"Off Balance Sheet Financing"

Harold Walker is CEO and Owner of Walker Enterprises (WE), a company that has shown strong and consistent growth over the years. However, WE is struggling with cash flow issues and Harold is looking for a loan and/or line of credit to bolster his company. The problem is that the companys debt to equity ratio is already high and he knows it will be challenging to find a bank willing to lend him additional funds. Fred, his CFO, has come up with an idea. A large portion of the companys debt is tied up in the mortgage of their five-story office building. Fred has suggested moving this debt to off balance sheet by creating an SPV (Special Purpose Vehicle) that owns the building on behalf of the company and then leases it back. This results in WE entering into an operating lease off the balance sheet and recording only the relatively small monthly rent as an operating expense. Fred says this will significantly increase the companys liquidity and present a balance sheet that will be much more attractive to any potential lenders.

Fred has assured Harold this is legal and common. This arrangement does not feel right to Harold.

• What additional information should Harold request?
• What additional reservations or concerns would you have?