Looking to attract vultures? Put out some distressed prey.
That’s a truism that a new online exchange, T-Rex (for trade-receivable exchange) wants to put into play. Launched Tuesday, T-Rex provides online auctions for bankruptcy trade claims, trade-credit insurance, and receivables-purchase contracts (also called put options). On the day that it launched, T-Rex featured its first auction—a $261,499 trade claim for bankrupt Northwest Airlines.
The exchange is out to improve the efficiency and liquidity of a market that by some estimates has grown to $500 billion. The process is straightforward: free of charge, credit managers can post an auction for their unsecured, Chapter 11 trade claims on bankrupt companies. If the exchange works as planned, the competition should give credit managers the chance to sell their claims at a higher price, and on more favorable contract terms, than those of deal struck with single buyers of distressed debt.
In general, a buyer of distressed debt (also known as a “vulture investor”) swoops in when a debtor is in trouble, offering to buy the stranded debt from creditors at deep discounts. The buyer then pools the debt with other receivables to thin out the risk and resells the package at a higher price than if the individual receivables were sold separately.
The problem with the current system, says Stephen Bastien, owner of Creditnews.com, an information service for credit managers, is that companies traditionally “fly by the seat of their pants” when appraising such offers. Bastien, a former credit manager for DeSoto Chemical (now part of PPG Industries) explains that even after poring over financial statements and credit reports to determine whether a trade claims offer is fair, it’s only an educated guess—”and often it doesn’t seem very educated.”
The exchange “makes a [traditionally] inefficient market more liquid,” notes Ray Poulos, director of credit at Tech Data Corp., a wholesale computer distributor that generates $20 billion in sales annually. Poulos, a former foreign exchange trader for Kodak, says that unlike the transparent currency markets, pricing for distressed debt “is hidden.”
“Vulture investors thrive on secrecy,” claimed T-Rex co-founder David Williams. He explains that confidentiality agreements are commonly used to prevent creditors from sharing the terms of their bankruptcy-claims sales, and that many creditors get “low-balled on pricing,” because of the lack of transparency. The idea that Williams and co-found Parker Freedman have is to make the opaque pricing transparent and let the free market orchestrate the rest.
Other distressed asset exchanges, such as Assetsforsale.com, exist. But the auctions focus primarily on consumer assets like houses, cars, and credit-card debt. T-Rex wants to take a piece of the commercial credit market.
Indeed, current market conditions may have made the emergence of an exchange like T-Rex possible. For the past two years, conventional insurance companies and new market entrants like hedge funds and specialty insurers have been introducing put options, trade credit single-debtors coverage, and other new risk-transfer products to clients, says Pieter van Ede, trade credit practice leader for insurance broker Marsh. “There is a trend toward alternative [insurance] solutions,” as bankruptcies decline (50 percent over the last year), and carriers are looking for new ways to boost business, he says.