Also known as tailored debt or customized debt, structured debt is some type of debt instrument that the lender has created and adapted to fit the needs and circumstances of the borrower. A debt package of this type usually includes one or more incentives that encourage the debtor to do business with the lender, rather than seeking to develop a working relationship with other lenders. While the overall structure of the debt is adapted to the needs of the borrower, the terms also benefit the lender in the long term.
One example of a structured debt instrument is a mortgage that contains provisions to shift between fixed and variable rates of interest. An option of this nature would allow the debtor to begin the mortgage with what is a very competitive fixed rate, but switch to a variable rate after a certain amount of time. This creates a situation in which the debtor can take advantage of any drops in the average interest rate that are likely to remain in effect for an appreciable amount of time. In this scenario, the debtor is able to minimize the amount of interest that is paid over the life of the mortgage, thus reducing the total amount of the debt.
Other business incentives may be included in a structured debt scheme. One option is the extension of longer grace periods for balloon payments. This benefit can be very helpful for a business that is attempting to rebuild after going through a difficult period, but has not quite reached the point where it can comfortably manage the payment.
Another common option is deferring interest due until the end of the loan. A popular option with bond issues, a deferred interest arrangement allows the debtor the maximum amount of time before having to disburse a payment to the lender. The debtor enjoys an increased chance that the project funded with the proceeds from the bond has begun to generate revenue that can cover both the principle and interest payments that are due.
The main goal of structured debt is to create a debt situation that provides the debtor with as many benefits as possible, while also keeping the overall debt load as low as possible. At the same time, the lender receives an equitable return for the structured debt arrangement. Assuming that both parties are satisfied with the outcome of the arrangement, there is a good chance they will do business again at some point in the future.
