The Hedge Fund Law Report

The definitive source of actionable intelligence on hedge fund law and regulation

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By Topic: Receivables

  • From Vol. 2 No.20 (May 20, 2009)

    For Credit-Focused Hedge Funds, Receivables are the New Zero-Coupon Bonds

    In today’s constrained credit environment, operating companies are still finding it difficult to obtain the credit they need for operations, expansion and working capital.  Risk aversion remains the order of the day among traditional lenders – banks, thrifts, credit unions – and as a result, lines of credit are being reduced, terms loans are harder to come by and fees and interest rates are increasing on various types of credit.  In this environment, companies are turning to alternative financing sources.  One increasingly popular option among such alternatives is receivables financing, in which a company that is owed money sells the right to receive that money to another party in exchange for an amount that is less than the amount owed.  As in other pockets of the credit markets, hedge funds are showing up with growing frequency as buyers of receivables under such arrangements – that is, as lenders.  For the companies selling receivables, such arrangements are the functional equivalent of term loans secured by the receivables, with the interest amount consisting of the difference between the sale price of the receivable and its face value.  For hedge fund investors, buying receivables is the functional equivalent of purchasing a zero-coupon bond, and the investment and legal analysis preceding such an investment is largely the same as in the zero-coupon bond context.  However, receivables financing offers hedge funds exposure to different credits, with a different (often higher) return profile and a different level of correlation with traditional asset classes.  For certain hedge funds, mostly those with a credit orientation, receivables financing offers an interesting alternative (or complement) to investments in more typical assets such as bonds and bank loans.  (However, claims arising out of the purchase of receivables often will rank lower in a bankruptcy of the obligor than bonds or bank loans.)  We detail the mechanics of a typical receivables financing transaction, the function of receivables exchanges, which types of hedge funds are participating in these transactions, expected returns, usury laws, default by the obligor and true sale considerations.

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