Whats Structured Finance All About?
The author of Credit Derivatives and Synthetic Structures (Tavakoli, 2001) would disagree with this statement. Here is a description of a tranched synthetic collateralized loan obligation (CLO) structure:
The quality of the portfolio of reference credits is
usually strictly controlled with an optimization program, which constrains
credit quality, credit enhancement based on historical default levels,
maturity, portfolio diversification, asset-to-liability maturity gap, and
liquidity eligibility, among other potential criteria. The program uses
many data inputs and takes into account recovery rates based on the debt
position in the capital structure and collateral type. It is impossible to
list all of the possible model inputs and protective covenants. (p. 243)
When analyzing packaged investments, we usually found that asset quality is inversely proportional to the amount of overlying structure. Perhaps the best advice is that of an investment manager’s. “If you can’t understand an investment after ten minutes of explanation, it’s a pass,” a very good rule for anyone.