What is Structured Finance?
When it comes to financing a transaction, there are ‘normal’ or ‘vanilla’ types of financial instruments widely available on the market. These are instruments such as a mortgages or overdrafts and look at the credit strength of the borrower.
However, there are borrowers in the market with unique requirements. With unique borrowers, comes a unique financing instrument. Structured finance refers to an instrument which helps dampen risk when applied to securitizations of various assets.
It is often perceived as the packaging up of receivables, however when we usually look at structured finance it is in relation to lending to borrowers through structures, and less about focusing on the packaging of debt.
The aim is to create situations in order to provide non-flow financing solutions and structured risk mitigation products for clients when looking at a number of industries and classes of assets.
At TFG when we discuss structured finance – we look at lending in multiple ways and syndicated financing.
Why is Structured Finance important?
One reason behind Structured Finance’s importance is because of the parties involved. Large institutions such as Banks participate in the use of structured finance, which means the sums that are made available and circulating the economy through the process are massive.
An example – if we mute the effects that the 2008 financial crisis had on the world, we can see that mortgage-backed securities were bought by the Federal Reserve for roughly $38billion. Consequently, through no fault of the basic concept, MBS’s crippled the American economy along with many others however it also (to begin with) generated large surpluses of money.
What is Securitization?
Securitization is a process in which non-tradable assets are packaged together to form their own financial instrument which is then issued to investors. Parallelly, the investors in the securities receive interest from the instrument.
The overall aim of these instruments is to increase liquidity in the market. A good example of Structured Finance is an MBS, which groups Mortgages together into a large pool. The issuer will assess the risk levels and the chance of payment default and create smaller pools based on this. The smaller pools are referred to as ‘tranches’, and investors participate at different tranches based on their own due diligence and appetite for risk.
Because there are different levels of risk available through different tiers of the repackaged instrument, it promotes investor activity and therefore liquidity in the market.
What is a Structured Note?
- Equity indexes
- Interest rates
Structured finance products include:
- Securitized and collateralized debt instruments
- Syndicated loans
- (CMOs) Collateralized mortgage obligation
- (CBOs) Collateralized bond obligations
- (CDOs) Collateralized debt obligations
- (CDSs) Credit Default Swaps and
- Hybrid securities
Structured finance – The Requirements
Although each case of Structured Finance is reviewed on a case-by-case basis, generally a financier would ask for the following in an application:
- Audited financial statements and cash flow statements
- Trades, the margin, product and countries involved
- Previous trading history
- Financial forecasts and growth projections
- Securities available
- Details and references of the directors
- Information on business assets and liabilities
Benefits of Structured Financing
Structured finance can aid companies restructure debt, make savings on repayments, and free up working capital to make cash work as efficiently as it can do. Furthermore, it is often useful when a company operates in different jurisdictions and trades globally.