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Trade Receivable Securitization

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, in case of Indian subcontinent companies other than
NBFCs don’t think of securitization. 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

The weak credit market is characterized by high risk aversion and low liquidity. The corporate bond
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 CP 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., days’ sales outstanding (DSO), quick ratio, returnon-assets (ROA), and debt-to-
equity ratio. Working capital is also reduced.

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Trade Receivable Securitization

Eligibility
• Only recurrent and predictable receivables can be included
• High quality customers are required
• Poor processes, as indicated by high dilutions, overdues and credit losses may further reduce the
eligible base

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. Once the securitization is finished, funds flow from the investors to the issuer and
then to the originator.

The securitization can be a new area of funding for any company provided the size of the transaction
accede the minimum required size of the transaction.

2|Page Confidential and proprietary information – copyright SPAN Analytics © 2010/ April 10, 2010