Tuesday, September 22, 2009

The Price is Right??

This is going to be a little tricky -- to say enough to make the point but not so much as to cross the line of prohibited disclosure. But the situation is interesting enough to warrant the risk, I think, and if I cross the line you can find my lawyer’s phone number in my wallet.

Here’s the situation: on a single trading day recently four auctions involving the same Seller and four different Account Debtors were sold on The Receivables Exchange.

The Seller’s history on the exchange was short. It had only recently become a Seller and had sold only a couple of fairly small deals. No payments from any Account Debtors had yet been received.

According to standard “Z-Score” analysis, the Seller’s financial position is weak.

Each of the four auctions sold on that day involved rather modest dollar amounts and all were of invoices that were already 1-30 days past due.

Up to this point in the analysis there is little to differentiate the auctions.

But the effective monthly discount (nominal monthly discount divided by percentage of funds advanced) actually varied quite widely.

The range from the low cost to the high cost transaction was over 160 basis points per month; the equivalent of almost 20% per year on the cost of funds to the Seller. Logic suggests that there must be some significant differences among the auctions.

Between the lowest cost and the highest cost transaction, the pattern of price change showed an almost equal variation from deal to deal. And the sequence of deals closed does not help explain the pattern of variance.

Given that we have the same Seller, similar auction sizes, similar invoice ages and transactions all occurring on the same date, the obvious variable that we would look to for an explanation of the pricing differences is the quality of the Account Debtors.

We decided to test for differences in the strength/quality of the Account Debtors in these transactions using a credit-rating service that generates a two-part overall quality assessment: the first part is an alphabetical grade on a scale of A+ for the best and C for the worst. The second is a numeric rating on a scale of 100 for the best to 70 for the worst.

The following are the scores of the Account Debtors whose invoices were sold in the four auctions ordered from the lowest-cost transaction to the highest-cost:

Lowest Cost: A+ 100
1st Intermediate: A+ 95
2nd Intermediate A+ 100
Highest Cost A+ 98

Obviously, these credit scores do nothing to explain the wide variation in prices paid for the four auctions closed on that day.

If neither the Seller, nor the Account Debtor, nor the size of the auction, the general character of the invoices nor the sequence of the auction can explain any significant component of the pricing difference, what do we have left?

The Buyers!

We’ve written recently about the impact of varying Buyer motivations on auction activity. This is certainly an indicator that that dynamic is both real and important.

Under these circumstances, can we pick which auction represents the “market” return for the receivables of this Seller? I think not.

Under these circumstances, can we draw any conclusions about the “market” cost of funds for Sellers of invoices of this quality? I think not.

What CAN we say?

There were a number of Buyers obviously willing to bid on a relatively untested and weak Seller. Some were probably more influenced by the quality of the Account Debtor. Some were probably more influenced by the quality of the Seller.

None seems to have been willing to go after ALL of the auctions even though the aggregate size was well within the range of some Buyers.

I think what we’ve got here is an atmosphere of continuing experimentation. Buyers are willing to make small bets on even weak Sellers in order to gain experience and information. The absolute returns, for some, at this point might be less important than the experience.

So long as the actual returns are considered to be less important than gaining experience in operating in the exchange environment and the returns are at least high enough that they don’t represent a COST, compared to other ready short-term options, the value trade-off is acceptable.

If that is true, however, the current pricing statistics should not be given too much credence. We've got a ways to go in both time, volume, breadth of market and number of participants before conclusions of value can be drawn by either Buyers or Sellers.


  1. Chuck, another great post.

    I am detecting a whiff of skepticism on your part concerning TRE's ability to recruit enough sellers of invoices to make the market liquid. If TRE fails I expect that the business coroner will note this as the cause of death on the corporate toe tag.

    Currently, the "viscosity" of the market is quite high....sort of like a jar of refrigerated Vaseline. Indeed, it is a fool's errand to attempt to draw conclusions from such an illiquid marketplace.

    Like you, I am bemused by some of the transactions that I see. However, I will not let the (foolish?) decisions made by other buyers effect my own screening criteria. I don't buy: past due receivables, anything less than $35,000, anything that won't be outstanding
    for at a least a month nor anything from a seller that has yet to complete at least a few transactions. Your mileage may vary.

  2. Thanks very much, Oldschool.

    I think even TRE itself has been surprised by the lack of activity over the summer months. I understand they do expect a ramp-up in the fall, which would be good.

    I've actually been more concerned about the quality of the new Sellers than I have the number. I expected, or hoped, that the pattern would be one of increasing quality as time passed. From my perspective, that hasn't been the case.

    I do have a set of written criteria for bidding, as you do, and I do stick to it. I have made a couple of changes as I've gotten some experience over time. And I'm currently considering a couple of additional changes.

    The bottom-line, though, is that there has to be appropriate compensation for the yield, security and control that I give up by buying on TRE as opposed to putting the funds out in my normal factoring business. And, as I've written, my cost of capital is not Libor, or even close.

    So if TRE becomes dominated by large Buyers just looking to keep idle cash busy until something else comes along, I'll be gone.

    If that happens, though, it will be bad for all concerned because the low-cost, high-velocity money leaves a market as quickly as it enters. TRE would do well to protect itself against that sort of domination.

    Thanks for the comment and the valuable insights.