Basics of Structured Finance

Ian Chinapoo
Table of Contents

• What is Structured Finance

• Techniques in Structured Finance

• Securitization (Definition, general concept overview, credit enhancements, SPV, types

and methods, advantages & disadvantages.

• Credit Derivatives

• Other Techniques

• Project Finance and Structured Finance

• Case Studies

• FirstCaribbean Capabilities

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What is structured finance?
Definition
• A service that generally involves highly complex financial transactions offered by many large financial
institutions for companies with very unique financing needs. These financing needs usually don't match
conventional financial products.
• Structured Finance includes “all advanced private and public financial arrangements that serve to efficiently
finance, refinance and hedge any profitable economic activity beyond the scope of conventional forms of
on-balance sheet securities (debt, bonds, equity) in an effort to lower costs and improve liquidity.”
• Structured Finance is used in both banking and in the capital markets.
• Structured Finance is used primarily in two instances:
1. established forms of finance are unavailable
2. established forms are too expensive
• Structured Finance because of its flexibility straddles the indistinct boundary between traditional fixed
income products, debentures and equity on one hand and derivative transactions on the other hand.

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 What is structured finance?
Definition
• The leading form of structured finance is capital based risk transfer whose two major asset classes include
asset securitization (which is mostly used for funding purposes) and credit derivative transactions (as
hedging instruments).

Basi
cs of
SF

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 Securitization
Overview – General Concept
• Securitization is a financing technique which involves an entity selling a portion of their cash-producing
assets to a separate legal entity financed directly through public and/or private capital markets

CIBC:
$10 Credit
(Financial Services Agent,
Enhancement
Structuring & Placement Agent)

Sell Assets worth $100 to Investment $90

Trust
Seller/
Originator Bond $90 Investors
Monthly Interest +
Proceeds of $90 Trust Principal (Amortizing)

• The company segregates cash-generating assets and supporting credit enhancement, which are then
sold to a special purpose vehicle (“SPV” or “Trust”)
– Level and combination of credit enhancement will depend upon the inherent risks of the
assets
» Conservative structuring techniques and credit enhancement of the cash flows
allows the SPV to achieve the highest credit ratings for its issued debt

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 Securitization
Overview – General Concept
• The Trust issues debt backed by the assets and credit enhancement and funds by issuing:
1. a public term note (“Term ABS”), or
2. a privately placed note, or
3. a note in the commercial paper market (“Asset Backed Commercial Paper” or
“ABCP”)
• The principal and interest collections generated from the assets are used by the Trust to
repay principal and interest owed to the Investors
• A portion of the periodic cash flow generated by the assets that exceed the periodic debt
service requirements of the SPV are flowed back to the Seller
• The Seller/Originator continues to bill, collect and administer the portfolio
– The transaction does not affect the business operations of the Seller and is totally
transparent to the Seller’s clients
• Through the low risk nature of selected assets and the credit enhancement of the asset’s
cash flows, securitization offers Sellers direct access to the capital markets at a reduced cost
of funding
– Lower cost of funds for higher rated debt

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 Securitization
Overview – General Concept
• Assets that generates recurring and predictable cashflows are eligible for securitization, e.g.:
– Loans (mortgages, hire purchase/consumer loans,
corporate loans)
– Leasing contracts
– Commercial real estate
– Trade receivables
– Remittances
– Bonds or derivatives portfolios
– Ability to securitize entire businesses with stable
cashflows (e.g. gas stations)

• One of the fastest growing areas in structured finance has been Collateralized Debt Obligations (CDOs).
CDOs are investment vehicles that allow issuers to refinance the purchase of debt instruments by
repackaging them into different slices of risk and maturity.

• CDOs vs ABS: While CDOs use the same structuring technology as ABS to convert a larger diversified pool of
exposures into tradeable commercial papers, their underlying collateral pool typically includes a wider and
more diverse range of heterogenous reference assets, such as senior secured bank loans, high yield bonds
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and credit default swaps (CDS), as opposed to more homogenous titles, such as home equity loans and credit
 Securitization
Credit Enhancement
• Credit enhancing is the use of structural features to improve the credit rating of the securitized bond in
order to achieve a lower cost of funding. The typical methods are:

• Senior / Subordinated Structure

• Over Collateralization and Deferred Purchase Price

• Reserve Accounts

• Outside Guarantees

• Monoline* Wrap and Outside Insurance

• The cheapest method is senior subordinate structures and is almost always used in the developed
markets.

• In emerging markets monoline wrap and guarantees are very common as these enhancers can be used
to mitigate political and sovereign risks.

*A monoline insurer or monoline wrap provider is an insurance company that takes on credit risk by providing guarantees on bonds and selling
protection on ABS and CDO tranches. Monolines typically invest in investment grade exposures and benefit from triple A counterparty credit
ratings.

