for the purchase of the Gap Contract, the second party may issue certain equity notes or securities (the “Investor Securities”). These securities may be purchased by various third-party investors, and may carry with them a characteristic interest rate, fee and dividend arrangement. The Investor Securities may have basic equity payment arrangements that consist of a base dividend and a risk premium dividend (the “Base Security Payments”). The base dividend can be indexed to a major interest rate index plus a fixed spread, such as from 0.25% to 1.25%. The risk premium may be based on a percentage of the face value of the Investor Securities, such as from 3.0% to 7.0%. The Investor Securities may also provide variable dividends, which may include all or a portion of payments to the second party from any excess over the Implied Value, after servicing any management fees and base equity payments.
Prior to inception or at inception of the program, the parties may coordinate with or consult an investment group to develop a specific gap contract program that considers the amount of economic and non-economic risk associated with the Protected Asset. Developing the program may include determining a non-economic value of the Protected Asset, determining a real economic value of the Protected Asset, determining purchase price for the Gap Contract, determining an Implied Value, determining a Protected Value, determining a base dividend and bonus dividend for the Gap Contract Coupon, determining a profit sharing value or percentage, and determining the expiration date. The specific values for these and other variables may be determined utilizing economic and risk based models, and by using computer processing systems having software adapted to determining these and other values. In addition, the parties may determine the conditions for early termination of the contract, if any.
Additional aspects of the gap contract program are apparent in view of the following examples, which are for explanatory purposes only and which are not in any way intended to limit the scope of the program.

Gap Contract Program Example 1

In one example, a first party financial institution (the “Client”) and a second party investment group (the “Investor”) enter into an agreement to establish a gap contract program for the mutual benefit of both parties. The parties select as the Protected Asset a FIS Portfolio (the “Reference Portfolio”) owned by the Client which the Client either determines to be undervalued in the current market, or desires to protect against future losses in value due to market conditions. In order to realize a capitalization of the Reference Portfolio that is more consistent with its perceived economic value, the Client coordinates with or consults the Investor or an investment advisor to develop a specific gap contract program that takes into account the amount of economic and non-economic risk associated with the Reference Portfolio.
By agreement of the parties, the gap contract program is established with a Protected Value of 80, an Implied Value of 90, and with the Gap Contract therefore having a purchase price of 10. In addition, the profit participation for the Investor with respect to the Excess Payments is determined to be 100% of the excess (i.e., the amount of the APP over the Implied Value). Referring to FIG. 1, at inception the Client 102 transfers control of the Reference 106 Portfolio to a third party trustee 108 and offers the Gap Contract to the Investor 104. With the obligations of the Client 102 backed by the Reference Portfolio 106 as the contract security, the Investor 104 purchases the Gap Contract from the Client 102 for the purchase price.
Referring to FIG. 2, over the term of the program the Investor 104 periodically collects Gap Contract Coupon payments from the Issuer 102. The trustee 108 directs cash received from principal payments and/or recovery cash flows from the Reference Portfolio 106 to the Client 102. Accordingly, the Gap Contract Coupon payments due to the Investor may be paid by the Client directly from the returns of the Reference Portfolio. Alternatively, the trustee may calculate the Gap Contract Coupon payments and pay them directly to the Investor from the Reference Portfolio returns, with the balance of the returns going to the Client less any fees.
Referring to FIG. 3, at the expiration date of the program, the APP of the Reference Portfolio 106 is determined by the trustee 108, and the difference between the Protected Value and the APP is calculated. If there is a deficit (i.e., the APP is less than the Protected Value), the Investor 104 receives no Gap Payments. Where the APP exceeds the Protected Value, the Investor 104 receives Gap Payments equivalent to the amount of the APP over the Protected Value and up to the Implied Value. Further, if there is an excess (i.e., the APP exceeds the Implied Value), then the Investor 104 receives additional payments equal to 100% of the APP over the Implied Value, in accordance to the profit sharing agreement of the program. Table 1 illustrates the potential payment amounts for this example.

