Ch6 Structuring Process (1)

1. Structured Finance
Process by which firms raise funds in a manner that is independent of their fundamental creditworthiness, thus enabling them to obtain funding at a cost independent of thier overall risk profile.

2. Securing Specific Liabilities with Specific Assets
Simplest form of structured finance is the issuance of secured debt. The collateral is pledged to the bond/note holders to secure performance on the debt instrument => credit enhancement

- issuing secured debt by specifically pledging assets as collateral => lower cost of capital & satisfy the claims of secured creditors
- pledging high quality assets mitigates information asymmetiries
- isolating assets as collateral for issuing asset-backed securities increase the overall transparency of the firm => lower overall cost of capital
- investor appetite for particular assets => sell these claims at more attractive rates => lowering WACC

3. Asset Securitization
A form of structured finance

3-1. Definition
The payment for the acquisition of assets is funded by the issuance of new securities whose P&I obligations are backed by the newly acquired assets as collateral.

3-2. Video lecture: http://www.youtube.com/watch?v=Z8kCQkfblzY

3-3. Three Key Ingredients
3-3-1. Pool (Credit Sensitive) Assets, e.g.) synthetic CDO

3-3-2. Transfer (De-link) Credit Risk
**4 criteria for true transfer of credit risk(="true sale") - SPV is bankruptcy-remote (When the insolvency of a company does not affect any other company within a corporate group, particulary any holding company or susidiary company of the bankruptcy remote vehicle, the company is called bankruptcy remote) - SPV has limited, predetermined activity - Originator surrenders (transfers) control - SPV can pledge/resell/exchange assets

3-3-3. Tranching of Liabilities: Senior, Mezzanine, Junior Debt & Equity Tranche: http://www.youtube.com/watch?v=HymdWTSrNTA
- Preservation Principle: Market value, cash flow, risk


**Important differnces between securitization and simple secured asset


**Synthetic securitization: the actual asset remain on the balance sheet but the economic risk of the assets is transferred to another firm through the use of a derivatives transaction.


4. Ring-Fencing Assets
4-1. Definition: http://www.investopedia.com/terms/r/ringfence.asp
Ring-fencing of the assets, to cover the liabilities, is another important self-protection mechanism.

4-2. Advantages
4-2-1. Risky assets: The parent company wishes to house (ring-fence) them in a bankruptcy-remote enterprise

4-2-2. Improved Creditworthiness: ring-fencing, overcapitalization, & obtaining higher credit rating than the parent

4-2-3. Runoff solution: exit strategy; improve transparency & valuation of the isolated assets

4-2-4. Collatral: large-scale capital-intensive project

4-2-5. Tax/Legal: housing cetain assets in a distinct legal entity

4-2-6. Reducing adverse selection cost: high monitoring cost -> increased transparency of isolating the assets -> higher value on the assets.