Biggest companies using deconsolidation transactions under established and recurring factoring programs or end-of-year or half-year “spot” transactions earn an average of at least 0.3x leverage, according to our experts Hugo Thomas and Olivier Talvard.

The factoring market experienced a historic decline in activity in the first half of 2020. In its semi-annual report, the French Association of Financial Companies (ASF) calculated the contraction in factor activity in France to be -10.2%. There were significant disparities between domestic invoicing (-13.4%) and export invoicing (-3.0%). It should be noted that these figures quantify the fall in invoice volumes sent to factors and not the amounts of financing.

Expectations of increased use of factoring to finance the resumption of activity after the summer did not pan out. The large factoring companies in France note that the number of new transactions has remained low, particularly in the micro-enterprise / SME customer segment. The explanation for this lies in the effectiveness of public measures to support the economy, at the forefront of which state-guaranteed loans have helped to cushion companies’ liquidity profiles, at least for a while. Another explanation can no doubt be found in the position of credit insurers, which have reduced their approvals quickly, and sometimes drastically, leading to reduced activity of the factor industry.


Improving leverage

However, the factoring market is receiving support from demand from mid-sized companies and large groups wishing to partially deconsolidate some of their trade receivables in order to manage their financial ratios.

As an example, let’s consider the following imaginary corporate, which has:

– a 2019 (pre-Covid) leverage ratio of 2x (net indebtedness of EUR 200m and EUR 100m of EBITDA)

– a 2020 (post-Covid) leverage ratio that rises to 2.7x (net indebtedness of EUR 230m and EUR 85m of EBITDA).

In such a situation a EUR 25m true sale of trade receivables held by such a company would see its leverage ratio fall from 2.7x to 2.4x (as net indebtedness would be reduced from EUR 230m to EUR 205m).

And, according to a Redbridge study, biggest firms using such deconsolidation transactions (under established and recurring factoring programs or “spot” transactions at the end of the fiscal year or half fiscal year) earn an average of at least 0.3x leverage.

The high proportion of requests for such one-off trade transfers of receivables for the half-year results in June and at the end of 2020 reflect the increased need among corporates to control their financial ratios for the fiscal year 2020. A borrower will often have an interest in improving its ratios by deconsolidating part of its receivables rather than soliciting a waiver from its lenders or bond investors, for whom accepting the request is far from automatic!

So-called “spot” transactions follow the same broad principles as recurring transactions (factoring programs) in the area of IFRS deconsolidation: almost all of the risks and benefits associated with these receivables must be transferred to the factor (which is then in the position of being the “transferee”) for the receivables to be taken out of the transferring company’s balance sheet. The transferee’s lack of recourse to the transferor is at the heart of the structure: credit risk is transferred to the credit insurer or, more rarely, directly borne by the transferee in its “own funds.” Transferees (such as factors and banks) guard against the risk of dilution (non-payments related to disputes, compensation, invoicing errors) by setting up a guarantee fund. The risk of holding a claim and late payment is dealt with by increasing the calculation time of the withheld financing fees (Days Sales Outstanding + security days).

From the perspective of a factor, a deconsolidation spot transfer in IFRS is more risky than a transfer in a recurring program. For example, the absence of an account dedicated to the receipt of transferred invoices (which is the rule for one-off transactions because the organization of cash management for a few weeks cannot be changed) creates a risk of commingling on the transferee; in addition, the inability to subsequently adjust the length of time to calculate the withheld interest increases the risk of late payment. As a result, factors’ appetite is reduced and concentrated on transferors with a strong credit profile. That’s because, despite the lack of recourse to the transferor, the transferee remains sensitive to the transferor’s credit quality.

The price is also higher: up to twice – all things being equal – that of a recurring factoring program. However, the savings on other financial instruments that such a transaction can facilitate puts its cost into perspective. The possibility of signing a spot transfer in a few weeks before a closure, despite the necessary validation of the package by the auditors, makes it a flexible tool for the transferor.

The current upsurge in deconsolidation operations, which is quite understandable in the face of the crisis, will lead auditors to strictly follow the IFRS constraints. This is certainly important to be bear in mind for transactions in late 2020 and 2021. In this context, a simple, legible documentary base (a spot transfer agreement or recurring factoring contract), well-paying transferred debtors and reasonable sought quantums are other key factors to bear in mind.

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