Sunday, January 10, 2010

Short Term Parking

In our post of September 17, 2009 entitled “The Company Capital Keeps” we commented on the fact that the TRE Buyer community is an unusual one.

In most, better-established financial markets, the professionals who provide capital have relatively similar motivations: they approach the markets in which they are active with similar analytical tools; they assess opportunities and risks relatively similarly; and their differences are usually apparent “at the margin”. Their assessment of appropriate pricing, for instance, will vary; but there is usually a fairly narrow range of central tendency.

In our last post we asked whether the TRE Buyers would provide the discipline required to act as an effective counter-weight to the Exchange’s understandable incentive to ramp up volume at the expense of quality.

These two issues are related.

The motivations of the TRE Buyers, as a group, are not as homogeneous as are typically found in more well-developed capital markets.

The TRE website, in its “Become a Buyer” section states: “Commercial banks, hedge funds and asset-based lenders are looking for new classes of high-yield investments to diversify their portfolios.”

Absent from this list (and from the “Become a Buyer” discussion generally) is any mention of the factoring community: the long and well-established industry of those whose business is buying accounts receivable.

TRE obviously seeks Buyer-members from the factoring community, but it is just as obvious that it has a strong emphasis on attracting capital from those NOT already in the business of buying accounts receivable.

In the list of benefits that TRE Buyers are provided by the Exchange, the short-term nature of the receivables purchase is specifically mentioned three times. References to the ability to “deploy more capital” or otherwise “access” a new market or “increase originations” are also a dominant theme of the advantages outlined in “Become a Buyer”.

The message sent to the reader, I believe, is that TRE provides a new place for investors whose business is NOT buying receivables to get some incremental yield on excess capital without committing money for a lengthy period.

So a hedge fund, for instance, that has cash sitting on the sidelines earning next-to-nothing, can pick up some extra income on that cash while retaining the ability to move the money fairly quickly into its more traditional business when opportunities arise.

This is the “TRE as short-term parking” model.

This model is likely to be employed by those committing only a small percentage of their capital to the receivables market. The combination of a relatively small commitment and a short duration provide two legs of a stool supporting the attractiveness of TRE to some of these potential Buyers. The third leg is the name-recognition factor of some Account Debtors.

TRE points out, quite accurately, that a significant percentage of the Account Debtors whose obligations are being offered on the Exchange are household names.

When the added yield and the lack of a significant time commitment is combined with the idea that the Debtor is a substantial, well-known, perhaps-public company, the decision process might seem quite simple i.e. “if I can pick up several hundred basis points of added yield on my cash position on a short-term instrument due from a AAA credit, why not?”

In the town where I live, the parking meters have a little button that you can push that gives you 10 minutes of free parking. So if you’re just going to run in to a store a pick up something quickly, it costs you nothing. But if you overstay the free period, the cost of a parking ticket will be the equivalent of your having put money in the meter 120 times! My guess is that the town makes a lot of money by giving away the first 10 minutes.

Those who employ the short-term parking model on TRE are not assessing risk in the same way that those whose principal business is buying receivables think about risk. They take comfort from the AAA Debtor name without, perhaps, fully realizing that it is the Seller, not the Account Debtor, that is really backing the obligation. And that many of the Sellers have much less than impressive financial capacity.

They take comfort in the notion that all invoices are verified by TRE when, in fact, that is no longer the case. They take comfort, perhaps, in the description of receivables as “attractive, low-risk investment opportunities”. Attractive? Yes. Low risk? Well, that depends.

The receivables-purchasing business has a very long history. There is much evidence to be used in assessing risk. That evidence should not be ignored.

The short-term parkers are providing buying power that TRE currently needs. But ultimately the short-term parkers are not the ones that, in my opinion, are going to prove the TRE concept.

Their money is “fast”, their interest is ultimately in other markets, and one deal gone bad may be all it takes to lose their participation.

Nor are they the Buyers that will provide an effective counter-weight to the risk of the Exchange’s clear growth-rate bias.

More to come on this subject.

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