Push Back and Protest Bids

Before I get to the point of this post I’d like to introduce our new web site:

www.1150Investments.com

1150 Investments LLC was formed in 4Q 2010 to carry on and expand the TRE buying activity of The Interface Financial Group, LLC.

I invite any members of the TRE “family” to link to our site, which also contains a link to this blog.

Now to the point:

I’ve written several times since last September about the impact of increased liquidity on buy-side TRE auction yields. The trajectory of buy-side yields has been steeply negative since the last week of August 2010.

We’ve wondered when and at what level resistance might ultimately be encountered.

It appears that the answer to “When?” might now be developing.

Just as it took some time to confirm that the downward trajectory constituted a trend, it will take some time to confirm that the situation has changed again. But it IS beginning to look like we might have reached a point where stability is being sought.

That doesn’t say that returns to Buyers are rising but it MIGHT signal that they’ve stopped falling.

Over the past week or so we’ve begun to see some auctions stay on the screen for appreciably longer periods than has been the case for some time now. Many of those have ultimately sold at buy-out pricing but they haven’t sold as QUICKLY at that pricing as they might have a month ago.

Even some of the Sellers that have become accustomed to split-second sales at ever-decreasing cost have gotten some modestly chilly receptions recently.

Buyers of these auctions, while still willing to buy, have begun to place bids more often at levels higher than the buy-out prices. More often now we’re seeing several competing bidders “walking” the pricing down to the point of ultimate sale.

As to the questions of: “Where?” the trend might end, I can’t use absolute numbers under the confidentiality rules of the Exchange but I can say that our own calculations of dollar-weighted average returns for all TRE auctions have fallen by about 38% since September 2010. That’s a substantial reduction that cannot, in my opinion, be attributed (at least wholly) to decreased risk perception.

While there are quite a few Sellers that have proven themselves over that period and should reasonably command better pricing; when the entire auction portfolio is considered, a large part of the return decline, I believe, has to be attributed to increased market liquidity in the face of only modestly increasing supply.

If that is true, then there should be scope for a retracement of at least a portion of the yield declines of the past 5 months. IF and when, of course, supply begins to catch up with demand.

The type of bidding that I’ve described above, that requires a Seller to wait a while before closing a transaction and involves a process where actual BIDDING occurs, as opposed to immediate buy-outs, I call “push-back” bidding. Especially in the face of declining buy-out parameters.

The Buyers are not inclined to immediately accept whatever is offered at whatever price is asked.

But there’s another type of bidding that has also become evident in recent days. I call it “protest” bidding.

Protest bids have been showing up recently in cases where Sellers post auctions with pricing that is SO low that some Buyers express their annoyance by registering a bid SO far out of the money that it can only be interpreted as a message to the Seller.

The message is “WHAT are you thinking!” (Or, maybe “What are you smoking!”) And certainly conveys the message “Not ME, my friend!”

I must say that I find these protest bids refreshing. They are really the only way Buyers can communicate to Sellers, to other Buyers and to TRE that what they see on the screen is beyond what they consider rational.

SO……while it’s too early to call a trend change, there ARE some signs in the market that we might be nearing the end of the free-fall in yields that began last September.

From my point of view, that would be healthy for all concerned.

The Very Good Gets Much Better

One of the first items I discussed on this blog was the advantage of the Louisiana treatment of receivables transactions. The so-called “true sale” provision of the LA version of UCC Section 9 largely removes the potential that a purchase of receivables might be subsequently deemed a financing rather than an asset sale.

That’s a big deal and one of the reasons that TRE chose New Orleans as its headquarters.

Now that benefit has been significantly expanded and essentially “tailored” to specifically include transactions on the Exchange.

Governor Bobby Jindal took time out from his work on the BP oil spill to sign into law Louisiana Senate Bill No. 256 (Act 958) entitled the “Louisiana Exchange Sale of Receivables Act”.

The title of the law itself signals one of its principal benefits to TRE.

It does not apply to ALL transactions involving receivables sold in Louisiana. Rather, it deals only with those receivables transactions that take place “over electronic and other types of exchanges located in” Louisiana.

In other words: transactions that occur on TRE.

To make its aims quite clear, the stated legislative intent is specific i.e. “to encourage and promote businesses to offer sellers the ability to sell their receivables to qualified buyers over electronic and other types of exchanges in this state, thereby availing themselves of Louisiana civil law principles not found in common law jurisdictions…”

A few of the new advantages accorded exchange-based transactions are:

1. Clear and specific language affirming that exchange-based transactions are included under the very strong “true sale” protections already in the Louisiana law.

