The securitization of accounts receivable is a financing process in which a company’s accounts receivable is structured into debt securities that can be sold to investors on the capital market for cash capital. This sale frees up assets that sit idly on the balance sheet. However, the securitization of accounts receivable doesn’t release the company from the responsibility of collecting on these accounts, which the company’s own credit rating now depends on.
Securitization and Structuring
The securitization of accounts receivable is designed to structure these accounts into debt securities that can be backed by future payments from the accounts. Like other asset-backed securities -- such as those backed by mortgages, credit card balances or car loans -- the quality of accounts receivable-backed securities lies in the underlying assets. The securitization of accounts receivable often requires a pool of accounts owed by a diverse base of a company’s obligors so that a default by some may not significantly undermine the securities’ total performance. Furthermore, interest payments and maturities are set in consideration of the expected collection schedules.
Sales and Funding
The goal is to sell these accounts as asset-backed debt securities to investors on the capital market. Unlike issuing unsecured debt securities -- such as bonds, which requires the recording of the debt securities as liabilities on the balance sheet -- the selling of accounts receivable-backed securities directly removes accounts receivable as assets on the balance sheet but doesn’t record the debt securities as liabilities. Therefore, the securitization of accounts receivable is a method of off-balance sheet financing that doesn’t increase the amount of a company’s debt as it appears on the balance sheet, thus improving balance-sheet quality.
Collection and Servicing
Through securitization, accounts receivable as assets are removed from a company’s balance sheet and replaced with the cash capital received. Meanwhile, the accounts receivable-backed debt securities are not shown as liabilities on the balance sheet. However, a company is still responsible for collecting its accounts receivable and is liable for servicing the debt securities by making on-time payments to investors. The ownership of the accounts receivable doesn’t change hands. This is similar to mortgage securitization, in which banks, not investors, still own the off-balance sheet mortgage loans and have the right to foreclose on any properties in default.
Credit Rating Effect
The securitization of accounts receivable has potential credit rating implications for companies that issue them, because companies effectively use the accounts receivable as a source of money to make ongoing payments on the securities. Without securitization, failure to collect on any accounts receivable would only result in potential worsening credit conditions for the company’s customers, not the company itself. But the same failure to collect on accounts receivable will reflect negatively on the company’s own credit rating if the company fails to make due payments on the securities due to any non-collectible accounts.