Question

In 500+ words write a term paper on securitization of Accounts Receivables.

Note: Write in your own words. Plagiarism will be checked.

Answer 1

A receivable securitization is predicated on the legal true sale of a company’s trade accounts receivable to a third-party funding source. Securitizing accounts receivable provides many companies with a cost-effective source of incremental liquidity. One common form of off-balance sheet financing is an accounts receivable securitization. In this, a company transfers most of its accounts receivable to a trust, where it is not available to general creditors. The financing source then buys a majority ownership stake in the trust while the company retains a small ownership stake.

Since the company has sold its ownership of the receivables, the value of the sold receivables should not be reflected on its balance sheet. Since it was a sale, not a loan, the money received from the financing source should not be considered a loan, and therefore no liability should be recorded on the company’s balance sheet. Only receivables not transferred to the trust or the company’s ownership interest in the trust appear on the company’s balance sheet, along with the cash they got at the time of the sale.

A larger organization can convert its accounts receivable into cash at once by securitizing the receivables. This means that individual receivables are aggregated into a new security, which is then sold as an investment instrument. A securitization can result in an extremely low interest rate for the issuing entity, since the securities are backed by a liquid form of collateral (i.e., receivables). In essence, a receivables securitization is accomplished with these steps:

1. Create a special purpose entity (SPE)
2. Transfer selected accounts receivable into the SPE
3. Have the SPE sell the receivables to a bank conduit
4. Have the bank conduit pool the company's receivables with those from other companies, and issue commercial paper backed by the receivables to investors
5. Pay investors back based on cash receipts from the accounts receivable

These process steps indicate that the securitization of accounts receivable is complex, and so is reserved for only larger companies that can attend to the many steps. Also, the receivables included in a pool should be widely differentiated (so there are many customers), with a low historical record of customer defaults.

There are approximately $10 trillion accounts receivable in the United States, a comparable amount in Europe, and more globally. According to estimates, a mere $60 billion have been securitized in the U.S. There are hurdles for companies implementing receivables securitizations. However, innovative solutions have been developed in recent years to provide more efficient access. Historic performance-based reserve calculations and carefully monitored structures can offer investment-grade executions even for non-investment-grade companies. Improved funding rates, preferred accounting, risk mitigation, cross-border flexibility, and funding diversification can motivate companies to implement receivable securitizations.

KEY BENEFITS OF SECURITIZING RECEIVABLES:

There are several reasons that companies might want to consider exploring this financing option.

• Securitized debt has a lower interest cost than other forms of corporate debt because the assets are legally isolated from the company’s bankruptcy estate and the transactions are structured to reflect a lower risk profile than lending directly to the company.
• Banks are generally willing to commit much larger amounts in a securitization than to a conventional revolving credit facility, and companies can also benefit by having a smaller bank group provide the securitization.
• Securitization preserves capacity in the bank market. Securitization commitments enhance rather than cannibalize your bank’s ability and capacity to provide other forms of credit commitments.
• Securitization can increase your company’s total liquidity and diversify its funding sources.
• Securitization is non-recourse financing that is compatible with all other forms of debt (including secured debt).
• Securitization can enhance the enterprise value of your organization.