Monday, May 31, 2010

A Lurch to the Left

No, this is not a political comment.

At the end of each day I print out a nicely-formatted spreadsheet provided on the TRE trading platform that displays certain data regarding the auctions closed that day. Before entering the data in my records I manually note on the spreadsheet the actual terms of each sale.

The format of the spreadsheet includes columns for “Minimum Advance %” and “Maximum 30-day Fee”. This represents the highest price the Seller is willing to pay for the funds it seeks.

To the right of those two columns are two additional columns representing the “Buyout Advance %” and the Buyout 30-day Fee%”. These are the pricing parameters that a Buyer has to meet in order to close out the bidding and be assured that he will be awarded the auction.

If an auction sells at or near the highest cost of money the Seller is willing to pay, the pricing will be at or near the figures found in the columns to the left. This suggests the Buyer has the greater power in the auction.

If the Seller has the greater power, the pricing will be at or near the figures in the right-hand columns.

A very low-tech way to get a sense of the relative power of the parties is to just mark the cells of the spreadsheet that come closest to representing the actual terms of sale.

If the Sellers were “in charge” that day, the marks will cluster in the right-hand columns. If the Buyers were “in charge”, however, the marks will cluster in the left-hand columns.You get a very quick visual picture of current market dynamics.

Then, borrowing the equally low-tech methods of early cartoonists, you can pick up a stack of these marked-up daily spreadsheets and just riffle through the stack. You’ll see a representation of the shifts in power over time.

If you were to do that for the past six weeks or so you’d see that the pricing of TRE auctions has taken a decided “lurch to the left” during that period.

Pricing power has shifted to the Buyers.

There HAVE been periods previously when the power has been decidedly on the side of the Sellers. And it’s reasonable to expect that market dynamics will change from time to time. But this period really HAS been a lurch as opposed to a gentle shift and it’s interesting to speculate about the reasons.

First, there have been many new Sellers brought to the market over the last 4 to 6 weeks and newer Sellers tend to command less attractive terms.

Second, volume has increased significantly and so, all else equal, it should be expected that increasing the supply of auctions should result in somewhat higher cost of funds.

Third, (and some might disagree here) I think there has been a decrease in average quality. A number of high quality Sellers have been relatively inactive and a number of lower-quality Sellers have increased their activity.

Fourth, the average terms of sale have shifted. There have been more and more auctions of invoices due in 45 days or 60 days, and some even in 90 days, than has been the case previously. Holding constant, just for argument, the supply of Buyers’ funds, a lengthening of the average auction duration will reduce the Buyers’ capacity to absorb supply.

Combining increased volume and increased duration compounds the pressure on funding required and, presumably, the pressure on pricing.

Now, I’m not suggesting that there is a shortage of Buyers’ funds. While volume has increased substantially, it still hasn’t reached a level that would come close to taxing the ACTUAL resources of the community of Buyers. It might, however, be a factor when measured against the ALLOCATED resources of some Buyers.

At the margin; increased volume, increased duration, decreased quality and a higher proportion of new Sellers should be expected to put upward pressure on cost of funds.

And that’s what we’ve seen.

If the brief history of the Exchange is a guide; as the new Sellers prove themselves over time the pricing for their auctions will improve. As some of the higher-quality Sellers that have had seasonal reductions in activity come back to the market, their renewed demand should reduce average pricing levels (but perhaps put even more upward pressure on the lower quality Sellers).

The macro issue that I wonder about is the impact on Buyers’ funds of the increased volatility in other financial markets.

May was obviously a month of increased volatility in both equity and fixed-income markets. TRE is still too small and too new to provide any real alternative to those major asset classes. But, over time, assuming its success, the month of May might have been a period when some marginal liquidity might have found its way from those other markets to an alternative destination like the Exchange.

That would likely cause a “lurch to the right”, which is precisely what we did NOT see this time. So I think it’s fair to assume that the aggregate allocated funding of TRE Buyers still represents a fairly small and “closed” system, responding more to internal trading dynamics than to either macroeconomic forces or the dynamics of more traditional financial markets.

So we lurch into the Exchange’s second summer still gathering experience, information and, hopefully, momentum.

No comments:

Post a Comment