Friday, May 14, 2010

Fear of Commitment

In a former life I was a lender, as I’ve mentioned before in these posts. One of the realities of the business was that when we issued a loan commitment we got a commitment fee.

The prospective borrower could walk away from the deal but if he did he’d forfeit the fee. That would at least partially compensate us for “reserving” the funds committed and for doing the work necessary to underwrite the loan.

I’ve been thinking about the value of “reserving” funds in light of the recent activity on The Receivables Exchange and that’s led me to post this unscheduled comment on a Friday afternoon.

We’re in a period of rapidly rising auction volume, which is great. Predictably, though, with a rapid increase in the demand for funds, the price of funds has also firmed a bit. The presence of a substantial number of new Sellers, whose auctions have not yet “proven” themselves, also tends to lift overall pricing levels.

While the pricing of auctions at the time of sale has firmed, the initial asking prices have remained pretty much constant. So the percentage of auctions sold at “buy-out” pricing has fallen. One consequence of this is that auction duration has lengthened.

So, what’s the issue to write about on a Friday afternoon?

It’s this—any bid except a buy-out bid is a commitment of funds without any corresponding compensation. And the longer the auction period, the longer the potential uncompensated commitment.

Let’s say there’s an auction posted with a stated duration of 5 days and a buy-out price of 85% advance and 1.5% per month discount. Let’s say, further, that recent experience suggests that auction should actually sell at 80% x 2.0%.

If I bid 80% x 2.0% as soon as the auction appears, I am agreeing to hold the funds at that price for up to 5 days, giving the Seller the option to take the deal at any time but being unable to re-allocate the funds until the Seller acts.

My incentive in such a situation is to avoid bidding early; to hold back, assuming the auction will sit on the shelf for a while, and react to others’ bids rather than take the initiative myself.

In that way I can maintain the flexibility to bid on something else that comes up in the interim.

In that way I avoid giving the Seller a free 5-day put option; a fee-free commitment of funds.

That situation is not really good for anyone.

All parties: the Seller, the Buyer and the Exchange, benefit from auctions that sell quickly. But if both price and time are barriers to bidding, what’s to be done?

I suspect that few Sellers are going to adjust their asking prices in a meaningful way except to reflect changed invoice payment terms or Account Debtor quality. (We HAVE seen pricing change in some cases to reflect short payment terms, which is rational and positive.)

My suggestion in this situation would be to shorten the auction duration.

We’ve seen some auctions come to the board with terms as long as 14 days! The idea of getting stuck allocating funds for that long is really unattractive. But even the more typical 5 day auction period causes problems.

If the Seller doesn’t want to adjust pricing to the level of the current market, why not counsel that Seller to post auctions with single-day durations?

Absent a buy-out bid, real price discovery frequently happens shortly before (sometimes VERY shortly before) expiration.

So accelerate the expiration!

Post an auction at 9:30 am expiring at 3:00 pm and find out what the pricing really is on that day.

If it doesn’t sell, post it again the next day. But then the previous day’s unsuccessful bidders are released to re-think the situation and the Seller can re-think the pricing if that seems appropriate.

When the shoe is on the other foot, and there is more demand than supply, the Buyers jump at good product. They pay up, and quickly, to make sure that they get the product they’re looking for.

The Sellers need to adjust in the same way when the cycle happens to be going in the Buyers’ favor. It won’t last forever!


  1. I admit to being a rookie at this, and read the post rather quickly..... but your comments make sense to me. The other option is to simply wait until the last hour or so of an auction, and then make your bid. Going once.... Going twice.... Sold!

  2. Hi Jeff.

    Thanks for the comment.

    In the current market environment it certainly can make sense to hold back til an auction is about to expire. I'd have to say, though, that this is an anomalous period.

    It's been more often the case that the Buyers have NOT been rewarded by waiting. It happens that we're in an unusual period when the advantage is to the buy-side.

    The suggestion in my post is really a suggestion that Sellers need to be flexible in reacting to changing market conditions just as Buyers must be when the shoe is one the other foot.

    It's always good to hear from you!