Glossary

What is Concentration Risk in AR Securitization?

When too much AR exposure is with a single obligor or group. Learn about concentration limits, tiered groups, HHI measurement, and how excess receivables become ineligible.

Concentration Risk Defined

Concentration risk in AR securitization refers to the danger of having too much receivable exposure to a single obligor, industry, or geographic region. If a large portion of the receivables pool is owed by one customer and that customer defaults, the impact on the portfolio is disproportionately severe. Concentration limits are contractual caps that restrict how much of the eligible pool can come from any single obligor or group of related obligors. The portion of an obligor's receivables that exceeds the concentration limit is classified as ineligible and excluded from the borrowing base, even if the invoices are current and otherwise qualify.

Concentration Groups and Tiered Limits

Most facility agreements define tiered concentration limits based on the obligor's credit quality. A common structure uses concentration groups: Group A (investment-grade, rated BBB- or higher) may have a 15% limit, Group B (strong sub-investment-grade) a 10% limit, Group C (standard) a 5% limit, and Group D (watchlist or unrated) a 2-3% limit. The percentage is applied against the total eligible receivables pool. For example, if eligible receivables total $20 million and a Group B obligor has $3 million in receivables, only $2 million (10% of $20M) is eligible, and the remaining $1 million excess is ineligible. Some facilities also include industry and geographic concentration limits to further diversify the portfolio.

Measuring Concentration: The Herfindahl-Hirschman Index

Beyond individual obligor limits, lenders often monitor overall portfolio concentration using the Herfindahl-Hirschman Index (HHI). The HHI is calculated by squaring each obligor's percentage share of the total pool and summing the results. A perfectly diversified portfolio of 100 equal obligors has an HHI of 100, while a portfolio with a single obligor has an HHI of 10,000. Most AR facilities target an HHI below 500-800, indicating healthy diversification. A rising HHI signals increasing concentration and may trigger reporting requirements or advance rate adjustments under the facility agreement.

Managing Concentration Risk

Borrowers can manage concentration risk by diversifying their customer base, negotiating higher concentration limits for well-rated obligors, and actively monitoring obligor exposure relative to limits. When an obligor approaches its concentration limit, the borrower may choose to prioritize collections from that obligor or redirect new sales to other customers. Platforms like Olycor provide real-time concentration monitoring with alerts when obligors approach their limits, what-if analysis to model the impact of new sales on concentration, and automated concentration excess calculations in the borrowing base.

Frequently Asked Questions

What happens when an obligor exceeds its concentration limit?+
The receivable amount above the concentration limit becomes ineligible and is excluded from the borrowing base calculation. The invoices still exist on the AR ledger and the obligor is still expected to pay, but the excess does not count as collateral. This reduces the borrowing base and available liquidity. The exclusion is recalculated with each BBC, so if total eligible receivables grow or the obligor's balance decreases, the excess may shrink or disappear.
Can concentration limits be changed after the facility is set up?+
Yes, but it requires a formal amendment to the facility agreement, which typically requires lender consent. Borrowers commonly request higher limits for specific obligors during annual facility reviews, supported by updated credit analysis. Lenders may agree to higher limits for obligors with strong credit ratings, long payment histories, and stable industries. Conversely, lenders may reduce limits if an obligor's credit quality deteriorates.
How do related obligors affect concentration?+
Facility agreements typically aggregate receivables from related obligors (parent companies, subsidiaries, and affiliates under common control) for concentration limit purposes. If Company A and Company B are both subsidiaries of the same parent, their receivables are combined and measured against a single concentration limit. This prevents borrowers from circumventing concentration limits through corporate structure. The definition of 'related obligors' is specified in the facility agreement and may reference SEC filings, ownership thresholds, or shared management.

Related Topics

What is an Obligor Limit?What Are Ineligible Receivables?What is an Advance Rate?What is a Facility Agreement?

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