Monday, August 30, 2010

In the Way of St. Augustine

St. Augustine of Hippo is famously known for pleading: “Lord, grant me chastity-- but not yet!”

Augustine clearly viewed chastity as a good thing but he wasn’t quite ready to enjoy its benefits.

In the receivables purchasing business, getting paid is a good thing. But getting paid much more quickly than expected – not so much.

The “good” in a payment pattern is more a function of predictability than absolute timing.

Regular readers might now anticipate my returning to a pet peeve. But hear me out.

An auction that I purchased recently was closed out last week: paid as agreed; which, in itself, is certainly a good thing.

But it wasn’t paid either “as expected”, or “as advertised”. And that’s not such a good thing.

When I first started buying receivables in my spot factoring business I made the mistake of telling a couple of prospective clients that I was looking for invoices that would pay in the range of 45 days, give or take. It’s been my good fortune to have gotten many of my clients via referral from other clients. And it’s amazing how often I’m told that a referred prospect’s payment expectation is about 45 days!

Word spread from those initial clients, of course, that that’s what I wanted to hear—so that’s what I’m invariably told. But those prospective sellers are most often saying “45 days” when the truth is that payments will take LONGER. They know it and I know it.

The phenomenon I’ve griped about in prior posts with respect to TRE auctions is having invoices presumably due in 45 or 60 days that get paid in 7 or 9 days.

Why do I gripe about that? Not because it happens once in a while -- that can be just the luck of the draw.

But recently the number of instances of significant disparity between the posted payment expectation and the actual payment experience has been increasing. This is the case both in auctions that I’ve bought and in those I’ve just been monitoring.

The trigger for this post is that the auction I referred to above, which was paid last week, was “due” to pay out in about 30 days. In fact, the actual weighted average duration was 3.7 days!

The result was that my actual net earnings on that auction were roughly zero. That was a “successful” but still unsatisfying transaction.

I had bought several auctions from that Seller prior to the one I’m describing and all had performed as expected. I have actually been quite happy with the experience.

And as annoyed as I was with the result of that one auction, I was prepared to assume it was just bad luck. That for some unknown and unusual reason the Account Debtor just paid very early.

And so I bought another auction from the same Seller even before this one had closed-out.

The first payment on the NEW auction was made ONE DAY after the auction closed. The invoices that were paid were not “due” until mid September.

With that additional experience, as much as I have been pleased with the initial auctions bought from this Seller, I’m now going to have to stay away from those auctions until there is evidence that these are anomalous situations and that a predictable relationship between the posted due dates and the actual payment expectations can be anticipated.

The reason, of course, is that acceptable pricing changes significantly as the duration of auctions changes. This is particularly true in cases of very rapid payment.

The marginal impact on return of payments expected in 45 days but received in 30 is actually pretty minimal. But the impact of a payment expected in 45 but received in 10 is quite significant.

I am not suggesting that the Seller in this case deliberately misstated the payment expectation. I don’t believe that is the case. Actually, I suspect that this transaction will have been as unsatisfactory for the Seller as for the Buyer.

Because of the TRE fee structure, the costs to the Seller on this auction will have been as high on a relative basis as the return to the Buyer was low.

But there is a small number of Sellers whose actual payment experience appears to be consistently more rapid than “expected”. That creates a credibility problem—-for me, at least. And I’m no longer willing to bid on those auctions.

Ultimately it is to everyone’s benefit for there to be a rational relationship between the posted “due date”, the Seller’s posted “expected payment date”, and the actual payment experience.

I’m not suggesting that there won’t always be outliers in payment patterns, in both directions. Of course there will.

But when the pattern itself is of “outlier” events – it has to be the posted due date or posted payment expectation that is called into question.

Wednesday, August 18, 2010

Bringing a Knife to a Gunfight

Last Friday I was listening to Bloomberg radio as I drove to a meeting.

Mohammed El-Erian, the brilliant CEO of PIMCO, was being interviewed on the question of European sovereign debt. Commenting on the assistance provided the Greek government he said that the program amounted to “applying a liquidity solution to an insolvency problem”. The implication was that, in his opinion, the weapon did not suit the battle.

As others might put it, the Euros were bringing a knife to a gunfight.

El-Erian’s words stuck with me, so I thought I ought to brush up on some definitions.

First, insolvency and bankruptcy are two different things. And Dr. El-Erian would know quite well, given his background at the IMF, that countries cannot technically become bankrupt. Bankruptcy is a legal concept that does not extend to sovereign entities.

Insolvency, on the other hand, is a financial condition. More accurately, there are two financial conditions associated with the term insolvency.

1. “Balance sheet insolvency” is the condition in which liabilities exceed assets, and

2. “Cash flow insolvency”, meaning that a company cannot meet its payment obligations on time.

The cure for balance sheet insolvency is a capital cure; increasing assets, decreasing liabilities, or some combination of the two that results in a positive capital account.

But, what is the cure for cash flow insolvency?

The condition has two elements: a) payment capacity, and b) time.

So the approach to a cure for cash flow insolvency (absent a reduction in the actual amounts due) will have to be a combination of increased payment capacity and extended payment terms. Both of which are liquidity solutions.

