How Does Structured Finance Work?
"Normal" ways to finance a transaction, such as a mortgage, typically look at the borrower's credit strength and the value of the asset Because of its complex and highly involved nature, structured finance is generally only offered to large financial companies or institutions whose specific needs are unsuited to the simpler loans available to regular borrowers.
Structured finance products are usually offered by alternative lenders, and they're offered only when there are several discretionary transactions involved.
Oftentimes, structured financing occurs through securitisation that is, when financial products are created using a combined asset pool, which is then split up into tranches.
They can help companies or businesses restructure debt or property leases, make savings on repayments, improve cash flow, promote liquidity, and mitigate risk. Structured finance products usually involve any number of different instruments, including (but not limited to):
1. Mortgaged backed securities (MBS) 2. Collateralised bond obligations (CBOS) 3. Collateralised debt obligations (CDOs) Credit Default Swaps (CDSs) 4. Hybrid Securities 5. Mortgaged Backed Securities
Mortgaged backed securities, or MBS
Mortgaged backed securities, or MBS, are where mortgages are pooled together, with the issuer judging risk levels and chances of default to create smaller pools based on levels of risk. Investors can then buy tranches from these pools.
Collateralised Debt Obligations
A collateralised debt obligation, or CDO, is backed by a pool of loans, with the repayment of those loans giving the CDOs value. So for example, a CDO pools together assets that generate a cash flow, such as mortgages, bonds and loans, and then repackages this asset pool into tranches to be sold to investors. smaller pools based on levels of risk. Investors can then buy tranches from these pools.
Collateralised Bond Obligations
Collateralised bond obligations (or CBOs) compile junk bonds with differing levels of risk. These bonds aren't usually investment grade, but because they're pooled together with other types of credit quality bonds, their diversification improves their investment grade.
Credit Default Swaps
A credit default swap (or CDS) is where the seller of the CDS compensates the buyer if there is a loan default or other credit event.The buyer pays the swap's seller up until the contract matures. In many ways, a CDS can be considered insurance against non-payment.If the debt issuer doesn't default by the time of maturity, the CDS buyer will loose money
Hybrid securities combine aspects of debt securities and equity securities.They promise to pay a higher rate ofreturn for a certain period.Many hybrid securities will have terms and conditions that let the issuer suspend interest payments or exit the deal whenever they wish.
Structured financing is a common option for property development companies looking to access more capital across multiple projects.