Structured financing deals with a high financial instrument which is usually offered to big corporations or companies whose financial needs are too complex and are not compatible with the normal financial products. For some time now, structured finance has become the need of many financial companies or corporations. Some of the examples of the forms of structured finance include the CDOs which translate to mean Collateralized debt obligations, synthetic financial instruments and the CBOs means the Collateralized bond obligations and loans syndicate.
Structured Financing Explained
There are various types of structured financing; some of them are listed below.
- Asset backed security. This is a representation of the use of an underlying asset to serve as collateral or using assets to have its basis on bonds.
- CDOs. This is translated to mean collateralized debt obligations. These have assets backed securities divided into different parts. It has some fixed income assets consolidated. Examples of this CDOs include; collateralized bond obligations, collateralized loan obligations, commercial real estate collateralized debt obligations and synthetic financial instruments.
- Collateralized bond obligations. These are CDOs that are used by corporations issuing bonds.
- Collateralized loan obligations. These are the CDOs that are used by banks that deal with leverage loan financing.
- Commercial real estate collateralized debt obligations. These are used by real estate management companies that deal in bonds and loans.
- Insurance linked security. These are instruments of risk that are used to make insurance in case of any bad occurrences or damages within the company.
Other types of structured finance are the mortgage backed securities, collateralized fund obligations which are used by companies that practices equity financing, partial guaranteed structures, loan sell off etc.
Structured finance targets helping the creation of transfer of risk with the use of corporate companies. This risk that is transferred is the securitization of most financial assets of a company and has provided increased funding strategies to corporations and has also helped in transfer of risks to structured products buyers. This financial asset can be credit card receivables, auto loans or mortgages. Structured finance has helped corporations to be able to divert their assets into different classes.
Methods used in structured financing
- Credit enhancement. This is used in the securitization under structured finance for creating a high rating security than the pool of the underlying asset. This is usually created by issuing or making use of subordinate bonds. The subordinate bonds are any losses from the collateral allocated before there is allocation to the senior bonds making use of the senior bonds as credit enhancement. So as a result, many deals mostly those deals with a higher risk of collateral such as alt A-mortgages make use of subordination and over collateralization. In over collateralization, the returns of the underlying assets are greater than the bonds consequently creating over interest rate in a deal which is supposed to act as cushion against any reduction in the value of the underlying assets. These interests can be used to settle the losses of the collateral before allocation of the losses to the bondholders. The use of derivatives such as stock options, warrants or swapping which provide an effective insurance for fees that negates the value decrease is another method of credit enhancement. Monocline insurers can be used in credit enhancements as they have played many roles in this modern credit enhancement.
- Securitization. This is a method used by the users of structured finance to generate pools of assets that helps in the formation of the financial instrument end product. There are many reasons for securitization which include; another means of funding, better maximization of the capital available to the company, reduction of concentration of credit use and for transferring of risk.
- Tranches. This is used in the creation of many sessions and parts of security from the pool of assets that were used before. This helps in creating different classes of investment for the available securities. Tranches makes it possible and provides opportunities for the cash flow got from the underlying assets to be used in financing of other investors group. The main purpose of tranches is the creation of a security class even if it is one class of security that its rating is very high than the underlying collateral pool rating.