TABLE 1

Program Payment Illustration

APP	Impact to Client	Impact to Investor

70	No Gap Payments or Excess	No Gap Payments or Excess
	Payments to Investor; net	Payments; net loss of 10
	loss of 10
85	Gap Payment of 5 to the	Gap Payment of 5 from the
	Investor; net benefit of 5	Client; net loss of 5
90	Gap Payment of 10 to the	Gap Payment of 10 from
	Investor; net benefit of 10	the Client; net of 0
95	Gap Payment of 10 and Excess	Gap Payment of 10 and
	Payment of 5 to the Investor;	Excess Payment of 5 from
	net benefit of 10	Client; net benefit of 5

Given an Implied Value of 90 and a Protected Value of 80, an APP of 70 at the expiration of the program results in an overall difference of 20 relative to the Implied Value. In this scenario, because the purchase price of the Gap Contract is 10 the total loss to the Investor is limited to 10. The remaining portion of the loss is absorbed by the Client. Accordingly, in this scenario the resulting deficit is borne equally by both the Investor and the Client.
For an APP of 85 at expiration, there is a resulting overall difference of 5. This deficit is reflected in a decrease in Gap Payments to the Investor. Accordingly the loss in value is substantially absorbed by the Investor, while the Client maintains a slight profit over the term of the Program, having only made a Gap Payment of 5 and having retained the other half of the purchase price of the Gap Contract received from the Investor at inception of the Program.
For an APP of 90 at expiration, the APP yield of the Reference Portfolio is equal to the Implied Value stated in the Gap Contract and no excess or deficit is recorded. In this scenario, the Investor recoups the full value paid to purchase the Gap Contract when the Client makes a maximum Gap Payment of 10. Overall, the benefit to the Client is in having received an up-front infusion of capital and in transferring the Gap risk of the Reference Portfolio substantially to the Investor.
For an APP of 95 at expiration, there is a resulting excess of 5 over the Implied Value. Given the profit participation of 100%, the entire excess is paid by the Client to the Investor through an Excess Payment of 5. In addition, the Investor receives a maximum Gap Payment of 10.
As is shown in this example, initial losses in value of the Reference Portfolio below the Implied Value are absorbed by the Investor. Any further losses below the Protected Value (i.e., below the Implied Vale and greater than the purchase price of the Gap Contract) are then absorbed by the Client.

