The Handbook of Credit Risk Management, 2nd Edition

CHAPTER 18Structural Mitigation

In this chapter, we present structural techniques used to mitigate the default risk of a debt instrument and to reduce the impact of a default by increasing the recovery rate.

When we review how to analyze the creditworthiness of a corporate, of individuals, of asset‐backed securities, and of CLOs in earlier chapters, we focus on the cash‐flow‐generating ability of a counterparty. What is different in this chapter is that we examine how the debt instruments can be structured up front to protect investors when the financial performance of the issuing entity is deteriorating. The two topics are closely related and complementary. Before considering investing, credit analysts must thoroughly analyze the issuing entity. Then, in a second step, they must focus on the debt itself and the way it is structured. All details regarding the structural elements are found in the various legal documents prepared at the time of the originating transaction.

The techniques we will review are structural insofar as they are either embedded in the way the financial instrument is engineered and documented or they utilize the support of third parties. There is a large variety of ways to strengthen a transaction to reduce its credit risk or to increase the recovery in case of default. There is no limit to creativity. Investors benefit from a steady evolution of structural features, which gradually become market standards.

For credit analysts, supporting the structuring ...