Asset Securitization: A Flexible Tool for Today's Companies
GE Commercial Finance (March 7, 2002)
Asset securitization was once discussed only in the wood-paneled offices of the nation's Blue Chip companies - but not anymore. Today, companies of all types, revenue size, and debt rating routinely raise capital by using financial assets to back securities issued in the capital markets.
"The economic environment these days is constantly changing," explains Brian Dietz, Managing Director, GE Capital Commercial Finance. "Companies find themselves in transition. For
example, their performance is affected while they gear up to diversify product lines or integrate an acquisition. Traditional lenders may not be hospitable to borrowers in these circumstances, and asset securitization may be the best way to obtain an attractive source of capital."
A typical example is a company that has experienced a higher interest cost on its senior revolving credit facilities as a result of declining financial performance or increased leverage. If the
company has a performing pool of quality trade receivables, a securitization facility can be established with the traditional revolving credit facility to reduce the overall cost of funding.
Bergen Brunswig Corporation, a subsidiary of AmerisourceBergen Corporation, illustrates this point. Prior to its merger with AmeriSource in 2001, the diversified drug and
healthcare distribution company made two major acquisitions that significantly increased its overall debt level. The acquisitions did not perform financially to expectations, prompting a series of rating agency downgrades. This limited the company's access to the commercial paper market and to competitively priced traditional loans to meet its working capital needs.
Bergen Brunswig, however, had strong accounts receivables. Working with GE Capital, the company was able to structure a $450 million securitization with high availability, competitive pricing, a five-year commitment and a flexible structure enabling next-day funding at an A1+
funding rate. This provided much needed working capital in an ffordable and convenient manner.
Any company with a minimum of $400 million in sales and working capital needs of at least $50 million should consider trade receivable securitization, according to the experts. "The securitization structure is well established and is the logical next step for companies who are approaching a half billion dollars in sales," says Dan Hom, Senior Vice President, GE Capital Commercial Finance. "This mechanism can either entirely support working capital needs, or it
can become an integral part of the total capital structure."
The motivations behind securitization are many. Typically, the primary objective is to obtain financing for a company's ongoing business needs. However, a properly structured financial
asset securitization also can permit a company to obtain a lower cost of financing compared to secured or even unsecured debt.
"For those who qualify," says Scott Fassett, Vice President, GE Capital Commercial Finance, "asset securitization can provide the lowest cost of capital available in the marketplace. Many different types of companies now understand the benefits of this financing technique, and it's become accepted practice in the business world."
For a company continuing to seek the lowest cost of capital, asset securitization can provide the company with a broader investor base. As a result, securitization affords additional liquidity and
a new source of capital, which is especially helpful in our constantly changing financial marketplace.
Things to consider
Prospective borrowers do, however, need to evaluate the cost of asset securitization. The legal and accounting aspects of securitization, as well as the related documentation, often are more
complex than for some other types of financing. As a result, companies will incur additional up-front costs to set up the securitization structure. Experience shows, however, that these costs are
generally recouped within 18 months by virtue of the lower interest rate.
The need for specialized expertise cannot be underestimated. "Accounting rules were changed in 2000, and they are complicated," explains Leslie F. Seidman, CPA, author of the upcoming
Accounting for Financial Instruments. "Often, accounting and tax goals are at odds in these financing structures, so you need a strong team of advisors to ensure the successful execution of this financing."
Another potential disadvantage to an asset securitization is an increase in reporting requirements with respect to the quality and ongoing performance of the securitized receivables. This is
mitigated by the rapidly increasing ability to generate reporting with PC-driven programs.
Structuring the deal
Stated simply, to obtain capital through asset securitization a company sells its trade receivables to an entity created for this purpose (a Special Purpose Vehicle or SPV). The SPV then
refinances this purchase by selling the receivables to an asset backed commercial paper conduit that issues commercial paper backed by this collateral. This transaction differs from factoring, which involves obtaining an advance on receivables from a lender who will collect payment from the account debtors. In an asset securitization, the SPV assumes ownership of the receivables via a "true sale" from the company, and pledges them to the conduit.
Quality receivables are essential, therefore, for any borrower to obtain low-cost, asset-based financing through securitization. "A company needs to demonstrate that its receivables aren't concentrated on just a few account debtors and also must show that there is a strong payment history backing them up," explains Hom.
Global companies have additional considerations. "The percentage of foreign accounts receivables needs to be considered because of the inability in some countries to perfect and enforce a security interest in the collateral," advises Fassett.
Likewise, corporate structure is a concern. "If a company has $100 million in receivables spread across 10 subsidiaries, the cost and legal complexity may make it difficult to structure a compelling deal. It is much more advantageous for the borrower when a company's trade accounts receivable are concentrated at the parent level or within a few primary subsidiaries, or if the reporting capabilities of the company allows for accurate consolidation of the information
from several subsidiaries," he adds.
Again, the need to consult with specialists is essential in structuring the best deal. "The most suitable structure for any particular securitization, including the best structure of the SPV,
depends on a multitude of factors," explains Carol Hitselberger, a securitization partner in the Chicago office of Mayer, Brown, Rowe & Maw.
"These factors include the type of receivables involved, whether term or revolving financing is desired, tax treatment and preferred securities execution, including public or private sale, and legal, accounting and rating agency considerations."
It's a proven technique
This financing technique has a solid history. The concept of asset securitization was introduced in the 1970s when the Government National Mortgage Association (Ginnie Mae) issued securities backed by a pool of its residential mortgages. The Sperry Corporation in 1985 issued $192.5 million of securities backed by computer lease receivables, one of the first instances of the securitization of non-mortgage assets. Since that time, according to researchers at Ohio State University, the market has grown an estimated 30% per year.
Benefits experienced by borrowers have helped fuel acceptance of asset securitization, but so has interest from capital markets investors. Asset-backed securities give investors more alternatives
with high credit ratings and less exposure to downgrade risks faced by corporate securities.
"Asset securitization 10 years ago was perceived as a financing structure only for large investment grade companies," says GE's Dietz. "Today, it is seen as an established vehicle for obtaining working capital. The securitization structure is broad, creative and an accepted tool for all members of corporate America, regardless of debt rating."
To learn more about senior revolving credit facilities, including asset securitization, visit GE Capital Commercial Finance -- Learn About Commercial Lending and Securitization of Financial Assets.