Gap Contract Program Example 2

In another example, a first party financial institution (the “Client”) and a second party investment group (the “Investor”) enter into an agreement to establish a Gap Contract program for the mutual benefit of both parties. Referring generally to FIGS. 4-6, the parties have selected as the Protected Asset a FIS Portfolio (the “Reference Portfolio”) owned by the Client 202 which the Client either determines to be undervalued in the current market, or desires to protect against future losses in value due to market conditions. In order to realize a capitalization of the Reference Portfolio 206 that is more consistent with its actual economic value, the Client coordinates with or consults the Investor 204 or an investment advisor 212 to develop a specific gap contract program that takes into account the amount of economic and non-economic risk associated with the Reference Portfolio 206.
At the outset of the program, the face value of the Reference Portfolio 206 is determined to be 1,000, and the book value (transferability value) is determined to be 800. By agreement of the parties, the Gap Contract program is established with an Implied Value of that is 90% of the face value, or 900, and a Protected Value of 80% of the face value, or 800. Accordingly, the Gap Contract has a purchase price of 100. In addition, the profit participation for the Investor is determined to be 60% of any excess (i.e., the amount of the APP over the Implied Value) with the remainder being collected by the Client. According to other terms of the program, the Gap Contract Coupon is indexed to the 6-month LIBOR plus a spread of 0.5% per annum on the Gap Contract Amount, payable quarterly in arrears to the Investor. The Client is permitted to cancel the Gap Contract in whole or in part at anytime, subject to a proportional reduction in the Reference Portfolio exposure, and payment to the Investor of an early termination fee equal to 15% per annum of the elapsed term on the terminated Gap Contract purchase amount.
Referring to FIG. 4, at inception the Client 202 transfers control of the Reference Portfolio 206 to a third party trustee 208 and offers the Gap Contract to the Investor 204. With the obligations of the Client 202 backed by the Reference Portfolio 206 as the Contract Security, the Investor 204 purchases the Gap Contract from the Client 202 for the agreed upon purchase price. In order to raise capital to purchase the Gap Contract, the Investor 204 issues Purchaser Securities that are purchased by third-party investors 210.
Referring to FIG. 5, over the term of the program the Investor 204 periodically collects Gap Contract Coupon payments from the Issuer 202. The trustee 208 directs cash received from principal payments and/or recovery cash flows from the Reference Portfolio 206 to the Client 202. Accordingly, the Gap Contract Coupon payments due to the Investor may be paid by the Client directly from the returns of the Reference Portfolio. Alternatively, the trustee may calculate the Gap Contract Coupon payments and pay them directly to the Investor from the Reference Portfolio returns, with the balance of the returns going to the Client less any fees. In addition, over the term of the program the Investor 204 pays payments and dividends on the Investor Securities to the third-party investors 210, according to the terms of the Investor Securities.
Referring to FIG. 6, at the expiration date of the program, the APP of the Reference Portfolio 206 is determined by the trustee 208, and the difference between the Protected Value and APP is calculated. If there is a deficit (i.e., the APP is less than the Protected Value), the Investor 202 receives no Gap Payments. Where the APP exceeds the Protected Value, the Investor 202 receives Gap Payments equivalent to the amount of the APP over the Protected Value and up to the Implied Value. Further, if there is an excess (i.e., the APP exceeds the Implied Value), then the Investor 202 receives additional payments equal to 60% of the APP over the Implied Value, in accordance to the profit sharing agreement of the program. In addition, at the expiration date the third-party investors 210 redeem the Investor Securities, including any dividends for profit collected by the Investor 204, or as otherwise in accordance with the terms of the Investor Securities.
Tables 2 and 3 provide illustrations of the economics for the Client 202 and Investor 204, respectively, according to the terms in the example contract and for various APP scenarios. In addition, FIG. 8 provides an illustration of the overall value collected from the Reference Portfolio 206 by the Client 202 for various APP scenarios, both with and without the gap contract program having been implemented. FIG. 9 provides an illustration of the benefit analysis for the Client 202 both with and without the gap contract program having been implemented, and additionally shows the payments due to the Investor according to various APP scenarios.

TABLE 2

Illustration of Client (Contract Offeror) Economics

APP Scenarios

	100%	95%	90%	85%	80%	75%	70%	65%	60%

Cash received at inception	100	100	100	100	100	100	100	100	100
APP to Client at Maturity	1,000	950	900	850	800	750	700	650	600
Bond gain/(loss) without	200	150	100	50	—	(50)	(100)	(150)	(200)
Program
Gap Payment to Investor	100	100	100	50	—	—	—	—	—
Excess Payment to	60	30	—	—	—	—	—	—	—
Investor
Net to Client w/Contract	940	920	900	900	900	850	800	750	700
Net to Client w/out	1,000	950	900	850	800	750	700	650	600
Program
Client benefit/(cost)	140	120	100	100	100	50	—	(50)	(100)
with Program
Client benefit/(cost)	200	150	100	50	—	(50)	(100)	(150)	(200)
without Program

TABLE 3

Illustration of Investor (Contract Purchaser) Economics

APP Scenarios

	100%	95%	90%	85%	80%	75%	70%	65%	60%

Investor Contract	(100)	(100)	(100)	(100)	(100)	(100)	(100)	(100)	(100)
purchase
Gap Payments
	100	100	100	50	—	—	—	—	—
Excess payments	60	30	—	—	—	—	—	—	—
Investor net gain/(loss)	60	30	—	(50)	(100)	(100)	(100)	(100)	(100)

