Securitization: Cash Flow on Tap

A popular financing technique, sometimes criticized for its off-balance-sheet treatment, may be skewing cash-flow statements too, says a new report.

Although the Georgia Tech lab’s research typically focuses on reporting practices that may give investors misleading signals of corporate earning power, Mulford is careful to note that securitization is an accepted technique. “I’m not saying you shouldn’t do it,” he says. “It’s a cheap form of financing. But users of financial statements, beware: The increase in operating cash flow that you see will beget a reduction at some future date.”

The report also gives high marks to several companies — including Metaldyne, United Stationers, and Convergys — that went beyond GAAP requirements to highlight the impact of their securitizations on operating cash flow, leverage, or both. “While not compulsory,” the report notes, “these companies nonetheless decided that investors may be misled if such disclosures were not made.”

For example, United Stationers noted in its annual report that GAAP requires that it not report the securitization as debt. However, it stated: “Internally, the Company considers accounts receivable sold to be a financing mechanism [and]…therefore, believes it is helpful to provide readers of its financial statements with a measure that adds accounts receivable sold to debt.”

The Georgia Tech report also examines the impact of securitization on financial leverage. “In a future period, when the securitization program is reduced or unwound, those commercial paper borrowings are reduced or repaid from the firm’s future cash collections,” the report notes. “In effect, a current benefit is repaid with a future sacrifice, much like the repayment of borrowed funds.”

“In every sense of the word, it is like a borrowing,” says Mulford. Indeed, the report points out that small shifts in a securitization can actually change its accounting treatment, noting that a securitization program at Arvinmeritor “shows what a thin line exists between the debt and non-debt treatment of securitized receivables.”

In September 2005, the company consolidated its securitization SPE, reporting its debt on its own balance sheet, and reporting the cash proceeds in the financing cash-flow portion of the cash-flow statement. Yet under Arvinmeritor’s earlier securitization program, in which two SPEs were used, the company did not report the debt, and the cash proceeds appeared in the operating cash-flow section.

“Arvinmeritor points to the arbitrary, rule-based nature of securitization,” says Mulford. “You jump through one hoop and it shows up as debt and financing cash flow. You jump through two hoops, and it’s off-balance-sheet and operating cash flow.”

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