2. Clear and specific language affirming that exchange-based transactions will not be re-characterized as financing transactions even when seller-guarantees of repayment are provided and even when the seller might be entitled to subsequent additional payments for the receivables sold.

3. Clear and specific rejection of common law theories under which sale of receivables have been considered financing transactions in other jurisdictions.

4. Expansion of the definition of “receivable” to include other third-party domestic and international payment obligations that are not subject to the Uniform Commercial Code.

5. Provisions requiring anyone who attempts to re-characterize receivables transactions as financing transactions to pay the exchange-buyer’s costs to defend itself.

6. Clear, strong and specific language regarding the application of Louisiana law, and of these provisions particularly, regardless of the legal domicile of the seller, the buyer or the account debtor.

7. Provisions making clear the right of a buyer of exchange-traded receivables to resell the receivables purchased and to pledge or grant a security interest in the receivables purchased: in other words, facilitating a buyer’s securing financing to purchase exchange-traded receivables.

I again remind everyone that I’m not a lawyer, but as I see it there are some really big things in this bill, which should probably be titled the “Let’s Help TRE As Much As We Can ” Act.

Clarifying the “true sale” status of exchange-traded transactions is a very good thing. And this is the principal benefit discussed in the press release from TRE on this new legislation.

Specifically prohibiting re-characterization of exchange-based transactions is a good thing.

Providing for buyers’ entitlement to recover costs is a good thing.

But, from my point of view, the really BIG things in the bill are:

a) The expansion of the definition of “receivables”. This is not discussed in the TRE release but opens the door to new markets that could be of major benefit to the Exchange and its participants.

b) The specific provisions allowing exchange-traded receivables to be pledged as security. This will certainly aid those buyers looking to obtain leverage without pledging other assets as security.

c) The provisions that basically say “our law is THE law and the rest of you can go to hell”. The language of the Louisiana legislature is very strong on this point and while there has not been, to my knowledge, a test of the choice-of-law provisions in the TRE participant agreements, this language looks to have been crafted by a lawyer wanting to pre-empt any challenge of those provisions.

The “true sale” issue is obviously important but I think these three provisions might actually provide the more important springboard for TRE’s growth.

My guess is that we’ll see some creative use made of these new provisions sooner rather than later.

Congratulations, TRE! And congratulations Louisiana!

Well done.

Business As Usual

I started buying TRE auctions on June 1 of last year. The Exchange was still in its fairly early days of operation and each new auction posted seemed to represent something of an event.

There were two days in the first half of last June, in fact, on which no auctions closed. It certainly seemed at that time that there were more dollars seeking auctions than there were auctions to bid on. So “losing” an auction was, at least for me, kind of a big thing.

There have been many changes in TRE operations and dynamics since that time. By my count, over the same period in June of this year there have been five times as many auctions sold as last year and the average daily dollar volume has increased by a similar factor.

The number of Sellers has continued to increase and, while there are quite a few that don’t make it through our screen, there are quite a few that do. There is now a significant number of Sellers, in fact, that I’m quite pleased to buy from.

One of the happy consequences of the continued maturation of the Exchange is that it no longer feels like such a big deal when an auction is “lost”.

A year ago, the process of analyzing a Seller; analyzing it’s Debtor(s); reviewing the invoices posted; considering the past auction history; deciding to bid; and then actually placing a bid; represented not only a significant investment of time and energy but had an emotional component as well.

It represented a serious commitment. To fail to win an auction after all that actually felt something like a failure.

Well, times have changed. I “lost” two auctions yesterday that I bid on actively. I liked the Sellers. I liked the Debtors. I’d had good experience with each and I offered competitive pricing—actually a series of increasingly competitive bids.

And then those auctions, that I really assumed I was going to win, were just gone; snapped up at prices that I suspect pleased the Sellers quite a bit but left me empty-handed.

But here’s the point……

I didn’t get THOSE two auctions--but later in the day I got two others.

And I know that the Sellers of the auctions I lost are likely to be back very soon and I’ll have another opportunity to buy some of their invoices.

It’s no longer an “occasion” when a good auction is posted for sale. It’s business-as-usual. If I miss one today I’ll have another chance tomorrow.

