Capital Markets

A New Security Blanket?

The SEC and FASB may soon eliminate many of the benefits of off-balance-sheet deals. Two alternatives: Optimize working capital, or set up a joint ...
Marie LeoneJanuary 1, 2003

It may be time for CFOs to consider alternatives to off-balance-sheet financing. Once new disclosure rules from the Securities and Exchange Commission and the Financial Accounting Standards Board are finalized later this month, these deals may lose their luster.

Lloyd Gold of REL Consultancy Group, which specializes in working capital strategies, believes that the alternative route is the better way to go, regardless of the rule changes. In many cases, asserts Gold, companies would do better first to optimize their balance sheet — and squeeze out all the working capital they can — before looking to an off-balance-sheet vehicle such as securitization.

(To find out more about how companies are improving their working capital, read “We Can Work It Out,” CFO magazine’s 2002 Working Capital Survey. You can also try out the free, interactive CFO PeerMetrix Working Capital Scorecard, which enables you to benchmark the working capital levels at your company, or thousands of public companies.)

A company that pulls the securitization trigger too soon, says Gold, hurts itself in several ways. High working capital may be a symptom of process problems, such as a high level of days sales outstanding (DSO), that should be addressed in any event. Spending a typical $300,000 to $500,000 to set up a securitization, especially in the face of a potential rise in interest rates, will only exacerbate working capital problems.

On the other hand, maintains Gold, a company that first attends to its balance sheet — say, by reducing DSO from 60 to 45 days — may be able to generate cash quickly enough that off-balance-sheet financing is unnecessary. And if the company decides to pursue a securitization nonetheless, he adds, a stronger balance sheet will lower its cost of capital.

The Way Out: A Joint Venture?

Michael Malone, CFO of Polaris Industries, uses another alternative to securitizations. For the past seven years Malone has accessed new capital for the company’s floor-plan financing program through an off-balance-sheet joint venture called Polaris Acceptance.

Floor-plan financing helps dealers stock their showrooms. In the case of the Minneapolis-based recreational-vehicle maker — whose slogan is “The Way Out” — that stock would include snowmobiles, all-terrain vehicles, personal watercraft, and motorcycles.

In 1996 Polaris Industries entered into a 50-50 joint venture with a subsidiary of Transamerica Distribution Finance to form Polaris Acceptance. The receivables portfolio, provided by dealer payments, is recorded on Polaris Acceptance’s book, which is then consolidated onto Transamerica’s balance sheet. The portfolio is funded 85 percent with Transamerica debt and 15 percent by cash invested equally by the two companies.

The arrangement is a straightforward joint venture that Malone maintains is “very visible” in the footnotes to Polaris’s financial statements. He points out that larger manufacturers — such as Honda, Harley-Davidson, and General Electric — often fund their own floor-plan financing deals, taking 100 percent of the risk and reward. Others securitize or sell receivables outright to raise capital.

Malone decided to enter the joint venture arrangement because he wanted to diversify his funding, and because he liked the idea of sharing the risk and reward of the receivables stream. In 2001 Polaris Industries invested $42 million into the venture; Polaris Acceptance financed $547 million in dealer loans that year, and Polaris Industries trade receivables from the joint venture were about $12 million.

John Peak, CFO of Transamerica, believes that some companies will be forced to rejigger or abandon their synthetic leases and securitizations because of new VIE requirements and other disclosure rules. However, he is quick to add that “eventually, the market will become comfortable” seeing these entities on the balance sheet, and lenders and analysts will adjust their thinking and consider the ratios accordingly.

In the meantime, he notes, three more manufacturers have signed up to create joint ventures in lieu of securitizations, including leisure products maker Brunswick and appliance veteran Maytag.