As is again shown in this example, initial losses in value of the Reference Portfolio below the Implied Value are absorbed by the Investor. Any further losses below the Protected Value are absorbed by the Client. Moreover, the Client is able to essentially secure the value of the Reference Portfolio at the Protected Value over a significant range of losses.
Referring to FIG. 7, the variables for the contract program are calculated using a processing system 300 that has software adapted to determining these values. The processing system 300 has a processor 302 for executing instructions from the memory 310, processing input from the input devices 306, communicating with the display 304, and processing data from any other peripherals. The processor 302, memory 310, input devices 306, display 304, network interface 328, and other peripherals may be communicably coupled via a single bus 308. Alternatively, these and other components may be joined by multiple buses, or several individual dedicated buses. The network interface 328 may communicably couple the processing system 300 to an external network of other processing systems. In addition, multiple processing systems may be linked via the network in order to coordinate the determination of variables for the share program.
The memory 310 has stored therein an operating system 312 and a multiplicity of software programs 314 designed to operate on the operating system 312. The software programs include: a program 316 that calculates the principal payments of the Reference Portfolio 316, a program 318 that calculates the interest of the Reference Portfolio 318, a program 320 that calculates the APP of the Reference Portfolio on an ongoing basis, a program 322 that models the Gap risk associated with the Reference Portfolio, a program 324 that models the program variables under various scenarios, and a program 326 that calculates the payments due each party under the terms of the program.
While the invention has been described in terms of several preferred embodiments, it should be understood that there are many alterations, permutations, and equivalents that fall within the scope of this invention. It should also be noted that there are alternative ways of implementing both the process and apparatus of the present invention. For example, steps do not necessarily need to occur in the orders shown in the accompanying figures, and may be rearranged as appropriate. It is therefore intended that the appended claim includes all such alterations, permutations, and equivalents as fall within the true spirit and scope of the present invention.
The invention can be implemented in digital electronic circuitry, or in computer hardware, firmware, software, or in combinations of them. The invention can be implemented as a computer program product, i.e., a computer program tangibly embodied in an information carrier, e.g., in a machine readable storage device or in a propagated signal, for execution by, or to control the operation of, data processing apparatus, e.g., a programmable processor, a computer, or multiple computers. A computer program can be written in any form of programming language, including compiled or interpreted languages, and it can be deployed in any form, including as a stand alone program or as a module, component, subroutine, or other unit suitable for use in a computing environment. A computer program can be deployed to be executed on one computer or on multiple computers at one site or distributed across multiple sites and interconnected by a communication network.
Method steps of the invention can be performed by one or more programmable processors executing a computer program to perform functions of the invention by operating on input data and generating output. Method steps can also be performed by, and apparatus of the invention can be implemented as, special purpose logic circuitry, e.g., an FPGA (field programmable gate array) or an ASIC (application specific integrated circuit).
Processors suitable for the execution of a computer program include, by way of example, both general and special purpose microprocessors, and any one or more processors of any kind of digital computer. Generally, a processor will receive instructions and data from a read only memory or a random access memory or both. The essential elements of a computer are a processor for executing instructions and one or more memory devices for storing instructions and data. Generally, a computer will also include, or be operatively coupled to receive data from or transfer data to, or both, one or more mass storage devices for storing data, e.g., magnetic, magneto optical disks, or optical disks. Information carriers suitable for embodying computer program instructions and data include all forms of non volatile memory, including by way of example semiconductor memory devices, e.g., EPROM, EEPROM, and flash memory devices; magnetic disks, e.g., internal hard disks or removable disks; magneto optical disks; and CD ROM and DVD-ROM disks. The processor and the memory can be supplemented by, or incorporated in special purpose logic circuitry.
