Off-balance-sheet financing---securitization of receivables and impact on leverage

CFA Level II
#1

For the life of me, I cannot make sense of this.

The study books say that if a company is selling their A/R to an SPV, that would reduce assets and liabilities. The opposite is also true, if we include off-balance sheet financing, an asset and a liability should be created, results in increased leverage ratios.

This is what I can’t understand—if we’re selling A/R into an SPV and we’re receiving cash, assets would remain the same right? Our A/R line item would decrease, but cash would increase by the same amount. So why are the books telling me assets would decrease if we sold A/R or increase if we brought A/R back onto the balance sheet?

#2

Where does it say that assets decrease? Pretty sure they increase when you consolidate, because you bring the A/R back onto balance sheet, and also keep the cash you got from forming the SPV (and add a liability to your balance sheet to make things balance) So instead of just having A/R, like you would if you hadn’t securitized anything, you have A/R plus cash plus a liability. This confused me because I thought consolidating would just be ‘reversing’ the transaction ie pretending it never happened. But it actually seems to result in something different. Can someone confirm this is right? Thanks

#3

Kikaha, I think you have it right. As I understand it, the transaction is treated as a secured borrowing wich is why you end up with cash,AR AND the debt/liability

#4

Ok I got it now----I just got confused. It seems like if you’re bringing the A/R back on the balance sheet you would be counting assets twice (cash we received from the original sale of the receivables and then the receivables themselves).

#5

Ok still confused:

Let’s assume we have company A:

Balance sheet looks like this:

Cash $50

A/R $100

The company decides to securitize $50 of A/R into a SPV. So the company would sell $50 in A/R and receive $50 in cash.

Our new balance sheet looks like this: (no change in assets)

Cash $100

A/R $50

However if we bring the off-balance-sheet securitization back onto the balance sheet, won’t we create $50 in “phantom assets”:

Cash $100 (still)

A/R is now $100 after bringing the A/R we previously sold back on the balance sheet.

Assets now total $200 versus $150 when we first started the transaction.

#6

right but the 50 addition to cash is viewed as a borrowing. so you now have also a 50 liability. i have not reviwed the material since jan so i culd be wrong

#7

This makes complete sense then.

Thanks.

#8

Can anyone else chime in on this…? I dont remember seeing this anywhere

#9

You are right. Securitizing a/r increases cash and liability (non-current) by an equal amount - balancing te equation.

#10

Is it the same for a sale of receivables with recourse?

#11

If recourse remains post sale, it isn’t a ‘true sale’, and it isn’t an off-balance sheet financing. Recourse has to follow whatever is being sold.

#12

whats recourse?

#13

LeaseAPlane borrows $100MM from Giant Bank to buy a plane. They then lease that plane to FlyByNight. They do the same thing 10 times. They then decide they need some cash, so they sell the stream of lease payments to StandAloneCorp. However, LeaseAPlane is still on the hook for the hundreds of millions that they borrowed from Giant Bank to buy the plane, because they were not thinking straight when they structured the initial or post transactions, so when FlyByNight goes chapter 11 and stops making the lease payments, StandAloneCorp can then go after LeaseAPlane for the money owed to its investors. That’s recourse: when a party can go after another for more than the value of whatever collateralized a loan/debt transaction.

#14

nice explanation !! thesloth