The Punch Bowl

The teams that will meet in the Super Bowl will be decided this afternoon.

We’ve already seen the Rose Bowl and the Sugar Bowl, the Orange Bowl and the Hula Bowl. For many business owners those bowls only briefly take their minds off the most important bowl of them all…

Yes .... it’s the Punch Bowl.

Ever since someone described the essential job of the Federal Reserve Board as taking away the punch bowl just as the party is getting started, the term has been understood as describing the fuel that gets a party going.

In economic terms that’s understood to mean cheap money, or low interest rates; and more specifically, low interest rates in the commercial banking system. Because that’s what’s generally considered the necessary ingredient to get a stagnant economy moving.

But the Fed’s punch this time around doesn’t have the kick it used to. The central bank been keeping the cost of money at an all-time low level and the party, for many businesses has been all but canceled.

The punch in this year’s punch bowl is a punch in the stomach!

That’s what it feels like after a business owner, used to being able to access traditional credit markets at SOME cost, gets turned down flat again and again. There's no bank money for him at ANY cost.

It’s well documented that the Fed’s monetary stimulus is fueling a powerful carry-trade allowing banks to rebuild capital at the ultimate expense of the national debt we leave to our children.

The cheap money is being used, not to make loans to businesses, but to play the yield curve. It shouldn’t surprise anyone. It’s a perfectly natural and logical, low-risk way to repair some of the damage done when punch was really punch.

I was looking over the financial statements of a TRE Seller this morning. This particular Seller provided audited statements for the year 2007; before the current liquidity crisis began and during the period when low interest rates still fueled (arguably over-fueled) business expansion.

The Notes to the 2007 Statements described an accounts receivable financing facility provided by a commercial bank.

The borrower was not in great financial shape at that time. It recorded a substantial net loss for that year and had obviously been restructuring its equity financing to compensate for operating losses.

I was struck by the financing terms that this borrower had been able to secure from its bank. The rate was pegged at a fixed increment BELOW a widely-used benchmark. And the absolute level of interest cost produced by that formula was, to my mind, quite low in light of the quality of the credit.

The punch still had its kick!

It could be argued that this sort of lending was a symptom of the problem that would rock the financial system shortly thereafter and, therefore, the terms of that facility should not be considered a fair benchmark for comparison to a cost-of-funds today. And that’s a fair argument.

But it’s still useful for dramatic effect.

The pricing that the Seller has indicated as acceptable for current invoices to be sold on The Receivables Exchange is roughly TRIPLE the rate it was paying just over two years ago on its former bank facility!

Now it’s true that the former facility was probably under-priced. And the TRE pricing might well come down as the Seller becomes better-known. And the Seller HAS continued to lose money in the interim periods; so it’s appropriate that its cost of money should have risen. But the magnitude of the change in cost-of-funds is still dramatic.

Let’s say, for argument, that the appropriate measure of the increased cost represents a doubling rather than a tripling of rate. An increase in financing cost of that magnitude over a relatively short time period HAS to require compensating changes in business models.

But the biggest change required in business models is not actually compensating for COST of funds. It is compensating for AVAILABILITY of funds.

For a very large segment of small to medium sized-businesses, the traditional funding sources are just not available.

There are non-traditional sources for some of them, of course. But most of those non-traditional sources are relatively small when viewed in the context of the size of the current national problem.

The Receivables Exchange aims to provide an alternative financing platform on a major scale at prices that will be generally lower than, and with a process generally more flexible than, the existing non-traditional sources.

I suspect this Seller might still feel like he’s been punched in the gut at the prices he’ll have to pay to get his first few deals funded.

But I suspect that he’ll nonetheless be happy to just be able to play the game; that is, to keep his business going; even if it feels like he's playing in the punch bowl!