Eye of Siva

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What are Structured Credits?

I have been facing a lot of questions around structured credits and what they are. Mostly this follows a post on the internet which used standard balance-sheet/cash-flow analysis to figure out a structured note and while it made for sensational reading, was not completely fair to the readers if the objective was educational.

There are two types of credit (or loans or whatever): cash flow and structured. Cash flow loan is where a business is able to demonstrate its performance and says I need to (expand) (store inventory) etc. A bank or lender assesses the repayment ability of the business and lends accordingly. So when your housing loan is approved based on your income the bank is taking a call that your cash flow is sufficient to meet the EMI.

But what if you have no cash flow. Take education loans. The bank looks at the cash flow (!) of an 18 or 22 year old looking to do a bachelors or masters and says no way. Or look at start-ups. No existing business. So does this mean no credit can be extended in these cases? No. This is where structured credit comes in.

In an education loan, the bank may take a parent’s guarantee. A businessman starting a business may put up his house as collateral (known in the parlance as Loan Against Property or LAP). A businessman who has an existing company may borrow on that company’s strength for a new venture. If this creates a pledge on the shares of the first company it is called Loan Against Shares or LAS.

In structured finance it makes little sense to look at the balance sheet or cash flow of the borrower. What is important is the strength of the collateral or guarantor. This is why structured finance desks at banks are separate from the normal lending. Why rating agencies have different corporate and structured teams.

To understand structured credit look at the value of the collateral or strength of the guarantor. Does the collateral cover the principal and interest components? What if there is a fall in the value of shares or property? Do you have enough buffer? What is the financial flexibility (ability to borrow) of the collateral provider/guarantor? These are the questions to ask.

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