Financial terminology: Do we really know what we’re talking about?

The financial situation over the past few years and the impact it has had on society as a whole has made us feel rather familiar with certain financial terms which we had practically never heard of before. Rating agencies, junk bonds or defaults are concepts that have often made newspaper headlines, or appeared in radio debates and pub conversations. However, the fact that a large part of the population may now be using this specialist financial terminology carries the risk of changing its precise meaning.

And so here we’ll provide an explanation of the most common financial terms, as well as of a few more technical ones, all closely linked to the infrastructure sector. So you’ll really know what you’re talking about.

Financial Terminology: some key terms worth remembering

• Credit rating agencies: companies that assign credit ratings, or creditworthiness, as per a generally-accepted scale to loans, companies, countries, etc. These ratings are used by investors when taking investment decisions or for pricing risk (for example, to determine the cost of a particular debt).

• “Investment grade” bonds: “good” bonds which have a good credit rating (according to the credit rating agencies), and therefore most institutional investors invest in them.

• Junk bonds: “speculative”, non-investment grade bonds (according to the credit rating agencies) in which only certain specialised institutional investors looking for higher yields in exchange for higher risk will invest.

• Bookbuilding: book for registering demand for and award of investor orders or offers for bond issues, by amount and price.

• Letter of credit (LC): an undertaking from the issuing bank whereby it guarantees payment on condition that the beneficiary complies with all the terms and conditions provided in the said letter of credit.

• Private placement: direct sale of bonds or other securities to a small number of investors.

• Covenants: the conditions, financial or otherwise, contained in a loan agreement.

• Default/Event of Default (EoD): cause for early termination of a loan agreement (due to failure to meet its conditions).

• Senior and junior debts: senior debts are those that must be repaid before junior (or subordinated) debts. In technical speak, senior debt has a “higher priority”. Junior debt has a lower priority than senior debt and will be paid with any assets remaining after senior debt has been repaid.

• Euribor/LIBOR: benchmark rates on the banking market for loans in Euros (Euribor) and Pounds and American Dollars (Libor).

• Bullet loans: financing where only interest is paid during the entire loan period, with the total loan principal being due at the end of the loan period.

• Performance Bond: instrument designed to give the holder increased security that a contract will be fully performed and fulfilled. If this does not happen, the issuing bank or guarantor must provide compensation.

• Interest Rate Swap (IRS): financial instrument for interest hedging, in which two parties agree to exchange fixed rate payments for variable rate payments deriving from the payment or receipt of obligations. The former undertakes to pay a fixed interest rate to the latter, who will in turn pay the former a variable interest rate.

• Mini Permanent Financing (mini-perm): short-term financing (usually 3 to 7 years), often used in construction projects where no income is yet generated and there is no access to long-term financing. These loans typically repay the entire principal at the end of the loan term, while paying only interest during the loan period.

• Pips: term used for referring to the basis points making up the margin (cost) of financing. In other words, 20 basis points is equivalent to 0, 20%.

• Syndicated loan: a loan granted by a group of lenders or banks where the loan amount is very high. All of the lenders sign the same syndicated loan agreement with the debtor.

• Debt service coverage ratio (DSCR): ratio used in project financing to measure a project’s annual or half-yearly ability to service its debt repayment obligations (principal and interest).

• Lock-up ratio: the same coverage ratio as above (DSCR) which, depending on compliance with a level set by the lenders, allows or prohibits equity distribution to project shareholders.

• Term Sheet: offer or document where financial institutions set out a summary of the main terms and conditions under which they will make a loan.

• Underwriting: guarantee by a bank of a specific amount of a debt.

• Waiver: request for temporary dispensation of compliance with any of the financial obligations set out in a loan agreement, submitted by a creditor to the financial institutions or investors issuing the loan.