Debt finance and leasing - Securitisation and private debt

Learning Outcomes

After reading this article, you will be able to describe the nature and purpose of securitisation and private debt as forms of debt finance, explain the process and benefits of asset securitisation, distinguish between capital and private debt markets, and assess the risks, advantages, and common features of these funding methods for business finance and leasing decisions.

ACCA Financial Management (FM) Syllabus

For ACCA Financial Management (FM), you are required to understand the main sources of finance available to businesses and their relative characteristics. This article focuses on:

• The features and advantages of debt finance, both traditional and innovative forms
• The process and impact of securitisation as a funding technique
• The nature and uses of private debt instruments
• How these options relate to the overall financing and leasing decision
• The risk/return trade-off between public and private debt funding

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which statement most accurately describes securitisation?
   1. Raising new equity on a stock exchange
   2. Pooling financial assets and issuing tradable securities backed by those assets
   3. Selling company-owned land to fund operations
   4. Negotiating an unsecured short-term bank loan
2. Which of the following is a typical advantage of private debt for businesses?
   1. Public credit rating requirements
   2. Lower negotiation flexibility
   3. Potential for customised terms
   4. Frequent requirement for a prospectus

3. True or false? Securitisation allows a business to transfer risk associated with certain assets to investors.

4. Briefly explain the difference between public and private debt markets.

5. What risk might arise if a company relies too heavily on securitised finance?

Introduction

Businesses regularly turn to debt finance and leasing to meet funding needs. While conventional debt, such as bank loans and bonds, remains critical, alternative methods have developed. Securitisation and private debt are significant innovations, allowing companies to access capital using existing assets or private financing arrangements, especially when public markets are costly or unavailable.

Understanding the structure, benefits, and risks of these instruments is essential for making informed financing and investment decisions. This article examines how securitisation and private debt fit into the range of debt finance and leasing options relevant to the ACCA FM exam.

Key Term: debt finance
The process of raising funds for business activities by borrowing (e.g., loans, bonds, or other credit instruments), requiring future repayment with interest.

Securitisation: Transforming Assets into Funding

Securitisation is a process by which a business pools together financial assets, such as loans, receivables, or leases, and then sells these as securities to investors. Investors purchasing these securities are repaid from the cash flows generated by the backing assets.

Key Term: securitisation
The conversion of illiquid financial assets into tradable securities backed by those assets’ future cash flows, typically to raise capital and transfer risk.

Securitisation is designed to achieve several objectives:

• Release liquidity from assets that are otherwise difficult to sell
• Transfer the risk of the backing assets to external investors
• Diversify sources of funding away from traditional bank finance

Once securitised, these assets are usually removed from the business’s statement of financial position (“off-balance sheet”), allowing for better financial ratios and sometimes less regulatory capital required.

Securitisation structures are common for mortgage loans, receivables, and lease obligations, especially in large or capital-intensive businesses.

Typical Securitisation Process

1. The company bundles together assets with predictable payment streams (e.g., trade receivables, lease payments).
2. These assets are sold to a special purpose vehicle (SPV), which is a separate legal entity.
3. The SPV issues securities (often called asset-backed securities) to investors.
4. Repayments from the original borrowers (e.g., customers) flow through the SPV to repay the investors.

Advantages of Securitisation

• Provides access to new sources of finance, sometimes at a lower cost
• Allows risk transfer away from the company
• Can improve key financial ratios and increase available credit capacity

Disadvantages and Risks

• Complicated setup and legal structure
• Ongoing costs for administration and compliance
• Can increase exposure if future cash flows from assets fall below forecast

Worked Example 1.1

A manufacturing business has $30 million in trade receivables. Its credit line from the bank is exhausted, but it needs to raise $10 million quickly for expansion.

Explain how securitisation could address this problem and what risks the company faces.

Answer:
By packaging its trade receivables into a pool, the company can sell them to an SPV, which issues asset-backed securities to investors and raises $10 million. This provides new funds without increasing bank debt. However, if the original customers default or pay late, cash flows to investors may fall short, and the company’s reputation could suffer.

Exam Warning

While securitisation can remove assets (and related debts) from the balance sheet, in some cases, the originator retains some exposure to losses. Be careful when identifying who bears which risks in exam questions.

Private Debt: A Flexible Alternative

Private debt refers to funding obtained via direct negotiation with a limited number of institutional investors (such as pension funds, insurance companies, or specialist debt funds), rather than issuing bonds publicly on a stock exchange.

Key Term: private debt
Loans or securities negotiated privately between businesses and investors, typically outside public markets and without public credit ratings.

Private debt may take the form of loans, notes, or bonds, but the documentation, interest rates, maturity, and covenants are customised to the needs of both parties.

Typical features:

• Flexible terms not available in public markets
• No requirement for public disclosure of all information
• Funding can be tailored for special purposes (e.g., acquisitions, refinancing, capital projects)

Private debt is attractive to businesses that are too small for public bonds, want to avoid complex prospectus procedures, or need to keep financing confidential.

Advantages:

• Access to funding when public markets are unavailable or unattractive
• Greater flexibility in structure, repayment, and covenants
• Reduced regulatory and reporting requirements

Drawbacks:

• May be more expensive than public debt, especially for riskier businesses
• Investors may impose strong monitoring or covenants
• Harder to trade (less liquidity) than public bonds

Comparing Securitisation and Private Debt

Worked Example 1.2

A retailer seeks a $12 million facility for warehouse upgrades but has a weak public credit rating and cannot issue a public bond.

What are two advantages and two disadvantages of using private debt instead?

Answer:
Advantages: (1) Facility can be tailored to the retailer’s operating needs and repayment capability; (2) avoids public disclosure and a formal credit rating. Disadvantages: (1) Interest costs may be higher due to less competition among lenders; (2) limited ability to transfer or sell the debt in the secondary market.

Leasing, Securitisation, and Private Debt in Practice

Leasing often creates steady, predictable cash flows—making lease receivables ideal for securitisation. Leasing companies may use securitisation to refinance portfolios and raise new cash while transferring some risk to investors.

For companies requiring large-scale equipment or projects, private debt may offer longer terms, fixed rates, or more flexible covenants than traditional loans.

Key Term: asset-backed security
A security whose payments to investors are backed by specified pools of financial assets, such as loans or leases.

Key Term: special purpose vehicle (SPV)
A separate legal entity created to hold assets and issue securities during a securitisation process.

Summary

Securitisation and private debt offer alternative routes to business funding. Securitisation allows a business to generate liquidity and transfer risk by selling asset-backed securities, while private debt provides funding through tailored agreements with institutional investors. Both offer flexibility beyond public bonds but require understanding of the associated risks, costs, and structural complexity. Their correct use can widen the financial tools available for achieving business goals and financing leased assets.

Key Point Checklist

This article has covered the following key knowledge points:

• Define debt finance and its importance in business funding
• Explain the process and purpose of securitisation
• Summarise the structure and typical uses of private debt
• Describe advantages and risks of securitisation and private debt
• Identify when leasing, securitisation, or private debt may be most suitable

Key Terms and Concepts

• debt finance
• securitisation
• private debt
• asset-backed security
• special purpose vehicle (SPV)