Preface

STRUCTURED FINANCE (OR THE LIFE OF MY FRIEND DAVID)

David is my best friend. I met him a few years back in business school. We were in the same class and shared a background in history and political science as well as an interest in finance. Unlike me and many others in our class, David was not lured into banking by the prospect of a big pay check. He chose what looked like a boring option at the time, joining the management program of a major French retail company. It turned out to be a very clever move. While those of us who chose banking experienced at first hand one of the greatest economic crises of all time (2008) - and the frustrations of the regulatory clampdown that followed - David has enjoyed a brilliant career. He was sent to Italy to assist the local CEO with trade union negotiations; worked in Brazil for two years setting up a joint venture with a local partner; and lived in Singapore while helping to establish his firm in Asia. He now serves as head of corporate strategy, sitting on the company's executive committee.

David teases me when we talk about work. He tells me that his business is simple, where mine is incomprehensible. The recipe for making money in the retail business is easy: since supermarkets sell products at low prices, they have to buy products at very low prices. Margins are small but are offset by volume. Structured finance is the exact opposite: high profits but a business model that no one understands, even when they pretend they do.

What David says is partly true. Most people have a very limited understanding of my industry. Despite the profits it generates, structured finance is less well known than M&A or capital markets. And what little is known about structured finance has mostly to do with its role in bringing about the subprime crisis, leaving it associated with shady dealing, tax evasion, and accounting manipulation.

Far from being responsible for all of the planet's woes, structured finance is actually essential to the global economy. Most people benefit daily from it. There is nothing exotic about it. It is simply a set of techniques used to finance the companies and assets that are part of our everyday lives.

Take my friend David for instance. He ignores it, but structured financing is all around him.

A TYPICAL DAY IN THE LIFE OF MY FRIEND DAVID

David flies to New York regularly to meet the local management of his company's US subsidiary. He wakes up early, has breakfast and goes down to a car ordered on his smartphone. On his way to the airport, he passes the Seine River and the Eiffel Tower, making it out of the city in time to beat the morning traffic. He flies to New York on Delta, United, American, or Air France - whichever has the cheapest business-class ticket. After landing at JFK Airport, he hails a taxi to the office. When the workday is over, he heads to his hotel, usually the Hilton Midtown, a few blocks away from Rockefeller Center. He takes a shower and spends an hour making calls and answering emails. Then he takes another taxi to a fancy restaurant and has dinner with the local CEO or some key suppliers.

Most of the next day is spent at the office in back-to-back meetings with the local management team. There are intense discussions about all the typical aspects of a retail business: sales, margins, finance, supply chains, and HR. David then usually meets investment bankers to have their views on the US market and the strategic options available for his firm. I know, for instance, that a couple of years ago he spent a lot of time working on a potential acquisition of Safeway, a retailer with a strong foothold in the West. David unfortunately lost that deal, and Safeway was eventually acquired by another competitor, Albertsons.

When he has a minute, David calls his wife and speaks with his kids. They talk about school and the toys they want for Christmas or their birthdays. Almost always, they ask if he will take them to Disneyland Paris when he gets back.

The following day, David picks up a rental car at Hertz and drives to New Jersey or Connecticut to check on a few stores himself. One of them, in Newark, not too far from the Port of New York and New Jersey, where large ships from all over the world can be seen loading or unloading containers, is a worry for him. The supermarket has been struggling for years and, despite recent refurbishments, there has been no real sign of improvement. Its location is not the best: David will probably have to close it.

In Connecticut, however, business is good, especially in the south where his company's upscale grocery stores appeal to the large, affluent hedge fund community. The fresh products the stores offer are in line with the expectations and means of people who pay attention to what they eat. Customers here are also more eco-conscious than usual, an attitude reflected in the wind and solar farms that David passes on his drive.

On a day like this, David enjoys a simple lunch. If he had been with a colleague, he would have eaten in one of the cafés inside their stores. Alone, he chooses a fast food restaurant, ideally Burger King, a favorite from his childhood. In the afternoon, David goes back to Manhattan and tries, if he can, to squeeze in a drink or dinner with a friend. The next day, he checks out early from the hotel, using a Visa card or an American Express. He then goes back to the office and starts another round of meetings, this time mostly with suppliers.

A few hours later, David is back at the airport. He can finally relax. Comfortably seated on the plane, he enjoys a glass of wine, plugs his headphones into his cell phone and listens to classical music or David Bowie, his favorite singer. He checks the sports pages in the paper, paying extra attention to articles on motorsports and Formula One. Then he gets some rest and starts thinking about his weekend, wondering whether he will have enough time to take his Harley Davidson for a spin.

STRUCTURED FINANCE IS EVERYWHERE

To David, structured finance seems entirely remote from his daily routine, an obscure corner of the banking world that he associates mainly with economic disaster. He does not realize that structured finance is literally all around him. During his three-day stay in the United States, David unwittingly came across no fewer than 20 structured finance deals - highly complex transactions designed to optimize the financing of companies, specific projects, and services.

Securitization, certainly, has been misused to sell bad loans to gullible investors, but Visa and American Express (whose credit cards David travels with) use this technique to finance cash advances to their clients. It is also a perfect tool for funding intangible assets. David Bowie's intellectual property rights and the broadcast rights to Formula One were both financed through this instrument.

Securitization is not the only structured finance product that David came across. Companies that invest in expensive movable assets rely extensively on other types of structured solutions. All the airlines that David flies with (Air France, Delta Airlines, American Airlines, and United Airlines) finance the acquisition of their aircraft through structured transactions. The shipping companies that he passes at the Port of New York and New Jersey also use these methods to finance their vessels.

Infrastructure is also an important sector for structured finance. Many large assets like roads, airports, wind farms, and photovoltaic farms are funded through structured solutions. Even the telecom infrastructures that David relies on when he uses his phone are often funded this way. Structured finance has also brought to life more unconventional projects, like the Eiffel Tower and Disneyland Paris.

Finally, we cannot talk about structured finance without mentioning leveraged buyouts (LBOs). Since the 1970s, the number of private equity firms formed to execute LBOs has exploded, and some of the world's most recognizable brands have been reshaped by the LBO industry. They include Hilton Hotels, which puts David up on his trips to New York, Hertz where he picks up his rental car, Burger King where he eats lunch, and Harley-Davidson, which sold him his motorcycle.

Structured finance, then, is the great paradox of modern banking. Much maligned - with good reason - for its misuse before the crisis of 2008, it is also the beating heart of the global economy. It is everywhere. It has given us the Eiffel Tower, American Express, and many large infrastructure assets a point too often forgotten by business school professors, the financial press, and my friend David.

ABOUT THIS BOOK

Why a new book on structured finance? This is a question I have been asked quite often. To this question, my answer is simple: there are in fact not many books on the topic. The ones that I know are either too theoretical (to my taste at least) or too specialized. They generally deal with one sub-product of structured finance only and too rarely with the concept as the whole.

The ambition of this book is to offer readers a tour of the structured finance world. It is to present in a simple manner and with the help of case studies the four major structured finance techniques: (i) leveraged buyouts, (ii) project finance, (iii) asset finance, and (iv) securitization. The book will be divided into four parts and each of them will analyze in detail one of...