Structured Financing - Overview, Types, and Benefits
January 09, 2023
Structured financing is offered to large businesses with complex financing requirements unmet by traditional financial products. Traditional lenders generally do not offer such financing because of complex structures and the nature of the risks involved. Collateralized debt obligation (CDO) is one example of a structured financial product that cannot be transferred.
The term "structured finance" is also frequently used to describe the bundling of receivables, although it actually refers more widely to the provision of a structured framework to assist borrowers and lenders in achieving specific objectives. The main objective is to provide less risky solutions available to customers who need them and to target diverse asset classes across multiple sectors by facilitating tailor-made financing solutions depending on the free cash flow.
Elements of Structured Finance:
- Securitization - Securitization is the process of creating financial instruments called securities by pooling together a group of assets and then selling those securities to investors. This allows the assets to be converted into a form that can be more easily bought and sold on the financial markets. In the context of structured finance, securitization refers to the creation of securities that are backed by a specific pool of underlying assets, such as loans, leases, or mortgages. These securities are known as asset-backed securities (ABS). Securitization is used in structured finance as a way to transfer risk from the issuer to the investors.
- Tranching - Tranching includes creating several groups of securities from a single pool of assets. It is used to divert the cash flow from the underlying asset to different investor groups.
- Credit enhancement - Credit enhancement is the key to creating security with a higher rating than the underlying pool of assets. Credit enhancement refers to measures used to enhance the credit profiles of such products or transactions, or the enhancement of the credit profile of a structured finance transaction. It is a crucial aspect of the structured finance securitization transaction and is significant for credit rating agencies when grading a securitization.
Different types of structured financing
There are several structured financing instruments:
- Asset-backed securities: Asset-backed securities (ABS) are securities that have underlying assets as their source. Financial firms combine many loans into a single security that is then offered to investors to generate asset-backed securities.
- Mortgage-backed securities: These are also asset-backed securities, especially against mortgage assets. The cash flow is backed by the principal and mortgage loans’ interest. They are primarily of two types:
- Residential mortgage-backed securities: these are usually associated with single-family residential homes.
- Commercial mortgage-backed securities: These deal with the real estate used for commercial use, such as malls or office complexes.
- Collateralized mortgage obligations (CMO): The term "collateralized mortgage obligation" (CMO) refers to a kind of mortgage-backed instrument that consists of a pool of mortgages that have been bundled and sold as an investment.
- Collateralized Debt Obligations: A financial instrument sold to investors and backed by a pool of loans and other assets.
- Collateralized fund obligation: This financial instrument securitizes the private equity fund and assets that are associated with hedge funds.
- Insurance-linked securities: These are the instruments that transfer the risks associated with losses in insurance due to catastrophic events that are mostly unrelated to traditional financial markets.
- Credit default swap: A protection purchased by one party from the other party against losses from the default of a borrower for a particular period. A credit default swap is a contract between two parties.
- Syndicated loan: It is a loan provided by a group of lenders and is arranged by a consortium of several commercial banks or investment banks. This group is often called the lead arrangers/syndicate.
Benefits of structured financing
- Structured finance helps companies borrow funds by utilizing cash flow as a security instead of their physical assets as collateral.
- Structured financing helps to reduce the risk to the lender, which results in lower interest rates and better terms.
- It acts as a tool for injecting significant capital into a company.
- Structured financial instruments are primarily non-transferable in nature.
The best-structured financing advisory company
Resurgent India Limited is a top-of-the-line investment banking firm in India. To satisfy our client’s complex needs, we offer specialized structured financing services. For complex transactions, our team draws on its comprehensive expertise in the financial industry. We also provide services in a number of other fields, including mergers and acquisitions, private equity, debt solutions, structured finance, capital market solutions, transaction advisory, valuations, government advisory, enterprise risk, stressed asset resolution, fintech solutions, training, and others.