Close the liquidity gap Featured

7:00pm EDT January 26, 2010

Middle market companies that entered into credit facilities on highly favorable terms from 2005 through 2007 are now finding that they must refinance in a much more difficult environment.

Today, both the number of banks and the overall bank lending capacity have declined, making it virtually impossible to fully replace the attractive revolvers of the past.

“As these revolvers mature over the next four years, the lack of bank credit resources will leave a liquidity gap that could hamper a company’s ability to finance working capital needs and pursue growth opportunities,” says Mark Falcione, managing director of PNC Capital Markets LLC.

Securitization can close that gap. It has enabled many companies to increase liquidity, lower financing costs and diversify their overall capital structure.

Smart Business spoke with Falcione about how companies utilize corporate receivables to fill out their capital structure.

What is securitization?

Securitization converts a diverse pool of assets into marketable securities that are sold to investors. The conversion legally isolates the pool of assets from the bankruptcy estate of the company originating them.

Securities backed by these assets and issued into the market are called asset-backed securities (ABS). The assets can be corporate receivables, such as accounts receivable, or consumer assets, such as credit card or auto loan receivables. Depending upon the frequency and characteristics of the cash flows generated by the underlying assets, these securities take the form of bonds or notes, or asset-backed commercial paper.

Why do companies securitize receivables?

There are several reasons why middle-market companies might want to consider this financing option. First, securitized debt has a lower interest cost than corporate debt because the assets are legally isolated from the company’s bankruptcy estate and the transactions are structured to reflect a lower risk profile than lending directly to the company.

Second, banks are generally willing to commit much larger amounts in a securitization than to a conventional revolving credit facility, and companies can also benefit by having a smaller bank group provide the securitization.

Third, securitization can increase a company’s total liquidity and diversify its funding sources.

What are some examples of how this works?

In one case, a company had a maturing $180 million revolver provided by 10 banks. It needed to maintain that level of liquidity in its capital structure, but the market had changed so dramatically that several of the banks no longer existed and terms for conventional credit facilities had become much less favorable. Combining a securitization with a smaller revolver provided this company with $190 million of total financing at an attractive cost and with the involvement of only five banks.

In another case, a company was making an acquisition and needed to refinance the working capital facilities of the company it was acquiring. The bank market did not have the lending capacity to fully cover this need. The fact that the client’s primary financing need was for letter of credit issuance presented an additional complication. Securitization alleviated the capacity limitations of the bank group and the company was also able to benefit from a letter of credit issuance capability.

Can you elaborate on how a securitization works?

Say a company maintains a large pool of accounts receivable. The cash due from these receivables may not be available for 30 days or more, but securitization allows the company to receive financing immediately. The interest cost is relatively low because the receivables’ cash flows are legally segregated and protected from other creditors in the event of a bankruptcy.

This legal separation of the receivables has no impact on the company’s operations; the business will continue to manage its accounts receivable (and customers) in the same manner as it did before the securitization. However, the proceeds from the securitization can be used to originate more assets, to reduce outstanding debt with higher interest costs or to provide for other capital needs.

What types of accounts receivable can be securitized?

Securitization of trade receivables is common in many industries, including metals, mining, energy, distribution and manufacturing. Generally, any diverse pool of accounts receivable can be securitized. Eligibility criteria generally require that the receivables not be delinquent, not be subject to offset, be fully earned with no future performance required by the company and not be due from an affiliate of the company or the federal government.

How can a company decide if securitization makes sense for it?

Securitization may be a source of financing if a company maintains total domestic receivables of $50 million or more. Through innovative structuring, securitization provides many middle-market companies with direct access to the capital markets. Middle market companies across a wide spectrum of industries have unlocked the value of their assets and obtained the necessary capital to support their current operations and future growth through securitization.

This article was prepared for general information purposes only and is not intended as legal, tax, accounting or financial advice, or recommendations to buy or sell currencies or securities or to engage in any specific transitions, and does not purport to be comprehensive. Under no circumstances should any information contained herein be used or considered as an offer or a solicitation of an offer to participate in any particular transaction or strategy. Any reliance upon this information is solely and exclusively at your own risk. Please consult your own counsel, accountant, or other adviser regarding your specific situation. Any views expressed herein are subject to change without notice due to market conditions and other factors. PNC Capital Markets LLC, a registered broker-dealer, is a member of SIPC and FINRA.

©2010 The PNC Financial Services Group. All rights reserved.

Mark Falcione is managing director of PNC Capital Markets LLC. Reach him at (412) 762-7325 or