Trade Receivable Securitisation allows corporates to raise liquidity at competitive pricing levels and without reliance on bank balance sheets.
The provision of bank credit to corporates is growing scarcer, and with the phased implementation of Basel III, this trend is expected to continue. In response to this development, corporates should continue their efforts to diversify their funding sources away from bank borrowings and towards capital markets based instruments where possible. One example of this is trade receivable securitisation.
So how does trade receivable securitisation work? It is an instrument which involves the sale of a portfolio of your accounts receivable to an entity (Special Purpose Vehicle or “SPV”) and is funded via asset backed commercial paper (“ABCP”), a short term investment instrument often purchased by for instance money market funds.
Figure 1: programme structure (overview)
As depicted in Figure 1, essentially a corporate’s subsidiary (also referred to as “Originator” in the context of this programme) will sell a collection of invoices to an SPV, which is funded by a “Conduit” from ABCP proceeds. A Conduit is a financing vehicle operated by a bank and usually rated by several credit rating agencies, which is in the business of raising financing in the international capital markets.
The SPV will pay an (initial) purchase price to the subsidiary, either directly or to for instance the central treasury department at the parent company level (in which case the receipt is allocated internally between parent and subsidiary via cash settlement or via inter-company accounting entry). The parent is designated master servicer and parent guarantor, meaning that it will look after periodic reporting to the bank and that it represents that its participating subsidiaries will perform their obligations in line with the programme agreements. The bank is responsible for structuring and monitoring the programme; and it will often act as security agent, holding the security rights over the purchased receivables on behalf of the investors.
The structure as outlined above has a number of implications:
First, with the sale of the receivable, its legal title and economic risk are transferred to the purchaser. Depending on how the transaction is structured, the seller may be able to achieve accounting de-recognition, thus shortening its balance sheet.
Secondly, in a securitisation programme an entire portfolio is purchased, as opposed to an individual invoice. The selection of the portfolio is based on a number of predefined eligibility criteria (such as payment terms, risk codes, customer or “obligor” jurisdictions, concentration limits etc.; see Figure 2). The quality of the assets purchased is monitored on the basis of portfolio performance indicators such as days sales outstanding, defaults (credit losses), delinquencies (level of overdues) and dilutions (credit notes). Those indicators also determine the advance ratio or initial purchase price paid, which is reset periodically (e.g. monthly).
Securitisation thus uses more of a statistical approach (diversification) to protect the quality of a portfolio and relies on a corporate’s internal credit (risk) management procedures. The sale of 5,000 to 10,000 relatively small invoices at any time is not a problem, provided they meet the eligibility criteria.
Figure 2: portfolio selection using eligibility criteria
Thirdly, the portfolio is sold to an SPV, not to the bank. The bank’s role in this programme is limited to structuring the transaction and monitoring its performance on behalf of investors. The bank generates revenues on the programme, but the purchased receivables are not owned by the bank. The structure does not weigh on the bank’s balance sheet, which is important at a time of pressure on bank capital requirements.
Finally, the purchase is funded by the issue of Asset Backed Commercial Paper. The structure is not dependant on bank funding.
Securitisation versus factoring
In other words, securitisation is similar to, but different from factoring (see Figure 3): whereas both generally involve the (non-recourse) sale of receivables, in the context of securitisation the selection process is conducted on the basis of a set of fixed predefined criteria. That approach allows you as a company to achieve scale in your financing facility more easily, as it welcomes diversification: the more debtors in the portfolio, the better.
By contrast, in the context of factoring the selection is done by the bank, based on the credit profile of the individual debtor and the bank’s credit appetite. That leaves a risk to you as a corporate that the bank will engage in cherry picking: selecting only a handful of the best debtors, leaving you unable to fill your entire factoring facility. Also, the bank often reserves the right to change limits at their discretion, which can cause surprises to you as a treasurer.
Securitisation therefore is often a solid funding source. However, in view of the somewhat larger amount of documents involved, the start-up costs associated with it tend to be a little higher than with factoring. That being said, this should not be an issue for most corporates considering the tool, as securitisation programmes are often set up for multi-year time frames and have competitive interest conditions attached, which makes it easy to recuperate the up-front expenses quickly.
Figure 3: Securitisation versus factoring: similar, but different
In summary, trade receivable securitisation requires periodic reporting and a well-managed and diversified portfolio of debtors. That said, it also allows corporates to raise liquidity at competitive pricing levels (better than bank borrowing) and without reliance on bank balance sheets, and once set up it is easy to achieve scale. Whilst perhaps not suitable for all corporates, at a time of decreasing availability of bank financing, it can be an exceptionally effective funding tool for some.