All references, including publications, patent applications, and patents, cited herein are hereby incorporated by reference to the same extent as if each reference were individually and specifically indicated to be incorporated by reference and were set forth in its entirety herein.
The use of the terms “a” and “an” and “the” and similar references in the context of this disclosure (especially in the context of the following claims) are to be construed to cover both the singular and the plural, unless otherwise indicated herein or clearly contradicted by context. All methods described herein can be performed in any suitable order unless otherwise indicated herein or otherwise clearly contradicted by context. The use of any and all examples, or exemplary language (e.g., such as, preferred, preferably) provided herein, is intended merely to further illustrate the content of the disclosure and does not pose a limitation on the scope of the claims. No language in the specification should be construed as indicating any non-claimed element as essential to the practice of the present disclosure.
Multiple embodiments are described herein, including the best mode known to the inventors for practicing the claimed invention. Of these, variations of the disclosed embodiments will become apparent to those of ordinary skill in the art upon reading the foregoing disclosure. The inventors expect skilled artisans to employ such variations as appropriate (e.g., altering or combining features or embodiments), and the inventors intend for the invention to be practiced otherwise than as specifically described herein.
Accordingly, this invention includes all modifications and equivalents of the subject matter recited in the claims appended hereto as permitted by applicable law. Moreover, any combination of the above described elements in all possible variations thereof is encompassed by the invention unless otherwise indicated herein or otherwise clearly contradicted by context.
The use of individual numerical values are stated as approximations as though the values were preceded by the word “about” or “approximately.” Similarly, the numerical values in the various ranges specified in this application, unless expressly indicated otherwise, are stated as approximations as though the minimum and maximum values within the stated ranges were both preceded by the word “about” or “approximately.” In this manner, variations above and below the stated ranges can be used to achieve substantially the same results as values within the ranges. As used herein, the terms “about” and “approximately” when referring to a numerical value shall have their plain and ordinary meanings to a person of ordinary skill in the art to which the disclosed subject matter is most closely related or the art relevant to the range or element at issue. The amount of broadening from the strict numerical boundary depends upon many factors. For example, some of the factors which may be considered include the criticality of the element and/or the effect a given amount of variation will have on the performance of the claimed subject matter, as well as other considerations known to those of skill in the art. As used herein, the use of differing amounts of significant digits for different numerical values is not meant to limit how the use of the words “about” or “approximately” will serve to broaden a particular numerical value or range. Thus, as a general matter, “about” or “approximately” broaden the numerical value. Also, the disclosure of ranges is intended as a continuous range including every value between the minimum and maximum values plus the broadening of the range afforded by the use of the term “about” or “approximately.” Thus, recitation of ranges of values herein are merely intended to serve as a shorthand method of referring individually to each separate value falling within the range, unless otherwise indicated herein, and each separate value is incorporated into the specification as if it were individually recited herein.
It is to be understood that any ranges, ratios and ranges of ratios that can be formed by, or derived from, any of the data disclosed herein represent further embodiments of the present disclosure and are included as part of the disclosure as though they were explicitly set forth. This includes ranges that can be formed that do or do not include a finite upper and/or lower boundary. Accordingly, a person of ordinary skill in the art most closely related to a particular range, ratio or range of ratios will appreciate that such values are unambiguously derivable from the data presented herein.

