Factoring and Securitization of Receivables

Understanding finance is not really tough and not so easy at the same time. You need to go through a lot of details involved with financial analysis and also bookkeeping and accounting and understand various terms of finance. Also, there are several questions in the mind of a person dealing with finance terms one of which is understanding the “difference between factoring and securitization of receivables”, so below is the answer to this important finance question.

What is Factoring?

Factoring in simple words means selling out accounts receivables at a discount. You get cash upfront and the factor then collects the receivables on the due date. There are variations to factoring like with recourse factoring and without recourse factoring. You can compare it with bill discounting. In India, we have both types of factoring with recourse factoring and non-recourse factoring.

Non-recourse factoring is possible in India based on the credit quality and the discounting factor. One can evaluate non-recourse factoring on the strength of credit insurance.

What is securitization?

In securitization, any class of financial assets like mortgage loans, credit card receivables, etc. are bundled up and securities are issued to investors against these assets. The issuer thus gets cash upfront through sale of these securities, which are backed by the cash flows from the asset.

Also,there is an agency, which buys banks bad assets and then tries to recover money from them. In turn, banks purchase the shares floated by that company.

In securitazation by a bank or financial institution, they create a venture which is called Special Purpose Vehicle (SPV), which is just like a trust that purchases receivables or other assets from the originator (banks) and issues securities to the investors to pay to the bank for these assets and this type of company is called ARC (assets reconstruction company).

Assets that can be securitized are loans like home loans, car loans, personal loans, etc. and other forms of future receivables like credit card payments, ticket sales, car rentals, or any other future cash flows.

Can securitization be done for vehicles financed by a non-banking financial company (NBFC)? If so, then by whom is it done?

These securitizations are done by a trust specially created for this purpose, which is special purpose vehicle (SPV). The loans are transferred to SPV. SPV is able to buy these loans through the funds raised by issuing the notes (just like shares, and these are traded in the secondary market). Either the loan is actually transferred (removed from the balance sheet of the originator) or only the risk associated with it is transferred (known as synthetic structure).

So the above was the difference between factoring and securitization of receivables. You can go through more information on questions related to finance, investment, loans, debt management, etc. in my previous and upcoming hubs to brush up your knowledge of finance.