Loans – The Last Thing To Consider When Financing Your Business

In the modern world of structured financing, a loan sits firmly at the bottom of the totem pole and is the last thing to consider when seeking project finance for your business.

Loans have more disadvantages than advantages. The application process for a business loan can be a trying one. Credit checks, endless forms, appointments with the bank, business plans, it’s just exhausting! And even when you have jumped through all these hoops, they can apply restrictions to your business. Bear in mind, most businesses make a loss for the first three years, so you need to think about if you could afford to keep up the repayments on the business loan until your business’ revenue could cover them. Would this business loan repayment be the difference between your business closing and continuing to push through the initial difficult stage that most businesses experience? This means that a business loan repayment could have a detrimental effect on your personal finances as well as your business finances.

Structured Finance

Structured finance is a sector of finance that was created to help transfer risk using complex legal and corporate entities.

This transfer of risk, as applied to the securitization of various financial assets (mortgages, credit card receivables, auto loans, etc.), has helped provide increased liquidity or funding sources to markets like housing and to transfer risk to buyers of structured products; it also permits financial institutions to remove certain assets from their balance sheets as well as provides a means for investors to gain access to diversified asset classes

Structured finance is a highly involved financial instrument offered to large financial institutions or companies that have complex financing needs that don’t match with conventional financial products.

Structured finance is typically indicated for borrowers – mostly extensive corporations – that have unique or highly specified needs. A simple loan or other type of conventional financial instrument, will not suffice to resolve such need. In most cases, structured finance involves one or several discretionary transactions to be completed and thus evolved and often risky instruments must be implemented.

When a standard loan is not enough to cover unique transactions dictated by a corporation’s operational needs, for example, a number of different structured finance products may be implemented. Along with CDOs and CBOs, instruments such as collateralized mortgage obligations (CMOs), credit default swaps (CDSs), and hybrid securities combining elements of debt and equity securities are often utilized.

Significance and Benefits

Structured financial products are typically not offered by traditional lenders. Generally, because structured finance is required for major capital injection into a business or organization, investors are required to provide such financing. Structured financial products are almost always non-transferrable, meaning that they cannot be transferred between various types of debt in the same way that a standard loan is.

More and more, structured financing (and securitization) are used by corporations, governments and financial intermediaries in advancing, evolving and complex emerging markets to manage risk, develop financial markets, expand business reach and design new funding instruments. For these entities, using structured financing transforms cash flows and reshapes the liquidity of financial portfolios.

What Are Structured Products?

Structured products are designed to facilitate highly customized risk-return objectives. This is accomplished by taking a traditional security, such as a conventional investment-grade bond, and replacing the usual payment features (e.g. periodic coupons and final principal) with non-traditional payoffs derived not from the issuer’s own cash flow, but from the performance of one or more underlying assets.

One common risk associated with structured products is a relative lack of liquidity due to the highly customized nature of the investment. Moreover, the full extent of returns from the complex performance features is often not realized until maturity. Because of this, structured products tend to be more of a buy-and-hold investment decision rather than a means of getting in and out of a position with speed and efficiency.

Loan Types

There are several types of structured finance instruments.

  • Asset-backed securities are bonds or notes based on pools of assets or collateralized by the cash flows from a specific pool of underlying assets.
  • Mortgage-backed securities are asset-backed securities, the cash flows from which are backed by the principal and interest payments of a set of mortgage loans. Residential mortgage-backed securities deal with residential homes, usually single family.
  • Commercial mortgage-backed securities are for commercial real estate, such as malls or office complexes.
  • Collateralized mortgage obligations are securitizations of mortgage-backed securities, typically involving multiple classes with differing levels of seniority.
  • Collateralized debt obligations consolidate a group of fixed-income assets, such as high-yield debt or asset-backed securities, into a pool, which is then divided into various tranches. Many CDOs are collateralized by various types of mortgage-backed securities and other mortgage-related assets. An extension of these CDOs are “synthetic” CDOs which are collateralized by credit default swaps and other derivatives. Collateralized bond obligations are collateralized debt obligations backed primarily by corporate bonds.
  • Collateralized loan obligations are collateralized debt obligations backed primarily by leveraged bank loans.
  • Collateralized debt obligations are commercial real estate collateralized debt obligations are collateralized debt obligations backed primarily by commercial real estate loans and bonds.
  • Credit derivatives are contracts to transfer the risk of the total return on a credit asset falling below an agreed level, without transfer of the underlying asset.
  • Collateralized fund obligations are securitizations of private equity and hedge fund assets.
  • Insurance linked securities are risk transfer instruments linked to insurance losses due to catastrophic events, which are generally seen as uncorrelated to traditional financial markets.
  • Partial guaranteed structures
  • Future flow transactions
  • Loan sell offs
  • Revolving Credit Financing (property or traded goods)

 

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