Well-positioned vendors unable to get traditional bank loans could get some financial breathing room through securitizations that are backed by the cash flow from accounts receivable.
Although mortgage-backed securities are the most familiar — and recently a highly reviled — form, a securitization is any financial instrument formed by the pooling of a group of assets that’s then sold to investors. Asset-backed securitizations have been around for years, can be divided into smaller pieces and may involve almost any type of financial asset.
In the fashion industry, the asset of choice for securitizations has been the trademark. Examples include the $53 million bond offering in December 2004 by BCBG Max Azria Group and the $25 million bond securitization of the Bill Blass trademarks in 1999. In these instances, investment-grade bonds were backed by the income streams associated with the respective firm’s intellectual property.
In the past, some retailers relied on accounts receivable for securitizations of their own credit card portfolios. The fashion industry has generally stayed away from them, but that could change as finance executives at fashion firms familiarize themselves with the securitization process and other forms of financing become tougher.
“The use of the trade [or account] receivable could be timely for the apparel industry, as well-positioned companies find themselves in a position where they can’t get bank financing,” said Hans Montag, a structured finance expert at the Baker & McKenzie law firm.
In a traditional loan scenario, assets are pledged to the bank, but that’s a disadvantage in the current economic environment because the secured loans go on the bank’s balance sheet, upping the potential risk to the bottom line. In securitizations, the loans are with a commercial paper conduit operated by the bank, technically putting the loans “off the balance sheet.” Since funding is from the capital markets, the bank has oversight but is not taking any risk, said Montag.
The attorney recently has worked with banks willing to do more securitized transactions. Most aren’t advertising these transactions — partly because of recent staff reductions, and the process requires several steps, such as setting up a special purpose entity and completing the paperwork to obtain an investment grade rating from credit ratings agencies.
Lack of knowledge and communication also are obstacles, Montag said. “The people on the balance-sheet side and those on the conduit side don’t talk to each other. A company can still get a no on a loan, but it will be the chief financial officer who has to know to ask to speak to someone on the conduit side to get this type of financing. The cfo has to push for it,” the lawyer explained.
Smaller vendors with accounts receivable less than $100 million will likely continue to rely on factors, who buy the receivables at a discount. Those with at least $100 million in receivables tend to be the ideal candidates that can get a transaction completed.
Harry Steinmetz, an accountant at Weiser LLP, said transactions where the pool of receivables is less than $100 million are probably not cost effective.
“The reason why people do securitizations is to lower the cost of money,” he said.
He said if a bank charges 6 percent interest on a loan and the securitization has a cost of capital of 4 percent, or 1 percent in transaction fees plus 3 percent interest paid to investors, then a securitization would save the vendor 2 percent in financing costs.
For Steinmetz, the ideal profile of a vendor firm considering a securitization is one that has retail customers that meet three criteria: They can be rated by the ratings agencies, have a broad geographic presence and have a history of profits and repayments.
“If a vendor has a retail account that represents more than 5 percent of the supplier’s receivables, that may be problematic, because a wide [breadth] of customers is needed to spread the risk,” he said.
The viability of securitizations for vendors may be somewhat limited now because so much, including a vendor’s credit rating, depends on the stability of retailers — hardly at its peak these days.
“Securitization has gotten a bad name due to people trying to securitize mortgage debt,” said Jeff Edelman, director of retail and consumer advisory services at accounting firm RSM McGladrey Inc. and a former retail analyst. “If it is done right, however, it is an OK financing vehicle. A [financial instrument involving a] receivable from a top-notch retailer in a strong financial position would be easy to sell to an investment group since the time frame, 30 to 60 days, is relatively short.”
Edelman said retailers posting declining same-store sales might present a tougher sell in terms of risk to investors, but the analysis then should be on some other factor, such as the long-term viability of the individual retailer or the history of sales and profits between vendor and retailer.
Edelman used Saks Inc. as an example. He said the retailer has low profitability because “when Saks went public, it needed a growth story and opened in some locations that are performing poorly” and are dragging down operations.
A solid vendor generating good profits for Saks could lessen risk by shortening the time frame of the receivables, he said.
Edelman pointed out there are a number of specialty stores that have no debt, decent cash flow and strong earnings before interest, taxes, depreciation and amortization over and above the rent expense. “Accounts receivables from these retailers should be fairly easy to sell to investors,” he concluded.
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