The Basics of Structured Finance

Structured Finance provides a viable option for funding when conventional methods of obtaining a business loan are either too expensive or not available. In essence, structured finance bases the viability of a loan on the performance of a business’ historical cash flow. As opposed to tying up assets as collateral, funding in a structured finance scenario is advanced based on a history of consistent cash flow produced by the borrower’s business operations.

The following examples show how structured finance may be the right option in a given situation:

• Low values in terms of material assets – A growing client base and a history of monthly cash flow can attract investors, even at rates less than traditional bank loans. Structured finance loans can also get put together and approved faster than standard bank loans.
• Companies carrying large sums of debt – Banks generally tend to avoid highly indebted companies but structured finance investors, seeing strong cash flow can be willing lenders. Businesses often use structured finance loans to replace debt carrying higher interest rates.
• Businesses with little or no credit history – New businesses are typically considered as high risk borrowers. This is especially true if the company’s principals do not have the personal assets to guarantee a loan.
• Companies with assets which can be collateralized – Structured finance in these scenarios is commonly executed as a collateralized debt obligation (CDO). This type of loan can be complex in structure but gives lenders security in the form of assets which back the loan.

These deals are often complex to build and require the experience of finance teams like the one led by Dmitrij Harder at Solvo Group. That being said, the use of structured finance products has given many businesses a chance for new life that would not have been possible using other financing methods.

CDO Basics

Collateralized Debt Obligations (CDO’s) are a type of structured financing in which loans are funded based on the cash flow generated by specified company assets. The cash flow producing assets then stand as collateral to secure the funds loaned to the business. While this basic description may sound relatively simple, the actual structure of a CDO can be extremely complex.

One of the reasons for this structural complexity is that CDO’s are divided into different risk classes, also known as “tranches”. Each “tranche” carries a varying degree of risk with the senior tranche being the most secure sector of the loan pool. Next in line are the subordinated tranches which, because they carry higher payment and default risk, offer higher interest rates and/or lower prices.

These subordinated tranches act as shock absorbers for the senior tranche by accepting payments of interest and principle only after obligations to the senior tranche have been satisfied.  The subordinated part of the loan pool can have its own hierarchy where, once payments are made to the senior note holders, certain subordinated tranches can receive payments before other subordinated holders. Still, in cases where interest and/or principle payments are not sufficient to cover all tranches in the pool, subordinated debt holders may end up with disproportionately large losses while holders of the senior tranche can, at least in theory, be made whole.

Businesses utilizing CDO’s for access to capital general see the following benefits:
• The potential for approval when traditional loans aren’t available.
• A faster timeline than traditional loans from inception to funding
• Lower overall interest rates

Structured finance using CDO’s is often the lifeline businesses seek when other methods of obtaining needed capital are unavailable.  As structured by Dmitrij Harder and the team at Solvo Group, access to capital can be achieved faster and cheaper than traditional methods.