In fact, absent the steps noted above with respect to balance sheet insolvency, the only REAL solutions for cash flow insolvency are LIQUIDITY solutions.

Moving from a discussion of the rarified issue of sovereign debt to the arena in which Buyers and Sellers on The Receivables Exchange spend their time, the realities include:

1. A large percentage of private businesses in the small-mid-size space are “balance sheet insolvent”.

The liability protections and the tax treatment of the S-Corp and the LLC, which dominate private business ownership structure, create a bias in favor of minimizing assets left in the business. Especially in companies with high depreciation expenses; these structures tend to generate negative net worth over time.

2. The balance sheets of many businesses in the SMB space tend to reflect the personal finances of the owners as much as they do the financial results of the companies.

For instance; often the liabilities that make the business “balance sheet insolvent” are loans due to the business owners, which would likely be treated as capital contributions in other circumstances. The odds of a business owner forcing a solvency crisis by accelerating a loan due him are (usually) low.

3. Many businesses in the SMB space are not far from the start-up phase and the early-period losses still dominate the balance sheet.

4. It is the income statement, or more-accurately, the BANK statement, that commands the attention of most private business owners. A high percentage will know their cash position every day. A very low percentage will examine their balance sheet in detail even quarterly.

5. Cash flow is the lifeblood of these businesses. If the bills can be paid and the owners can draw enough cash to meet their personal needs, the fact that the balance sheet shows a negative net worth is not likely to affect management’s decision making, at least in the short term.

6. But, as we all know, it is cash flow that has suffered most during the recent financial contraction and de-levering of credit-granting institutions. And the relative complacency of owners whose businesses are balance sheet insolvent does NOT apply equally to the case of cash flow insolvency.

7. Cash flow insolvency threatens the going-concern viability of small businesses to a far greater degree than balance sheet insolvency.

Many recent studies and surveys have documented that access to cash is the number one problem in the SMB market today.

It is precisely a LIQUIDITY solution that is required for a problem of cash flow insolvency. It might not be a permanent one. It might well be that a capital structure solution is required in the longer term.

But in today’s financing environment the acceleration of cash flow via the sale of accounts receivable might provide the BEST solution for many smaller businesses.

In the world of global sovereign debt finance there might be room to question the KIND of solution used for a financing problem. To a small business owner, though, the existence of ANY solution is a big, and a welcome, thing.

Maybe a knife doesn’t win in a fight against a gun. But if I don’t have any bullets for my gun, the knife looks like a pretty good alternative!

Sunday, August 15, 2010

The "Two-Feet-Deep" Danger

We’ve all heard the one about a man (hopefully a statistician) drowning in a river that is, on average, only two feet deep.

It’s not that the information about average depth is either inaccurate or unimportant. It’s just that it’s not ENOUGH information if you happen to be crossing at the wrong point.

In my last post I said that I’d write next about the 2nd quarter figures in the “National Summary of Domestic Trade Receivables” published by the Credit Research Foundation. The CRF has published this survey quarterly for 50 years.

I’ll only make broad comments because the material is copyrighted. See for subscription information and other products and services offered.

The CRF has devised and publishes a “Collection Effectiveness Index”, which is a single-figure indicator of the general health of the domestic trade receivables market.

That measure showed a significant improvement in 2Q-2010 compared to 1Q and a small improvement over the year-ago period. Most other aggregate measures they report showed similar improvements:

a) decreasing days-sales-outstanding,

b) decreasing delinquencies,

c) increasing percentage of accounts current, and

d) decreasing percentage of accounts over 91 days past due.

These high-level, market-wide measures are useful indicators that nevertheless have to be understood in the context of potential lag-effect, bias from sample size and bias from self-reporting.

The breakdown provided by industry group can be more valuable since it reveals substantial variances from the reported medians.

For example, in the category of “% Current” the range among industries in 2Q-2010 was from 39.13% to 94.76%.

Of particular interest to me as I studied the results was the disconnect between the improving picture painted in the CRF report and the anecdotal information that I’ve been hearing recently from clients and others. The message I’m hearing is that there has been a continued deterioration in the ability to collect money owed to small and mid-sized businesses.

I’ve written in prior posts about an organized and concerted movement by Wall Street houses to educate large, credit-worthy businesses on the virtue of substantially lengthening payment terms to their suppliers and then offering to accelerate payments at a discount.

This “squeeze the little guy” campaign demonstrates a cynical disregard for the long-term damage to the SMB community, which is so important a source of job creation. Its openly-stated purpose is to leverage the large companies’ access to cheap capital as a tool to force suppliers to reduce effective prices.

Let me add a few, admittedly anecdotal, data points from conversations I’ve had in just the past week:

1. A colleague told me the other day that he had knowledge that a large, multi-national company had instituted a new, purposely-draconian, “reject the invoice” policy. The AP staff of this company will now reject any invoice for ANY deviance from its increasingly complex and difficult-to-understand invoicing policy; requiring a revision and re-submission. And, of course, stringing out the time to payment.

2. A client told me this week that one of their customers; an architectural firm that had done a substantial amount of work for a large public hospital; had had to fight for over 120 days to get a check, which then bounced.

