Securitization as a financing technique
There is no universal definition of structured finance, but the Bank for International Settlements (BIS) defines structured finance through three key characteristics:
- pooling of assets (either based on balance sheet assets or synthetically created)
- trenching of the liabilities backed by the asset pool
- dissociation of the credit risk from the pool of collateral assets through the use of an autonomous, limited-life special purpose vehicle (SPV).
Structured finance thus allows companies seeking financing for their infrastructure or equipment projects to receive off-balance sheet treatment and thus increase their short-term liquidity. It is therefore specifically designed to meet unique capital needs and solve financing problems that are not easily covered by traditional loans.
As such, these financing instruments are designed to transform cash flows and reshape the liquidity structure of balance sheets through securitization.
The different types of structured finance
There are several types of structured finance:
Leverage Buy-out (LBO) allows financial entities to take advantage of the debt markets to raise funds to acquire a target company (or even part of its business) with limited capital.
Future cash flows from the acquired assets can be used to secure the debt. It can use a mix of multi-tiered debt (senior debt, mezzanine debt and junior debt).
The MBO (Management Buy-Out) allows a management team to acquire all or part of the company's shares through a new company formed specifically for this purpose.
Project finance is a form of syndicated financing designed to finance long-term infrastructure, industrial and utility projects using a non-recourse or limited recourse financial structure.
The debt and equity used to finance the project is repaid from the cash flows generated by the project. Again, this is a loan structure that relies primarily on the project's cash flows for repayment, with the project's assets, rights and interests held as secondary collateral.
Project finance is particularly attractive to the private sector because companies can finance large off-balance sheet projects.