Structured Financial Products - Intro

8/2/2019 Structured Financial Products - Intro

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INTRODUCTION


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What is a Structured Financial

product?

Structured

Financial

Product

Securities that provide investors with an redemption amount .Redemption Amount includes full or partial capital protection with a certain

type of return.

Return depends on the selected underlying security

Variety of debt +

other instruments

COMBINED

VEHICLE

Issued as

Secured Bonds

Specific Coupon

Rate and Principal


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What is a Structured Financial

product?

Structured

FinancialProduct

They are synthetic investmentsSynthetic investments simulate return of actual

investments.

Return is actually created using a combination of

financial products.

Eg: Options Contracts, Equity Index

Why Structured Financial Products?

To meet specific needs that cannot be met from the

standardized financial instruments available in the

markets.Structured products can be used: as an alternative to a

direct investment

As part of the asset allocation process to reduce risk

exposure of a portfolio

to utilize the current market trends.


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History and Origin


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Terms and Structures associated with

Structured Products

Various Types of Contractual

Debt

Residential Mortgages

Commercial MortgagesAuto Loans

Credit card Debt Obligations

Financial Pooling

and Selling to

Investors

Bonds

Pass-through

securities Collaterized Mortgage

Obligations (CMO)

Securitization

Securitization involves conversion of assets that are not readily marketable into

rated securities that that are tradable in the secondary market.

It involves sale of cash flow generating assets to a Special Purpose Vehicle

(SPV)which has been created specially for the purpose, which then issues

notes which are tradable.


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Structured Products

A piece, portion or slice of a deal or structured financing.

This portion is one of several related securities that are offered at the same time but

have different risks, rewards and/or maturities.

A senior tranche may be rated AAA or AA while junior unsecured tranches may be

rated below investment grade (


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Structured Products

Structured products have a defining features: they can split the bulk of funds with the

SPVs into different tranches.

With the help of credit rating agencies the are ranked from the highest (AAA) to less

than BBB or junk bond.Some of the other techniques used are overcollateralization, An excess spread between

the interest rate on the underlying security and treserve accounts etche issued notes,.

Credit Enhancement and Credit Rating Agencies

Over collateralization:An excess spread between the interest rate on the underlying security and reserve

accounts etche issued notes,.


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A sample SFP

Auto Loan

Home loan

Student loan

Credit Card

Debt

Other

Receivables

SPV

Tranche 1

(Senior)

Tranche 2

(Mezzanine)

Tranche 3

(Mezzanine)

Tranche 4

(Mezzanine)

Tranche 5

(Subordinate/J

unk)

Risk

&

Return

Increase

Banks AssetsBonds


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Instruments and Products

Structured products have a defining features: they can split the bulk of funds with the

SPVs into different tranches.

With the help of credit rating agencies the are ranked from the highest (AAA) to less

than BBB or junk bond.Some of the other techniques used are overcollateralization, An excess spread between

the interest rate on the underlying security and treserve accounts etche issued notes,.

Credit Enhancement and Credit Rating Agencies

Over collateralization:

An excess spread between the interest rate on the underlying security and reserve

accounts and issued notes.


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Asset backed securities are bonds which are based on underlying pools of assets. They

are secured by assets other than mortgages, such as auto loans, home loans, banks

receivables, credit card payments due etc

1. Asset Backed Securities (ABS)

Mortgage backed securities are the original forms of structured financial products.

They are similar to asset backed securities, the only difference being that the underlyingsecurities are mortgages.

These mortgages are almost always secured (By the government or a mortgage insurer).

An MBS pays out the cash flows from the pool of assets

2. Mortgage Backed Securities (MBS)


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CDOs are a type of ABS whose value and payments are derived from fixed income

underlying assets. They are backed by a collateral, and deal mainly in debt

instruments.The types/classification of CDOs are:

Prime: Where the collateral is fixed through the life of the CDO and known to the

investor

Managed: Where a portfolio manager is appointed to actively manage the collateral

Balance sheet CDO: Used by institutions especially banks to offload assets from

their balance sheets.Arbitrage CDO: Where the institution issuing the CDOs attempts to gain from the

interest spread between the CDO and the underlying security

1. Collateralized Debt Obligation


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A CMO is a type of MBS in which bonds are issued and investors are paid fixed

interest amounts in accordance with the bond they hold. CMOs differ from other MBS

instruments in the way that they are not instruments for Mortgage pass throughs

4. Collateralized Mortgage Obligation (CMOs)

CLOs (Commercialized Loan Obligations) that have only loans as the underlying

security

CBOs (Commercialized Bond Obligations) that have bonds as the underlying security

5.Others


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Le Meridien Hotels

Two-horse race between Nomura and Marriott in2001

The hotels made a sales of 493m. Estimated EBITDA

was 247m.

Offers for the hotel chain had been 2.2 billion pounds.

Fear of a slowdown in the United States


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Nomura's Principal Finance Group secured theleasehold interest in the 120-property of Le Meridiengroup from Compass Group PLC

Sale/leaseback arrangement with the Royal Bank ofScotland.

Nomura got hold of the hotels without actuallyhaving to pay for them.

Le Meridien Hotels


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Deal StructureAmount

Equity

Nomura International plc's Finance Group 227 million

Royal Bank Private Equity 100 million

Alchemy Investment Plan 35 million

Abbey National Treasury Services 15 million

Juergen Bartels 10 million

Royal Bank of Scotland (Sale & Lease Back) 1.25 billion

CIBC and Merrill LynchSenior Debt GBP 750 million

Revolving Credit GBP 25 million

Capex Facility GBP 110 million

Mezzanine (PIK) GBP 160 million


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The deal included a GBP160m "payment-in-kind"mezzanine tranche arranged by Lehman Brothers,chosen instead of ABS

Cost of redeeming these bonds early and achieving arapid realization of the assets made mezzanine amore attractive option in this instance.


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Securitization Funding For Toyota Motors

Toyota Motor Corp., through its finance arm,sold $1.29 billion of bonds backed by autoloans

Toyota

MotorsReceivables

(Auto Loan)

Remote

SPE

QSPE

TrustInvestor

Bonds


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Credit Enhancement

Internal Credit Enhancement

Subordination

Excess spread Overcollateralization

External credit enhancement

Surety bonds (CDS)

Wrapped securities


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Structured Products for Retail Investors

Equity linked structured products

-- principal protected notes

-- enhanced yield notes-- reverse convertible notes


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What is the problem with retail investors

Does not understand the risk-return tradeoff

Cost incurred

retail investors consider principal protection avery attractive feature


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Say no to Retail structured products

Over priced at the offering

There after thinly traded

Exposed to the credit risk of the issuing brokerage

firms without adequate compensation Opaqueness obscured their true risks and costs and

the high fees earned by underwriters andsalespersons

The potential for high fees and commissions createdstrong incentives to develop and sell ever morecomplex variants of these inferior investments


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Conclusion

Simple portfolios of stocks and bonds can bepurchased and periodically rebalanced which willyield more wealth at maturity than an investment inany of the structured products we have analyzed at

issuance whatever the level stock price.

These products add nothing to retail investorsportfolios that cant be acquired from investmentsalready available in the market in the form of less

risky, less complicated, or less costly products andtherefore fail the reasonable-basis suitabilityrequirement for sale to retail investors.

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