On the other side of the coin, if a Seller has to pay a little more today because of the dynamics of this particular day’s activity, he can probably count on evening the score on a day when the Buyers are feeling the pressure to put money to work.

In short, what was a novelty a year ago is not a novelty today.

When I log onto the TRE platform tomorrow morning I will have every expectation that I’m going to have the chance to do some business.

Some days will be better than others. You win some and you lose some.

But that’s what a market is about, right.

And that’s what the Exchange has now really become.

Sizing It Up

In my March 21 post, “The Diet of 900 lb Gorillas”, I referred to the recently-published Morgan Stanley report on B2B Finance. That report raises a number of issues, only one of which was really addressed in that prior post, so I want to return to it again.

This time I want to point out a couple of statistics that are key to assessing the long-term potential of The Receivables Exchange.

The first of those statistics is the gross size of the SME (small to mid-sized enterprises) market. Morgan Stanley reports that the SME market accounts for about 45% of all business revenues in the US. Morgan defines the SME category as all businesses with annual revenues of less than $500 million.

Now for the purposes of discussing TRE’s near-to-intermediate term potential it’s unrealistic to assume that its addressable market includes businesses with $500 million in sales. So we have to adjust Morgan's 45% figure.

The smallest category Morgan uses comprises businesses with revenues of less than $25 million. That category accounts for 25% of total corporate revenues.

TRE requires Sellers to have annual revenues of about $1.5 million and, at present, a $25 million Seller would be at the upper end of the TRE size spectrum. So this is really the near-term target market-segment for TRE marketing efforts.

To eliminate those businesses that are too small to qualify for TRE Seller membership we have to reduce the 25% total. This is completely guesswork on my part but I suspect we wouldn’t be far off if we reduced the 25% figure to maybe 15-20% to eliminate the smallest businesses.

If we apply the 15-20% range to the estimate (based on the Fed’s flow-of-funds report) of the overall volume of annual B2B accounts receivable generation (about $18 Trillion), that suggests a potentially-addressable, near-term market size in the range of $2.7 to $3.6 Trillion.

That ignores the fact that some of those businesses, especially the smaller ones, probably do not extend trade credit, but it’s also the case that some large businesses extend very little trade credit. It’s hard to know how to adjust those volume figures with any confidence, so I’ll just let them stand with the caveat that there are potentials for error from a number of sources.

If we use the mid-point of that indicated range, or $3.15 Trillion, and we assume an average AR duration (days-to-pay) of 45; that suggests that the average outstanding AR balance on the books of that segment of the business community would be about $390 Billion.

That’s a big number!

The Morgan Stanley estimate of the total US factoring market is given at $136 Billion, suggesting that our estimate of the near-term, potential TRE-addressable market is three times the size of the entire current industry. But that's not really the appropriate comparison.

It is clear that the smallest businesses will account for no more than their relative percentage of the total factoring market and probably quite a bit less. How much less is a guess, but let’s just say for conversation that it’s overstated by 100%, or that the actual factoring activity in this smallest segment of the economy is half its representation in the total economy.

That would suggest that $10-$13 Billion is employed by the factoring community in the smallest segment of US business.

If that’s anywhere close to the mark, it implies a current market penetration of only 3% or so of indicated near-term potential.

If a realistic maximum penetration were, for argument's sake, to be measured at 25% of the currently-addressable market, the implied potential would be $390 Billion x .25 = $97.5 Billion, less (about) $12.5 billion (already served), or something in the range of $85 Billion in potential for capital employment.

That’s clearly a market worthwhile pursuing.

And that is without considering the potential ultimately afforded by businesses with revenues above $25 million, some of which, over time, should be attracted to the flexibility of an auction environment.

On the other hand, it has to be recognized that many smaller businesses are in no condition to be brought to TRE at this point.

TRE’s marketing effort has to include a long-range education program to bring potential Sellers to the realization that “clean” and accurate financial records and disciplined management of their billing and other AR functions are critical to positioning themselves for access to a market like TRE.

It’s easy to make the case that the market potential for TRE is substantial in the near-term and extremely substantial in the longer-term.

It’s not a stretch to view the TRE growth curve as exponential for some time to come.

But that doesn’t mean achieving that potential is a certainty.

There are difficult problems to be solved, not least of which is maintaining the discipline required to adequately vet potential Sellers and to strictly implement the safeguards in place to protect against abuses.

But it seems clear that the size of the opportunity makes tackling the problems well worth the effort.