Back to the Big Picture

My last post addressed one relatively small element of my own proof-of-concept question as a Buyer Member of The Receivables Exchange.

But this is the year in which the larger Exchange-level, proof-of-concept question will have to be answered: i.e. will TRE, in its current format, prove its economic viability?

The principals of TRE are actively seeking additional capital. This would be their third “round” of funding for the Exchange. This is not an unexpected development. Even at its own initial estimate of 2009 transaction volume the Exchange would not have reached break-even last year. So an additional round (at least one) of capital-raising was probably always in the cards.

I have no information on how the process is going but I would guess that they will succeed in raising enough funds to make it through 2010. At the end of this year, if the operation isn’t pretty close to breaking even, a fourth round of financing is likely to be a pretty hard sell. At that point the question of ownership structure and operating format would almost certainly come into play.

For those of us who have invested significant time, effort and money in the TRE concept there is an understandable desire to see the effort succeed; to see the concept proven; and to participate in the fruits of that success. And so I, for one, have to admit a bias on the positive side. The challenge is to avoid allowing that bias to affect either my analysis or my actions as a Buyer.

While my bias puts me on the same side of the larger conceptual issue as the Exchange itself, there is an important difference between the impact of the bias on an individual Buyer and the impact on the Exchange.

The essential trade-off in all financial markets is risk vs. reward.

In the context of the Exchange operations that trade-off is expressed in terms of volume vs. quality. We’ve commented before on the clear incentive the Exchange has to sacrifice quality for volume as it stretches to reach its proof-of-concept economic goal. There is an internal TRE counter-weight, however, provided by the very real need to control defaults and losses in this period. There’s only so far that TRE can afford to go in ramping up the aggressiveness of its Seller-marketing.

But the closer the time comes for clear proof-of-concept demonstration, the less effective a counter-weight that internal caution will provide.

The true counter-weight has to come from the Buyers.

If Buyers, who by definition have made a bet that the potential of the Exchange is worth their devoting time, effort and capital to it, hold a bias that is directionally similar to that of the Exchange, how can they be expected to provide an effective counter-weight?

The Buyers have to refuse to buy when the risk-reward proposition defies logic. If Buyers do not reject auctions that should be rejected, the message to the Seller-marketing group is “you haven’t yet found our pain threshold”. And the quality envelope will inevitably be pushed a bit farther.

There are those who would argue that rejection of auctions is not an appropriate response; that pricing should provide a clearing mechanism for any transaction. In theory, and on a large scale, that is true. But anyone who has had to try to enforce a judgment and collect funds from a defaulted receivables purchase will testify that there are some deals that just shouldn’t be done at any price. There just isn’t enough reward available to balance the risk. The cost in time and irritation exceeds any possible financial reward.

Will the Buyers provide the discipline to balance the Exchange’s clear incentive to push for growth?

There is mixed evidence at this point.

That question and its implications will be the subject of our next few posts.