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 Securitization
Special Purpose Vehicle (SPV/SPE)
• This an a entity established for a limited purpose only. Generally for:
- Investing in specified assets
- Securitizing risks

• The SPV can be structured in a variety of legal forms, but is typically structured as:
- Trusts (single seller or Master Trust)
- Partnerships (popular in project financing)
-Limited Liability Company
**There are regulations in the region which allow for Multi-cell SPV structures**

• Other important features of the SPV are:

- Ownership (must be owned by third party or limited interest)
- Domiciled (typically in a tax neutral jurisdiction, e.g. Cayman, BVI)

• SPV’s are necessary for securitization for the following reasons:

- They allow for legal isolation of the securitized assets from the originator/seller
- The SPV allows for bankruptcy remoteness of issuer from originator
- SPV provides investors with a clear route for recourse
- They allow for separation and allocation of risks to multiple market participants
- They allow for off-balance sheet financing to the issuer once certain conditions are met (especially under
IAS 27 and SIC 12)
- They provide tax benefits (withholding tax, etc)

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 Securitization
Single Seller

• Single-Seller Market

– Single-Seller vehicles are special purpose vehicles sponsored by the originator

– Single-Seller vehicles generally issue ABCP or Medium Term Notes (“MTN”)

• MTN’s can be public or privately issued

– Originator is known to investor and all assets are usually originated by one originator or affiliates of
the originator

– Advantages of the Single-Seller Market include:

• captive funding source

• name recognition
• structure can be tailored to meet sellers needs

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 Securitization
Issuance Options

• Basic Summary of Securitization Options for Issuers

Issuance by Issuer
(“Seller”)

Medium Term Notes

ABCP Program (Term ABS)
(ABS, MBS,CDO)

Issue Note to Multi-Seller Discrete Private Placements

Issue Single Seller ABCP Public MTN Shelf Program
Conduit (Offering Memorandum)

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 Securitization
Benefits to Originators Benefits to Investors
• Lower weighted average cost of funding due • Provides portfolio diversification.
to the ability to create a bond which is rated
higher than the seller/originator.
• Provides stability in portfolio return since
credit spreads on ABS are historically more
• Allow for customization of bond structure to stable than that of pure vanilla corporate
match the duration of assets and liabilities bonds.
hence mitigating basis risk.
• Allows investors to gain exposure to
• Diversification of investor base and extension assets/risks to which they would otherwise
of lending resources by tapping the capital have no exposure.
markets.
• ABS provides a premium above securities of
• Allows sellers/originators to sell credit risk on similar credit rating thus offering investors a
specific assets. spread pick-up.
• Provides regulatory capital relief in the case of
financial institutions.

• Clean up the balance sheet and positively

impact ratios such as ROE.

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 Credit Derivatives
Overview – General Concept

• Derivatives in general are financial contracts on a pre-determined payoff structure of securities, indices,
commodities, or any other assets of varied maturities.

• In its basic concept, credit derivatives sever the link between the loan origination and associated credit risk,
but leave the original borrower-creditor relationship in tact.

• Credit derivatives are predicated on the isolation and transfer of credit risk as a reference asset. The
significance of credit derivatives is their ability to supplement traditional ways of hedging capital related
exposures.

• As a common working principle it involves the sale of contingent credit protection for pre-defined credit
events and/or asset performance.

• The protection buyer of a credit derivative hedges specific credit risk at the expense of periodic premium
payments to the protection seller, who assumes the credit exposure of the underlying transaction.

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Credit Derivatives
Overview – Select Credit Derivatives

• Credit Default Swaps (CDS) and Total Return Swaps (TRS) are arguably the most important forms of credit
risk transfers.

• CDS is a non-funded instrument to transfer credit risk. The CDS buyer pays a periodic premium to the seller.
If a specified credit default event occurs the buyer delivers specified securities in return for the notional
amount from the seller.

• TRS exchanges the total economic performance of a specified asset against another cash flow. The buyer of
a TRS is entitled to receive the total cash flow from the specified underlying asset (interest, fees, dividends,
principal repayments or market value at termination) in return for a LIBOR-based floating payment.

• Whereas CDS provides insurance against a credit event affecting the underlying asset, TRS replaces the
exposure to the underlying security altogether.

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 Other Structured Financing Techniques
Other structured financing techniques include Debt Restructuring, Debt Consolidation, Mezzanine
Financing , Asset Repackaging and Sale and Lease Back. A typical sale and lease back structure is
outlined below.

Copyright © 2010 Pearson Education. All rights reserved.

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 Project Finance & Structured Finance

Definition – Project Finance Similarities

• Project finance is the long term financing of • Risk identification and allocation is a key
infrastructure and industrial projects based upon the component of project finance. A project
projected cash flows of the project rather than the may be subject to a number of technical,
balance sheets of the project sponsors. Usually, a project environmental, economic and political
financing structure involves a number of equity investors, risks. The financing of these projects are
known as sponsors, as well as a syndicate of banks that distributed among multiple parties, so as to
provide loans to the operation. The loans are most distribute the risk associated with the
commonly non-recourse, which are secured by the project.
project assets and paid entirely from project cash flow,
rather than from the general assets or creditworthiness
of the project sponsors. • A complex project finance structure may
• The financing is typically secured by all of the project incorporate corporate finance,
assets, including the revenue-producing contracts. securitization, options, insurance
Project lenders are given a lien on all of these assets, and provisions or other types of collateral
are able to assume control of a project if the project enhancement to mitigate unallocated risk.
company has difficulties complying with the loan terms.
• A riskier or more expensive project may require limited
recourse financing secured by a surety from sponsors.

