Debt in Disguise

The boundaries between receivables securitizations and loans are blurring.

Why does WESCO International Inc. use accounts-receivables securitization, a form of financing so closely linked to the subprime-mortgage meltdown? “Because we can,” says senior vice president and CFO Stephen Van Oss.

Van Oss is speaking only partly tongue-in-cheek. His company, a $5.3 billion distributor of electrical products, has a high-quality customer base and a robust IT platform for tracking the performance of receivables, capabilities demanded by banks and credit-rating agencies.

But securitization is also cheap. “It’s 60 to 80 basis points better pricing than any other asset-based program,” he says. “It’s the most efficient way to borrow money.”

Indeed, low cost is a key reason all forms of asset-backed securitization (ABS) have flourished (see “What Lies Beneath” at the end of this article), reaching $1.2 trillion in outstanding issues of asset-backed commercial paper last July. That’s up 83 percent in three years, according to the Securities Industry and Financial Markets Association (SIFMA). The “other” category of outstanding asset-backed securities, which includes corporate trade receivables, has also grown, to $993 billion as of second-quarter 2007. That $993 billion was more than the dollar amount of securities backed by credit-card receivables and home-equity loans combined, according to SIFMA.

The other advantage to ABS is that, unlike a loan, a corporation does not have to record it as debt. Securitization allows companies to transfer their trade receivables to a special-purpose entity, isolating them from the risks generally associated with the company. Accordingly, the SPE can raise money in the capital markets at a lower price than the company could directly because the SPE can garner a higher credit rating than the company as a whole (see “Anatomy of a Typical Securitization” at the end of this article).

In light of the crisis in subprime mortgages, however, securitization doesn’t seem as clever as it once did. “The subprime mess reminds the market that it matters what you securitize,” says Adrian Katz, CEO of Finacity, an asset-backed financing company. “A securitization is ultimately only as good as the ‘security’, the collateral.”

From a corporate perspective, another problem is that securitization vehicles may not be as safely off the balance sheet as they seem. The legal structure has not been battle-tested in the courts, lawyers admit. Employees may inadvertently cross invisible legal boundaries and invalidate these structures altogether. Some companies, WESCO among them, are putting them back on the balance sheet. That, in turn, reinforces the notion that receivables securitization is, in many ways, a secured bank loan in disguise — and a loan to a company that may be nowhere near investment-grade.

“What interests me is how this product got so big, when its legal underpinnings are arguably shaky,” says Ken Kettering, an associate professor at New York Law School.

Speculative-Grade Roots

To date, no one has claimed that trade-receivables securities are as flawed as those backed by subprime mortgages. Most securitization agreements come with representations and warranties that protect the cash flow, as well as credit enhancements like “overcollateralization,” the posting of more collateral than is needed to obtain financing.


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