Get Working Capital at Competitive Rates - Accounts Receivable Financing at The Receivables Exchange

Credit in financial markets is the current focus of the world wide media. Today's discussion of credit is not the traditional margin credit of previous booms. Instead, the discussion revolves around swaps, repos, options and other forms of derivatives that most people in the financial world are unfamiliar with. The use of and dollar volume in these instruments has grown at a very fast pace over the past 30 years. In many cases, this has made the world economy more flexible and resilient during times of stress and shock.

The innovation of these instruments and general economic success that the US economy has enjoyed has provided the housing and business cycle with a smoothing mechanism. This has helped hide, until now, the repercussions of loose lending standards. The growth in the derivates market, especially the asset back CDO market, has been jaw-dropping and serves as a good example of the leverage and appetite for risk that led the U.S. to the position it is in today. From its peak in the first quarter of 2007, new CDO issuance is down 95% (from $186 billion to $11 billion). This precipitous drop not only highlights the poor credit quality of the 2006 and 2007 vintage CDO's but also the decreased appetite for risk currently in the market.

With the first de-leveraging of world financial markets in 18 years, we are just beginning to see an extended decline in new loan growth. This is not because new loan growth has slowed but because credit lines that were set up for a rainy day before the Credit Crisis take an average of 12 months to peak out. August of 2008 will be the twelfth month marker.

By looking at past international credit crises (including Finland in 1991, Japan in 1992, Norway in 1988, and Sweden in 1991), the Bank of England concluded that in the aftermath of a credit crisis, it has historically taken 4.3 years for bank lending growth to revert to trend. We are currently facing a financial system that is in its first year of perhaps a 4.3 year (on average) de-leveraging cycle. That is taking into account the length of the previous 2 serious periods of de-leveraging (1991-1994 and 1975-1977) in the U.S. over the last 30 years. The average 5 year growth in credit going into these previous de-leveraging periods was 3.8 percent. During the past 5 years, the growth in credit going into the current cycle was 6.4 percent, a much faster growth in the amount of leverage in the financial system.

De-leveraging is not going to slow down tomorrow. As pointed out by Satyajit Das in his article "Nuclear De-Leveraging", we are in the initial phases of a massive de-leveraging throughout the whole economy which could continue to accelerate. We are possibly on the cusp of a serious contraction in gross domestic product, and we think that is why the Federal Reserve has been so vigilant in cutting rates and doing everything they can to stop the contraction. The deleveraging process can have a circuitous effect that has the potential to harm the underlying economy and the banking system.

The world's largest financial institutions are being forced to de-lever their balance sheets. By selling assets and raising capital, banks can preserve their capital ratios. Since the beginning of 2007, banks have recorded credit losses of $329.2 billion. Yet, they have only raised $246.6 billion to cover these loses. Credit standards and interest rates are rising which is slows the growth in new loans during a period when the economy needs easy credit and low interest rates in order to stabilize. Businesses are at a difficult place where only the most fortunate borrowers, who do not need loans, are being offered credit. The bottom line is that financial institutions are going to any lengths to shore up their balance sheets and raise capital right now.

Large institutions that supply the regional smaller institutions with money are tightening lending standards on interbank lending as well. Swap rates and LIBOR are significantly higher than the interest rates set by the Federal Reserve indicating that uncertainty remains in lending between banks. Big banks need to help themselves first so they can continue to fund smaller institutions and businesses in need of growth capital.

The silver lining in this situation is that many non-financial businesses and niche financial institutions in the U.S.A. and around the world have never had such solid balance sheets as they have right now. It is due to a number of factors that are beyond the scope of this article, but it highlights the fact that the world is not over as we know it. It is the cash rich institutions that are right now positioned to capitalize on this current situation. For example, according to Bloomberg News, John Paulson, the money manager whose wagers against the U.S. housing market helped his flagship Credit fund earn a gross return of 690% in 2007, is planning to start another hedge fund to provide capital to financial firms hurt by mortgage write-downs. Many of these well-funded institutions currently lack the infrastructure to accomplish the sourcing of new loans. So instead, they are investing at the equity level of the bank holding company. This type of transaction allows fresh capital to flow to banks which can then resume lending.

It has been said, in a joking way, that commercial and investment banks were in the business of financing hedge funds, and hedge funds are now the new banks of the 21st Century. Even with rigorous underwriting standards, banks were unable to avoid problematic loans. Now, hedge funds and sovereign wealth funds are providing the capital to support some of these institutions. Roughly 25% of the $246.6 billion of capital raised by global financial institutions has come from hedge and sovereign wealth funds.

This is where The Receivables Exchange can bridge the gap between cash rich institutions and the small and medium-sized businesses (SMB's) that need money to finance operations. The Exchange is the world's first online marketplace for real-time trading of accounts receivable where registered companies can list single or multiple invoices. The invoices are then auctioned and bid on by a global network of accredited Capital Providers. The Exchange will standardize and centralize the Account Receivable (AR) asset class and create a capital market for SMB's while providing a rich origination platform for financial companies looking to invest in the asset class.

The Receivables Exchange is the only game in town right now for the full spectrum of borrowers and lenders. We believe this market was long overdue for change and the fact is that the turmoil has provided the opening for businesses to get the best interest rate. Their platform takes open market theory and competition to get the borrower the best rate available. For investors that are looking for a better return than the 2.6 percent they are receiving on 2 year Treasuries, accounts receivable financing can be a very easy and secure way to increase the overall return on their firm's portfolio. Historically, the AR asset class as represented below by the ABL Index has provided very steady, non-correlated returns.

For SMB's, the Receivables Exchange will offer a new avenue for short term finance that is flexible, fast and will compliment a company's current options for external liquidity. Most importantly, by using the exchange model, SMB's will be able to take advantage a competitive pool of capital providers that will bid for the right to advance funding to a company. With a centralized exchange, we believe that the potential for increased liquidity and transparency could allow people that did not have the time or contacts the ability to participate as investors. The increased volumes and number of participants brought about by the innovation of The Receivables Exchange will benefit both investors and small and medium-sized businesses. The Receivables Exchange is not creating a new asset class. Instead, they are changing the way that people who utilize this asset class go about their business whether that be as an investor who buys accounts receivable assets or as a CFO who uses accounts receivable as collateral for finance. This asset class has been around since the beginning of time, and it is more important than ever given the stage of the credit cycle we are at right now.

We see this technology and service as an integral part in handling the current Credit Crisis. A parallel example that illustrates the potential of The Receivables Exchange would be the potential for large Commercial and Investment banks to use the Receivables Exchange as a source of liquidity for their on-balance sheet securities. These securities are currently highly illiquid and thinly traded. Applying this technology to hard-to-value securities will serve as a mechanism for price discovery which all banks could use to calculate the value of their inventory. With the successful launch of The Receivables Exchange, we see many future uses for the product.

Here is one last story before we finish up. We did not go into real estate because we never knew with certainty what the real estate was worth. There are many people like us that get involved in banking and finance who feel the exact same way. The Receivables Exchange takes the guesswork out of fair market value. It will attract people that want to invest in accounts receivables but do not have the time to build an insider network to buy and sell this asset class. Similarly, it will provide SMB's with a new source of competitively priced short term financing.

Mr. Corcelli is Managing Member of Alexander Alternative Capital, LLC a global macro hedge fund based out of Miami, Florida.