3. A colleague reported that a large, national customer recently notified a certain class of supplier that it suspected that there had been fraud on the part of some of those suppliers and so had put a freeze on ALL payments to ALL suppliers in that category until an audit could be completed. Completion of the audit is not expected until YEAR-END!

4. A professional services firm that has been in business since 1914 has had to enter into a workout payment arrangement with a subcontractor on some UNDISPUTED bills to a large municipal school construction agency that have been unpaid for nearly a YEAR.

5. A painting contractor that has been doing a significant volume of work for one of the largest residential property management firms in the area for over 20 years now has about 75% of its receivables at over 90 days.

These are just a few items that have come up in the past week.

It’s certainly possible that my experience reflects a regional bias. It’s possible that the lag effect is a partial explanation. It’s also possible that it reflects a bias toward the kind of client I typically deal with in my spot-factoring business.

But the anecdotal reports that I’ve been getting certainly paint a picture that is at variance with that of the 2Q CRF report.

I do not question the CRF results. I think that the information they compile and analyze is valuable and important and I’d recommend it to anyone interested in top-line industry trends. It might well be that the next quarterly report will show the sort of softening that current anecdotal information hints at.

What I do suggest is that the need for liquidity in the SMB market and, specifically, for acceleration of receivable collections in that market, continues to be among the top two or three problems facing business owners.

And that’s good for prospecting by the TRE Seller-marketing group.

Friday, August 6, 2010

Misfiring Synapses

Some days the coherence of a rifle shot gives way to the less-organized pattern of a scatter-gun. This is such a day.

Rather than a single topic, I have a scatter-shot list of points to make and issues to address.

So, here goes…..

1. This week we’ve marked the close-out of our 150th TRE auction. (We’ve bought all or part of 189 auctions to-date.)

I can no longer say that we have encountered NO repayment problems but I CAN say that the issues that we have encountered have been handled professionally and successfully.

2. It has ALWAYS been unrealistic to suggest or to believe that everything would always work smoothly in the environment of SMB factoring. It doesn’t and it won’t. The challenge is to anticipate and avoid situations with a higher likelihood of problems, even if that means refraining from bidding on auctions that seem very tempting.

3. I was reminded this week that holding-period duration can be every bit as important as discount rate. I made an error and bid on an auction that could potentially have been repaid so soon that the TRE fee structure would generate a negative or negligible return to the Buyer. As I was berating myself for the bidding error and hoping that somehow I could be spared “success” on that auction, another Buyer placed a more aggressive bid that I’m convinced was also an error on his part. Give thanks for dodged bullets!

4. I continue to believe that the TRE fee structure should be re-considered. It provides a powerful disincentive for Buyers to bid on short-duration auctions and, therefore, acts to damage Sellers’ ability to maximize utilization of the platform.

5. In last Friday’s “Liquidity Weekly” email, Bill Siegel noted that July was another record month for exchange volume. The actual volume figures are TRE’s, not mine, to make public. But I think I can add a specific data point of interest without violating the Buyer confidentiality agreement.

By my reckoning, July 2010 represented the 12th consecutive month during which auctions were closed on EVERY trading day of the month. That’s pretty cool—a full year without a zero on the daily volume chart.

6. As I was considering the last twelve months activity, I looked back just out of curiosity, at the activity in the last week of July 2009 versus that of the last week of July 2010. What I found was interesting.

A high percentage of the Sellers active in the current period were also active in the year-ago period. Some of that seemed coincidental. Two Sellers, for instance, that were active in July 2009 have been largely absent from the exchange over the past several months but happened to pop up in the last week of July 2010. And their auctions were treated very well buy Buyers.

In a couple of cases, Sellers that were active in both year-apart periods found that their pricing in the 2010 week was much different than in the 2009 week.

My interpretation of that is that the Buyers are paying more attention to the updated financial statements, to the strength and payment records of the Account Debtors and to the likely duration of auctions; and they are adjusting their bids accordingly.

In other words, the analytic process is improving, at least among the Buyers that have been active for a while. That’s a good and healthy development.

7. While there was a surprising number of Sellers active in each of the two periods studied, there has also been an interesting pattern of rotation in the more-active Sellers over the intervening months. One Seller will be a major driver of volume for a few months and then go “quiet”, for instance. Some of these are seasonal issues. Some seem to reflect the Seller acquiring more traditional financing sources.

8. The positive aspect of the historical pattern is that when one major Seller goes quiet another tends to come along to replace it in fairly short order. The volume pattern of the last year should not be interpreted as continually building on a base of established and reliable Sellers (although there are certainly quite a few in that category).

Rather, the pattern is more like “rotation” in the equity markets. Leadership changes and Seller -participation changes for a variety of reasons, but the top-line trajectory remains strongly positive.

9. It is to the Exchange’s credit that, so far, there have been new leaders brought on to replace those who go quiet in a fairly seamless pattern.

10. The Credit Research Foundation has just published its newest quarterly “National Summary of Domestic Trade Receivables”, which is quite interesting. I’ll write about that in my next post.

In the meantime, pardon the misfiring synapses of an August Friday afternoon!