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 Project Finance & Structured Finance

Differences

Structured (Typical) Project Finance

•Existing company borrower financing for an •SPV borrower financing a greenfield project or
expansion expansion

•Limited recourse to borrower • Non recourse to sponsors

•Non recourse to sponsors •Analyze project’s future cash flows

•Analyze historical & projected cash flows •Complex documentation to perfect security

•Limited “perfection of security” •Capitalize IDC

•Maximum repayment term usually longer

•Pay interest during construction (IDC)

•Maximum repayment term usually 10 years

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Case Study
Structured Finance techniques – Lease back structured financing

Port of Spain Waterfront Development Limited Financing:

The Port of Spain Waterfront Development Limited US$375MM, 15.9-year credit
tenant note financing completed on Feb 9th, 2007 was pioneering for several
reasons. It is believed to be the largest lease-backed transaction ever priced in the
US private placement market and only the second such structure known to have a
Port-of Spain Waterfront
sovereign obligor as lessee, the other having also been executed by Barclays and
Development Limited
February 2007
FirstCaribbean. It is also the largest non-energy sector fundraising for any Trinidadian
US$375,000,000
Lease-backed Notes
entity (sovereign or corporate) and the first international issue for UDeCOTT and the
Financial Advisor
first direct offering of T&T paper into the USPP market. Also, notwithstanding the
fact that UDeCOTT does not have a credit rating, the offering was oversubscribed
and priced at a very competitive 150bps above 10yrUST. The project includes two
26-storey office towers and a 22-floor Hyatt Regency Hotel. Other features of the
project include a conference centre with exhibition space, pre-function rooms,
translation booths, media facilities, retail shopping facilities and a car park with a
1,200 vehicle capacity.

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 Case Study
Structured Finance techniques – Lease financing

Barbados Correction Corporation Financing:

The US$162MM, 26.5-year Barbados Correction Corporation Secured Tenant Notes
financing executed in September 2006 was a groundbreaking transaction in
Barbados and the wider English-speaking Caribbean. This unrated offering
Barbados Correction
Corporation represented the first time a regional or Barbadian corporate has accessed the USPP
September 2006
US$162,000,000 investor market and the issue was over-subscribed. The issue included a number of
Secured Credit Tenant Notes
structural innovations, which have benefited the company significantly and reduced
Financial Advisor
project uncertainties and costs. The BCC project involves the construction of a
modern, state of the art correctional facility in Barbados. It is believed to be the first
USPP Lease structure to have a sovereign obligor.

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Case Study
Structured Finance techniques – Public Private Partnership (PPP) financing

Turks & Caicos Islands International

In 2008 - FirstCaribbean HospitalBank,
financing:
as Lead Arranger, closed an innovative
US$124 million financing for the Turks and Caicos Islands Hospitals Public Private
Partnership (PPP) Project.

The Turks and Caicos Islands Hospitals Public Private Partnership (PPP) Project
included the design, construction and operation of two new hospitals in the Turks
and Caicos Islands by a consortium led by Interhealth Canada as well as the
provision of clinical services and a medical equipment service. The PPP followed the
UK Private Finance Initiative (PFI) approach which was an initiative to involve private
companies in the provision of public services, particularly public buildings. Under a
PFI scheme, a capital project such as a school, hospital or housing estate, is
designed, built, financed and operated by a private sector consortium, under a
contract that typically lasts for 25 years.

The Project was financed by a total debt and equity funding package of
approximately US$124 million, US$62million of which was funded by way of senior
debt supplemented with mezzanine debt and subordinated debt. The deal also
included provision of interest rate swaps and a price inflation swap.

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FirstCaribbean Corporate & Investment Bank (CIB)
Structured Finance Capabilities
• Our Investment Banking Team provides specific focus on Real Estate, Energy & Utilities, Tourism/Hospitality,
Manufacturing & Distribution, Sovereign & Financial Services to provide customized financial strategies
including structured finance solutions to our client’s individual Business Units.

• Our CIB can access CIBC research expertise to support our Advisory product and can benefit from CIBC
Wholesale Banking distribution capabilities to deepen access to international capital pools. This has been
done for transactions closed by the Investment Bank in since 2008.

• Our CIB and CIBC Wholesale Banking Product Teams also partner to enhance support to our regional
clients. CIBC group has an A+/Stable credit rating from the Standard & Poor’s credit rating agency.

• Our CIB has market expertise with regional and international links with access to a full range of financial
and advisory services.

• Our CIB has a leading Capital Markets presence in the Caribbean region where we are a leading debt
financing arranger for sovereigns and sovereign related entities in the region.

• Our CIB has a world class transaction execution process with significant transaction experience and
distribution capability throughout the English and Dutch-speaking Caribbean.

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Select FirstCaribbean Regional Issues

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