How The Interest Rate Cuts Hurt MCAs

David Roitblat is the founder and CEO of Better Accounting Solutions, an accounting firm based in New York City, and a leading authority in specialized accounting for merchant cash advance companies. To connect with David, email david@betteraccountingsolutions.com.

In recent weeks, for the first time since 2020, the Federal Reserve cut interest rates by a historic 50 bps- a percentage that hasn’t been seen since 2008. The cut lines up with the Fed’s projections that inflation is coming down and their hopeful outlook for the economy, and while it might seem like good news for most industries, the merchant cash advance (MCA) sector has its own complex feelings to the dramatic change.

Obviously, unlike traditional businesses that might simply celebrate cheaper borrowing costs, MCAs operate in a space where the time-value of money and risk evaluation play major roles, making this rate cut a more nuanced event for the industry. The effects will be felt across multiple areas of the MCA business, from how funding decisions are made to the shifting expectations of clients seeking advances.

Our entire business exists to serve merchants that can’t easily secure loans from banks or other traditional lenders. These clients often turn to MCA providers for fast capital, even at higher costs, because they can’t wait for lengthy approval processes or don’t meet conventional lending criteria. In an environment where the Fed has reduced rates, traditional banks will also lower their rates, making loans more attractive to a wider pool of businesses. This increase in competition from more traditionally recognized financial institutions could pose a challenge for MCAs, which rely on servicing clients who can’t or won’t pursue standard loans. With lower interest rates, more businesses that typically look to MCAs for funding might find themselves newly eligible for cheaper and more merchant-friendly bank loans.

This shift in the competitive landscape means MCA business must be both more open and more selective in the clients they take on. If more of the relatively creditworthy businesses opt for traditional financing, MCA providers will see a shift in their applicant pool towards higher-risk clients. This introduces an even greater need for vigilance in deal underwriting. The riskier the client, the higher the potential for default, and MCA companies must make careful decisions to avoid unsustainable losses. Rate cuts at the Fed don’t just lower the costs of borrowing—they also squeeze the margins on risk. While banks can afford to cut rates for a broad swath of clients, MCA companies operate on thinner margins due to the nature of the businesses they work with. I’ve long been an advocate of businesses embracing what initially appears to be riskier propositions, but that doesn’t come at the expense of ensuring they have a good chance of paying you back.

Additionally, the Fed’s decision also affects inflation expectations, which in turn impacts how MCA providers price their advances. In a higher inflation environment, MCAs can justify their higher factor rates more easily, as they are providing capital at a time when the value of money is declining faster. But with the rate cuts signaling a more accommodative stance from the Fed, inflation is expected to stabilize, or even decline, over time. This changes the conversation around MCA pricing. Businesses may push back harder on MCA rates, arguing that with cheaper money available elsewhere and stable inflation, the high cost of cash advances feels disproportionate. MCA companies will need to defend their pricing models in a market where the cost of borrowing is generally falling.

Of course, rate cuts can also benefit the MCA industry. Lower interest rates can improve liquidity across the market, which means MCA companies may find it easier to access their own lines of credit or syndicate deals with investors. With cheaper money flowing through the economy, investors might be more willing to syndicate MCA deals, seeing them as a worthwhile risk given the higher returns MCAs can offer compared to more traditional investments. This could lead to more efficient underwriting processes, helping MCA companies better evaluate potential clients and manage their risk portfolios more effectively.

But there is also the longer-term concern of economic volatility to consider. Interest rate cuts are often seen as a tool to stimulate a sluggish economy or to project confidence during an election season, but they can also be a warning sign that things are not going well. If the rate cut is a harbinger of broader economic challenges, MCA providers should brace themselves for increased default rates. When businesses are struggling, they may be more likely to fall behind on their payments, making it harder for MCA companies to collect on advances. The specter of recession looms over any rate cut, and MCA companies, which cater to businesses that may already be operating on the edge, must be prepared for a potential uptick in defaults.

Ultimately, the impact of the rate cut on the MCA industry will depend on how both MCA providers and their clients adapt to the new financial environment. While lower rates might make it harder for MCA companies to compete with traditional lenders, they also open up new avenues for growth, particularly if companies can leverage cheaper credit to improve their operations and attract new investors. The key for MCA companies is to remain vigilant, carefully assess their risk, and be prepared to explain the value they offer in a world where borrowing is getting cheaper. As always, the MCA industry thrives on its ability to respond quickly to market conditions, and this latest development from the Fed will be another chance for the business to prove its resilience.

David Roitblat is the founder and CEO of Better Accounting Solutions, an accounting firm based in New York City, and a leading authority in specialized accounting for merchant cash advance companies.

To connect with David, email david@betteraccountingsolutions.com.