Off-Balance Sheet Factoring In Focus

As companies increasingly turn to the secondary market for

finance, the effective structuring of off-balance sheet factoring

facilities takes on a new level of importance.

The problem

Where a company is of a reasonable size, it is likely that there

will be existing facilities in place which contain covenants

relating to debt/equity ratios. It may not be possible for the

company simply to discount its receivables as the debt to equity

ratio may breach the covenants in senior lending agreements.

To avoid this situation, a company may try to raise working

capital by using off-balance sheet funding solutions. One example

is to discount the company's invoices through an off-balance

sheet factoring facility. In this article, we briefly examine the

mechanics and the treatment of this facility.

Explanation of the mechanics

In order for an off-balance sheet facility to be a viable

funding method for both the lender and the borrower, it must be

workable from the client's point of view and secure from the

lender's standpoint.

The first component is that the client obtains a credit

insurance policy from a major credit insurer. This is in turn

assigned to the factor. Due to the nature of the facility, this

insurance policy must cover 90% indemnification of loss. The

customer then enters into a letter of undertaking which

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