Thursday, March 15, 2012

The REST of the story...

REVISED 3/25/2012 CRL

I got a note after my last post from a regular reader who is smart and knowledgeable and very much a part of the supply-chain finance industry. He’s not directly involved with TRE but is quite familiar with the sell-side mechanics of the process.

I referred only briefly in that post to potential market reactions to recently-instituted fee changes. He wrote that he was unaware of any changes in the fee structure. But his comment was specific to the sell-side and was made in a way that suggested he might not be aware that Buyers also pay fees.

From a subsequent exchange of notes I learned that, in fact, he was NOT aware of the existence of Buyer fees. His assumption seemed to have been that the costs of TRE transactions were borne by Sellers only.

I asked myself: if this bright and well-informed person is unaware of the existence of fees charged by TRE to Buyers, who else might be trying to understand TRE auction dynamics knowing only a part of the story?

I’ve been curious about some Sellers who devise odd-looking pricing parameters that produce round numbers when the monthly discount is divided by the advance rate and the result is multiplied by 12. I ask myself: is it possible that this Seller really believes that such a fee structure is an appropriate way to think about either his cost of funds or the the return to the Buyer?

For example: does the Seller who prices an auction at 1.05% per month with an 90% advance rate really believe that he is “offering” the Buyer a 14% annualized return (.0105/.9 x 12 = .14)?

If so, that would actually explain a lot of Seller pricing and behavior that seems odd from the buy-side.

Those whose experience listening to radio news broadcasts goes back far enough will remember one of the most distinctive of radio personalities of the 20th century: Paul Harvey. Harvey ended his newscasts with a distinctively-delivered summary line:

“And now you know the REST of the story!”

So, for the benefit of those who might not be familiar with the existence of Buyer fees let me first assure you that TRE Buyers DO pay fees. I can’t actually tell you what the fees ARE but I can offer some general comments about them.

To the Seller (above) who might have thought he was “offering” the Buyer a 14% annualized return, I'd say that the ACTUAL annualized return to the Buyer will certainly be meaningfully lower than that and, in fact, depending on the auction size, duration and terms, it could be could be far lower. If the auction were paid back TOO quickly, the fees charged to the Buyer could actually exceed those earned on the auction!

TRE Buyers are charged fees that are based on the size of the auction and on the gross discount earned. The fees based on the size of the auction are paid when the auction is purchased and will vary depending on whether or not the auction is subject to risk-mitigation program charges.

I've written before about the importance of auction duration to the Buyer's return from a TRE auction. Because there is a fee component that is based on auction size, regardless of earnings, the shorter the duration of the auction (all else equal) the greater the portion of total earnings that are consumed by fees.

I can offer a current example...

I purchased an auction on March 16. The invoice in that auction had a due date of April 11 and prior history suggested that a payment date close to the due date could be reasonably expected. With an expected duration of about 26 days the anticipated return seemed fair to me.

But in fact, the invoice was paid quite early and the auction was closed out on March 23, producing an actual auction duration of only 7 days.

The impact of the very short duration was to magnify the effect of the fixed transaction fees, substantially increasing the proportion of the gross discount that was absorbed by fees. That, of course, substantially diluted my actual annualized return.

In fact, the only reason my actual return was positive, given such a short duration, was because the auction was not a part of the risk mitigation program. If it had been part of that program the total of all fees payable would have exceed the total gross earnings.

That sort of situation has happened before but, in fairness, it hasn't happened to me very often.

But because the calculation of a Buyer's total fees and costs has a number of variables, there is no simple way to describe the relationship between the "apparent return" that might be suggested by the basic auction pricing and either the actual expected return or the actual realized return to the Buyer on that auction.

The following statements are true, however:

--in any TRE auction, the Buyer will pay a meaningful percentage of the gross discount to TRE for the various Buyer fees charged,

--certain fairly common circumstances can produce auction economics in which the fees payable by the Buyer are equal to or greater than the income actually retained by the Buyer from an auction, and

--it is possible that, depending on actual circumstances, the "successful" Buyer of an auction can close out a deal at a loss even if all invoices purchased are paid in full.

None of this will come as any surprise to the experienced Buyer or to the Exchange. But I don't know how many TRE Sellers are actually aware of these circumstances.

It is unfortunate, in my view, that TRE chooses to maintain that all such matters must be kept confidential. Its competitors, while admittedly a long way behind TRE in market development, make their fee structures public. In such circumstances Sellers can tell quite easily what the actual returns to Buyers of their auctions will be.

Ultimately the Seller pays. The question is: "Who does the Seller pay?"

If the Seller thinks it is paying the Buyer compensation that is actually going to TRE, via the Buyer fees, that misconception can potentially distort market dynamics.

And that’s at least PART of the rest of the story!

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