Structured finance: Introduction

Security is a key concept in debt. If you don’t understand your security then you are unlikely to fully grasp your risk level. And risk is another one of those pesky credit fundamentals.

This month, PDI explores structured credit. We haven’t covered the whole market, primarily because the range of strategies that full under the headline “structured credit” is vast: from securitised products like collateralised debt obligations and commercial mortgage-backed securities, through to leasing and other forms of asset-backed loans.

You could write a whole magazine just on collateralised loan obligations (CLOs), let alone every type of structured finance offered by sophisticated financial markets.

From the Asian perspective, PDI asks Singapore-based EFA Group about its new structured credit fund (p.48). The firm has expanded its trade finance offering to tap into the working capital needs of the same borrowers who use the original strategy.

The new asset-backed lending fund, marketed as a direct lending strategy, will target 10-12 percent IRR from longer-term loans to supply chain companies secured against their assets.

In a similar vein, in Europe we’ve traced the evolution of asset-backed lending.

More and more non-bank lenders and institutional investors are seeking to access this very top tier of the credit market, where the structuring is so extensive that a lender should only face a loss in the most extreme of credit scenarios. Of course, structuring that complicated takes a lot of experience and asset-specific market knowledge.

Take shipping finance. Many bank lenders were burned by the asset class in the wake of the financial crisis; hit by a double whammy of falling demand and over-supply as the previous shipping shortage ended just as trade flows plummeted.

That has left a clear financing gap, one that Breakwater Capital and Hayfin teamed up to fill in 2014.

Of course, the supply/demand dynamic and its sometimes painful outcomes can be mitigated by scrappage, says Breakwater Capital’s Andreas Povlsen: “The beauty of shipping from the point [of view] of cyclicality is that it is probably a little easier at times to take out capacity than it is in some other industries, because you can scrap the vessels and be paid for doing it. In addition, supply normally has a certain lead time of say two years from order to delivery.”

“Beauty” is one way of viewing this convergence of factors. “Complex” is another valid interpretation.

Also highly structured but with a completely different risk profile, are CLOs. The vehicles – bundles of syndicated leveraged loans and high-yield bonds sliced into different risk profiles and sold to investors – were one of the first access points into leveraged finance markets for institutional investors. They wax and wan in terms of attractiveness of the opportunity with a transatlantic ebb and flow that keeps investors on their toes.

Not unlike shipping finance, perhaps.