|CFO Magazine Questions the Stability of Securitization
|A common but misunderstood borrowing tool.
|June 10, 2003|
Boston, MA June 10,2003-It is a tool that companies use all the time to raise money. But the June issue of CFO magazine reports that poorly understood asset-backed securitization, or ABS, has become the latest off-balance-sheet financing method to come under fire in the post-Enron age.
CFO’s article “False Security?" focuses on the far-reaching but obscure world of securitization, a $6 trillion industry, in a three-part look at the struggles faced by American companies emerging from bankruptcy. In the recent rash of high-profile bankruptcies, creditors, regulators—and even some bankrupt companies themselves—have tried to gain access to ABS funds by claiming that the special purpose entities (SPEs) set up to hold those funds are invalid. Even if the legal basis for securitization isn't challenged, carefully constructed ABS contracts often fare poorly in bankruptcy courts, where they are at the mercy of judges and regulators.
In their most common form, ABS transactions allow companies to get quick cash in exchange for “selling” the rights to anticipated streams of money that is owed to them, but not yet collected. While this basically constitutes borrowing against future cash flows, accounting rules have historically allowed companies to keep this debt off their balance sheets, recording it instead as a sale to the SPE. Constructed to be legally separate from the company, and its creditors, the SPEs are considered “bankruptcy remote”—unable to be touched when a company seeks court protection—at least until the recent challenges. The investment-grade credit ratings that make asset-backed securities attractive to investors depend on a company's ability to sell assets (such as corporate receivables) to bankruptcy-remote SPEs, thus placing the assets out of reach of creditors.
"In the wake of Enron, when many types of structured finance are being questioned, ABS facilities still are widely considered safe, plain vanilla transactions," says senior writer Tim Reason, who wrote CFO’s article. “Given their popularity, we felt it was important to explore whether that perception is correct." While securitization so far has survived high profile bankruptcies such as Worldcom, says Reason, "finance executives may be surprised to learn how unstable they can be. That in turn, may affect the pricing that makes them so attractive to CFOs today."
Asset-backed securitization has been in the news lately because new accounting standards that become effective July 1 require companies and banks to disclose off-balance-sheet SPEs used for securitization, and, in many cases, put them back on their balance sheets. The chairman of the Financial Accounting Standards Board (FASB), Robert Herz, tells CFO that the board also plans to review “qualified SPEs”—which are exempt from the new rule—to see if their definition needs to be tightened as well. But, the magazine notes, the regulatory threat to this form of “structured finance” may be dwarfed by the legal challenges to the ABS concept that are being raised in bankruptcy courts.
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