In this turbulent market, obtaining financing through securitization of trade receivables could be a more interesting option than traditional debt financing. A common view is that securitization is not a preferred source of financing. Traditionally, CFOs and treasurers tend to consider securitization only after other sources of financing become difficult to obtain. However, considering the state of the banking market, the possibility of lowering the cost of financing, and the opportunity to free up money and improve key financial key ratios, we think that trade receivables securitization should be an obvious financing alternative to any medium/large company.

The cost of financing a company by issuing debt is largely dependent on the company’s credit rating, which is derived by the probability of defaulting on interest and principal payments. Securitization, on the other hand, allows for financing to be based on a specific asset class with a lower risk profile than the company as a whole, offering the possibility to lower the cost of financing.

Securitization of trade receivables is an interesting financing option, since it entails a true sale of claims on a company's customers to investors. Thus, the quality and credit rating of the company issuing the securities becomes less important for investors. Rather, the investor will be mainly concerned about the quality of the trade receivables.

Impact of the current credit market on potential A/R securitization programs

The weak credit market is characterized by high risk aversion and low liquidity. The ABCP market is slowly improving, but the investor base is still limited. Yet, banks and other lenders are still interested in funding attractive trade receivables portfolios.

The cost of credit in general will remain relatively high in the short and medium term. However, capital requirements for rated trade receivable portfolios (typically AA or AAA) are far lower than for unrated portfolios or corporate loans. As the ABCP market improves, banks will be able to increasingly finance trade receivables portfolios off their balance sheets.

Pros and cons

The main drawback of setting up a securitization process is the administration cost, which results in a higher fixed cost compared to traditional forms of financing. Moreover, using trade receivables as security for new funding may affect the cost of traditional debt in future refinancing, but typically no significant such effect is seen.

The higher cost can be offset by the advantages, but the value of the receivables must be significant to justify the process. However, if this criterion is met, a company can obtain a number of advantageous effects.
    
Financing through trade receivables securitization could be less expensive than ordinary debt given that an arbitrage exists between the company’s rating and its customers. In addition, the receivables are removed from the seller's balance sheet and placed in a bankruptcy-remote entity, thereby increasing transparency, which lowers the credit risk and thus the financing cost. It is important to note that not all securitization of trade receivables are off-balance, depending on how the solution is structured.

A fundamental benefit of receivables securitization is that it allows the company to gain immediate access to the future cash flows which it would receive from its customers, and therefore it enhances liquidity. The proceeds from the securitization can then be used to make needed investments in higher-yielding assets.

Securitization of trade receivables offers an option to diversify the liquidity sources from more traditional debt/equity financing, thereby reducing refinancing risk. Another effect of receivables securitization is that when the receivables are sold, the company’s balance sheet becomes less heavy, which affects several financial key ratios, e.g., increased return on assets. Working capital is also reduced.

The process

In a securitization process, the originator (the company that securitises its accounts receivable) transfers them to a separate entity. The separate entity is called a special purpose vehicle/entity (SPV/E). This transfer must be a so-called true sale, to protect the receivables from the claims of creditors to the originator in case of bankruptcy. In its simplest form, the SPV then acts as issuer and markets the securities to investors. When the securitization is finished, funds flow from the investors to the issuer and then to the originator.

The size of an A/R securitization program depends on three main factors

Scope

• Geography/jurisdictions covered – each jurisdiction may drive additional legal costs, e.g., for true sale opinions
• Legal entities and A/R ledgers – the number of ledgers will drive implementation effort and complexity of feasibility study

Eligibility

• Certain types of receivables cannot be included in the portfolio, e.g., specific jurisdictions, government invoices and retail
• Only recurrent and predictable receivables can be included
• High concentration (over 2%) to individual customers not eligible
• Poor processes, as indicated by high dilutions, overdues and credit losses may further reduce the eligible base

Advance rate

• The quality of the portfolio will affect what share of the value is paid upfront – key factors include:
• Dilutions
• High overdues

Benefits for LBO firms

Securitization of accounts receivables can be especially useful for LBO firms. These firms generally have a credit rating below investment grade, due to their heavy debt burden. Hence, the benefits for LBO firms are many. The freed capital from the securitization, together with the decreased need for amortization and interest payments, can for example be used to grow the acquired company more rapidly, which reduces the time it takes to divest the company. In addition, the typical length of an accounts receivables securitization, five years, is often an excellent fit with private equity companies’ exit strategy. An important aspect to consider is to establish whether current funding restricts the ability to sell trade receivables, or whether it can be carved out.

Capacent’s role

• Evaluate the fit of trade receivables securitization with strategic and treasury priorities and analyze the potential impact on relevant KPIs of a successful initiative
• Support feasibility and RFP process
• Sounding board for client, to ensure that they first clarify and then stick to their own strategy and prioritized objectives