What is Structured Finance?
Structured Finance is basically a whole new way of lending. Within this world, each loan is considered to be an asset that can be bought and sold on a market like any other investment. It is the financing of an asset with an enhanced form of security that has been changed from its original form. The goal of this is to allow the funding to be longer or shorter in duration than typical marketable securities are, depending on the type of asset being financed. Structured finance can be used in many different forms. These forms are securitization, repackaging, factoring, and derivatives used as capital structure or risk management.
“Structured finance is a type of financial engineering that strives to meet specific requirements for the issuer of the securities, including issuing debt that hedges risk. Structured finance can take many forms, including swaps, collateralized debt obligations, and hybrid securities.” Structured finance usually refers to the ways in which instruments have been designed that have been especially tailored with regards to funding for acquisitions or other needs. In recent years, these securities have been designed as a means of raising money as well as helping the need for risk management. The latter is something that has been done through the use of derivatives, which are used as hedging tools by those who have structured finance arrangements in place. These instruments are used by both financial institutions and corporations alike.
Structured finance has become increasingly popular over the years, even in spite of the fact that it has become somewhat of a scapegoat for some issues. This may be because there are many people who would like to see any means by which they can get more money, but there are also those who feel that these derivative instruments are very risky and may not be the best thing for their balance sheets. This is because while assets can be created out of debt, debt itself can also create losses that may take place down the line. The issue of how to deal with this risk is one that has caused problems in the past, and will continue to cause them in the future.
Structured financing Vs Traditional Financing
It differs from traditional financing in two important ways:
1) Instead of owning the loan directly for your company, you buy the loan on the secondary market.
2) The interest rate on these loans can exist entirely independently of traditional lenders like banks and bond markets.
Benefits of Adopting Structured Finance
1) To access capital, you don’t need to pay a higher interest rate than you would with traditional loans.
2) You can now combine those loans into one package, which can offer significant value to investors. This package is often sold as a securitization (an issue of securities with multiple portions). Now your company can sell your loan portfolio as a whole (such as an A-B-C), rather than just the original piece it took out originally. The more pieces that they sell, the more investors can be attracted to that A-B-C bundle and thus the greater the price it will fetch.
3) Different investors can now theoretically bid for your loan portfolio as an entire “bundle”, which might result in a more profitable sale. This makes it easier to sell, as you don’t have to worry about individual pieces of your loan portfolio going on their own. Then again, some investors might be interested in a more selective “pick and choose” method of purchasing. Still, no matter what kind of investor you are trying to attract, the fact that the loans are all being offered together as a whole is definitely a huge advantage.
4) Because you aren’t taking over the loan directly, you won’t have to include the interest rate as part of your company’s financial report.
5) Because your loans are sold as a package, it can be easier for investors to accumulate a large number of loans and spread out the risk. This makes it easier for them to sell those loans as an A-B-C bundle.
6) The selling points of selling A-B-Cs with investors is that there’s no need to name any one piece separately. You can combine all your pieces together and say: “This is how we use our entire pool of capital”. This is a great marketing tool for ensuring that you come out as the winner of the securitization process.
7) When buying Structured Finance, you can negotiate more favorable terms with lenders than if your company was trying to access conventional financing. This can be a big advantage for some companies that need capital right away and don’t want to wait around for banks to approve them.
Disadvantages of Choosing Structured Financing
1) Because Structured Finance is not taking over the loan directly, there is no need to include the interest rate as part of your company’s financial report. That means there’s no need for you to report it on your income statement either. This can be a big disadvantage for you as an investor, especially if the loan is performing poorly. Because you won’t have to report any interest payments, it can be much easier for companies to overstate their profit figures. This makes it harder for investors to figure out whether or not the company is making money.
2) If you’re looking at Structured Finance purely as a financial investment, then this isn’t the best approach. The benefits mostly come in terms of negotiating favorable terms with lenders and attracting more investors to your loan portfolio; you don’t really need Structured Finance if you want to make money on interest payments alone (which is what most people are interested in).
3) Structured Finance is often referred to as “securitization” (this term has taken on a much different meaning recently, but the basic idea behind it still applies). Often times you’ll see references to “A-B-C” or other combination terms. This means that you will be paying more for your loan portfolio than if you had simply bought that loan piece separately. This can be a disadvantage depending on what you’re buying into.
4) Banks have started using Structured Finance more extensively, which can have the effect of raising interest rates for traditional loans. This could lower the profits of companies that are trying to access funding with their own assets, which can lead to overstated financials over time.
How Can Fintalent Help Meet Your Structured Financing Needs?
In general, structured finance has been greatly beneficial for both companies and individuals who have used it to their advantage to reduce risk and generate more income for operations, however it does have its risks which can bring about a negative financial situation if not handled correctly. There is no doubt that the use of derivatives and other securities, such as collateralized debt obligations (CDOs), has made it possible for many businesses to put together good-looking balance sheets that look very capable of handling an economic downturn, yet this may not be enough when there is a recession. This risk must be managed in some fashion if the business plans to keep going. It is true that some of these instruments can create a lot of debt and that the risk associated with it is taken on by those who have these arrangements in place. This means that if something goes wrong, then those people will also be left with debt. If this debt is not handled correctly, then the debt holders may be left with losses as well as lenders who were involved in such engagements. To avoid this sort of situation, business owners can look to Fintalent to hire best in class Debt financing Experts to look through any potential debt-financing decision in order to avoid further losses and possibly, even bankruptcy. While there are considerable risks involved with structured financing options, it is also important to point out that there are also some advantages and disadvantages involved with traditional financing. It is up to individual companies to decide whether or not they think Structured Finance is right for them. Businesses can easily arrive at a well informed decision by looking towards Fintalent for all of their financial advisory freelance consultant needs.
