What is Structured Credit?
Structured Credit is a very broad term that takes various forms in today’s markets. Generally, it refers to the method of pooling debt obligations and then re-distributing the associated cashflows, in theory re-allocating the associated risks at the same time. This has led to more complicated structured credit instruments such as CMOs, CLOs, and most famously, CDS. The trading of these products has created enormous new markets and allowed for new credit arbitrage trading strategies.
Generally, the term refers to methods of slicing and dicing the risks and/or cash flows associated with a debt obligation, and transferring them out to different parties.
What is the origin of the term?
The first generation of structured credit deals involved pooling of loans. So, instead of selling one mortgage to one buyer, a bank would throw a bunch of mortgages into a trust, and then sell off rights to receive cash flows from the whole trust to different buyers: first cash flows to Tranche A, second set of cash flows to B, etc. In this way nobody was assuming all the risks of a given mortgage… So, the structure changed how credit risks of the underlying loans were allocated.