Cashing in on receivables - securitization of receivables - Corporate Finance

Chief Executive, The, Nov, 1995 by Joel Kurtzman

When economic historians write this century's story, they no doubt will mention the insights of Lord Keynes, the free-market musings of Milton Friedman, the econometric models of Wassily Leontief, and the portfolio theories of Harry Markowitz. They also no doubt will mention Lewis Ranieri, the brash, ex-Salomon Brothers trader who worked his way up from the mail room and - with the help of the federal government's mortgage twins, Fannie Mae and Ginnie Mae - created the market for mortgage-backed securities. Today, there is about $1.4 trillion in outstanding mortgage-backed securities obligations.

Ranieri's chief insight was that when you bundle together $10 million in home mortgages, all with the same maturities and interest rates, it begins to resemble a bond. But while bonds represent a claim on a company or government, Ranieri's little creation was backed by homes. From Ranieri's insight came the realization - which spread throughout the financial world - that if you can back bonds with something as illiquid as Martha Stewart's dream house or Sigma Chi's animal house, you can back them up with practically anything.

Within a few years, traders were swapping mortgage-backed securities as well as those backed by car loans, department-store revolving loans, car leases, jet-aircraft loans, and credit-card debt. According to Mark Adelson, an analyst at Moody's Investors Service and author of a recent study on securitization, "Excluding mortgage instruments, there is now more than $300 billion outstanding in asset-backed commercial paper."

In finance, each new development leads to another development. Asset-backed commercial paper, or asset-based lending, is no exception. "One relatively new technique for companies that want to clean up their balance sheets is the securitization of receivables," says Robert E. Flaherty, president of Chatham Associates, a financial consulting firm in Boston. Flaherty headed the retail factoring business at Bank of New York and, later, at Bank of Boston.

By securitizing receivables, a company can go into the market in a manner much like factoring. But unlike factoring, the receivables are still serviced by the company selling its paper. "In many instances, the company selling its receivables in the market does so for very brief periods of time - 30 days or so - and then buys them all back," Flaherty says. Though costs vary, securitization of receivables is generally more cost-effective than factoring or letters of credit. "Generally, the cost for a mid-cap company is 100 to 150 basis points lower than the marginal costs of borrowing from a bank." On top of that, there are steep lawyers' fees, which, Flaherty says, have been falling as the technique catches on and volume grows. Currently, there is about $60 billion outstanding in securitized receivables.

By selling the receivables for 30 days or less, companies get a chance to put a little extra cash on the books at the most opportune moments. Doing this over the short term and at strategic intervals - before the quarterly lunch with analysts or at the close of a fiscal year, for example - can add a measure of visible bounce to a company's otherwise gloomy ledger. By the time the analysts move on to another company, or the new fiscal year begins, the receivables can be repurchased so that key customers never know they were bought and sold, and all vital relationships remain intact.

It's getting easier to enter and exit the market quickly as the technique becomes more commonplace. A number of investment banks, working closely with corporate law firms, can take a pile of messy receivables - $50 million to $100 million or more - and turn them into a tidy security in under a week, according to Moody's Adelson. After they are securitized, "then we rate them just like any other corporate paper," he says. The leader in the field - the major investment conduit - is Citibank, followed by First Chicago. These big players take receivables from large and mid-size companies, merge them into pools, and sell them to investors.

But the real future of securitizing receivables may not lie in selling bundles of paper in the anonymous market. Instead, it may rest in the private placement of these products, with banks acting more as packagers and brokers. "A company with excess cash swaps some of that cash for the receivables of a cash-strapped company," says Flaherty. When the cash rolls in, "the selling company buys back its receivables." Both companies benefit, he says. The only real losers are the banks, who "move down the food chain from lender to broker."

Joel Kurtzman, former editor of The Harvard Business Review, is an international business consultant and author. He is the director of the International Trade Program at The Manhattan Institute.