Claims

1. A method for implementing a contract program for quantifying and transferring non-economic risk between a first party and a second party, said method comprising:

receiving data representing an asset belonging to the first party, wherein the data includes a market value of the asset and principal payments of the asset;

receiving a term date for the program;

generating an economic value of the asset based on the data representing the asset;

calculating a protection value for the asset based on the market value of the asset;

calculating an implied value for the asset based on the economic value, wherein the first party agrees under the program to assign to the second party aggregate principal payments (APP) exceeding the protection value and up to the implied value (“gap payments”);

calculating a contract value based on the difference between the protection value and the implied value, wherein the second party agrees under the program to provide a capital payment to the first party equal to the contract value;

determining the APP of the asset as of the term date;

calculating gap payments due under the program; and

indicating the gap payments due under the program;

wherein at least one of the steps of generating an economic value, calculating a protection value, calculating an implied value, calculating a contract value, determining the APP, and calculating gap payments is performed by a computer.

2. The method of claim 1 wherein calculating an economic value of the asset comprises:

performing a risk analysis based on the data representing the asset; and

determining the net present value of expected future principal payments according to the risk analysis.

3. The method of claim 1 wherein the first party agrees under the program to assign to the second party a portion of the APP exceeding the implied value (“excess payments”), and wherein the method further comprises the steps of:

calculating any excess payments due under the program; and

indicating any excess payments due under the program.

4. The method of claim 1 wherein the data representing the asset further includes a maturity date of the asset, and wherein the term date for the program is the maturity date of the asset.

5. The method of claim 1 further comprising the step of calculating a contract coupon value having a base component based on a major interest rate index, wherein the first party agrees under the program to periodically pay to the second party the contract coupon value.

6. The method of claim 5 wherein the contract coupon value also has a bonus component that is based on a risk assessment of the asset.

7. The method of claim 1 further comprising the step of determining a termination premium for the early termination of the program, wherein the first party is permitted under the program to cancel the program prior to the term date by paying the second party the termination premium.

8. A computer-readable medium for implementing a contract program for quantifying and transferring non-economic risk between a first party and a second party, said computer-readable medium bearing a computer program containing instructions which, when implemented by a computer, cause the computer to execute the steps of:

receiving a term date for the contract program;

calculating an implied value for the asset based on the economic value, wherein the first party agrees under the contract program to assign to the second party aggregate principal payments (APP) exceeding the protection value and up to the implied value (“gap payments”);

calculating a contract value based on the difference between the protection value and the implied value, wherein the second party agrees under the contract program to provide a capital payment to the first party equal to the contract value;

determining the APP of the asset as of the term date;

calculating gap payments due under the contract program; and

displaying the gap payments due under the contract program.

9. The computer-readable medium of claim 8 wherein calculating an economic value of the asset comprises:

performing a risk analysis based on the data representing the asset; and

10. The computer-readable medium of claim 8 wherein the first party agrees under the contract program to assign to the second party a portion of the APP exceeding the implied value (“excess payments”), and wherein the computer program further contains instructions for:

calculating any excess payments due under the contract program; and

displaying any excess payments due under the contract program.

11. The computer-readable medium of claim 8 wherein the data representing the asset further includes a maturity date of the asset, and wherein the term date for the contract program is the maturity date of the asset.

12. The computer-readable medium of claim 8 wherein the computer program further contains instructions for calculating a contract coupon value having a base component based on a major interest rate index, wherein the first party agrees under the contract program to periodically pay to the second party the contract coupon value.

13. The computer-readable medium of claim 12 wherein the contract coupon value also has a bonus component that is a based on a risk assessment of the asset.

14. The computer-readable medium of claim 8 wherein the computer program further contains instructions for determining a termination premium for the early termination of the contract program, wherein the first party is permitted under the contract program to cancel the contract program prior to the term date by paying the second party the termination premium.

15. An apparatus for implementing a contract program for quantifying and transferring non-economic risk between a first party and a second party, said apparatus comprising:

a processor;

a display;

a memory coupled to the processor and containing instructions executable by the processor which, when implemented by the processor, cause the processor to execute the steps of:

receiving a term date for the program;

determining the APP of the asset as of the term date;

calculating gap payments due under the program; and

displaying the gap payments due under the program on the display.

16. The apparatus of claim 15 wherein calculating an economic value of the asset comprises:

performing a risk analysis based on the data representing the asset; and

17. The apparatus of claim 15 wherein under the program the first party agrees to assign to the second party a portion of the APP exceeding the implied value wherein the memory further contains instructions for:

calculating any excess payments due under the program; and

displaying any excess payments due under the program.

18. The apparatus of claim 15 wherein the data representing the asset further includes a maturity date of the asset, and wherein the term date for the program is the maturity date of the asset.

19. The apparatus of claim 15 wherein the memory further contains instructions for calculating a contract coupon value having a base component based on a major interest rate index, wherein the first party agrees under the program to periodically pay to the second party the contract coupon value.

20. The apparatus of claim 19 wherein the contract coupon value also has a bonus component that is a based on a risk assessment of the asset.

21. The apparatus of claim 15 wherein the memory further contains instructions for determining a termination premium for the early termination of the program, wherein the first party is permitted under the program to cancel the program prior to the term date by paying the second party the termination premium.