What is Structured Finance?
Within an Investment Bank there are multiple product groups. One of these includes the Structured Finance group (“Structured Products”). When it comes to these SF Groups, though, what exactly they do is different depending on the bank. In general, these groups help companies raise capital by creating complex and specialized securities and then help in selling them to investors. SF Groups typically work with auto loan, credit card and student loan companies due to the fact that they have stable cash flows. Clients may use these structured notes to refinance high yield debt obligations or help pay off this debt once it has reached maturity.
Structured Products
Structured products are instruments created to meet specific needs of an investor with a custom asset combination. Typically, these include the use of derivatives and are called structured due to the fact that the securities included in these financial transactions are backed by collateral. The most common structured financial instruments include asset-backed securities and mortgage backed securities. Asset backed securities is a security whose values are derived from a bunch of underlying assets and mortgage backed securities are a type of asset backed security which is secured by a single or collection of mortgages.
Depending on the investor and the risk tolerance that they have, structured products can vary drastically. A structured investment often starts out with a regular security such as a bond but instead replaces usual payment, with non traditional payoffs. These payoffs are normally not from the issuer’s cash flow but from the performance of one or more underlying asset.
Positives of Structured Finance
One of the main positives of structured products for investors is the ability to customize a variety of assumptions into one instrument. Within structured products there is also something called a “lookback product” that is considered a major positive for investors. In this, the value of the underlying asset is not dependent on its final value at expiration but on an average of values taken over time. In Structured Finance, you can also use “credit enhancement” and “bankruptcy remoteness” to help bridge gaps in company’s corporate ratings. Because of this, investors are more likely to invest and therefore entail a lower interest rate that overall decreases the issuer’s cost of debt.
Negatives of Structured Finance
Structured Finance sometimes has a negative connotation due to the fact that there is a large credit risk. This credit risk comes along with the fact that there is a high lack of liquidity and the cost is not always clear.
