Impact Of COVID-19 on The Merchant Cash Advance Market

deBanked recently caught up with Gunes Kulaligil, author of Merchant Cash Advance Valuation Dynamics.

Gunes Kulaligil: The pandemic has redefined what “off the charts” means for unemployment claims and other leading economic indicators, but the full impact of job losses and halted economic activity has yet to be observed in the credit performance of many specialty finance assets. MCAs are unique in the sense that payments are daily or weekly and tied directly to revenues. As such, we were able to observe the preliminary impact of the lockdown on MCA cashflows earlier than for most other types of non-bank specialty finance loans.

When incomes and revenues are disrupted, consumers and businesses alike will often prioritize which debt to service first. They may be unwilling to pay certain accounts, even if able to do so, in order to preserve cash for prolonged uncertainty. However, this is not the case for MCAs as payments are remitted automatically; therefore, the cashflows are aligned with and reflect true business performance free of the impact of payment prioritization. As early as the second half of March, we observed payments from merchants drop approximately 20% to 30% depending on the type of industry. In addition, payment pace continued to decline into April and May, albeit at a slower pace, as modifications and servicing efforts picked up. Funders have a vested interest in merchants being able to stay in business and to build their revenues back up. Thus, any modification effort — whether that is a deferral, reduced percentage of sales remitted, or lower payback amounts — that incentivizes the merchant and provides some flexibility goes a long way.

At the same time, funders’ portfolios look worse as performing MCAs pay down and a lack of new origination results mechanically in the remainder of their portfolios having more tail risk – a lack of new origination would be a drag on performance even without the pandemic. For these portfolios, it is crucial to monitor portfolio performance at a granular level to identify businesses that will successfully navigate reopening and increase their revenues; so that servicing resources can be directed where they are most needed and will be most effective. Funders that have invested in technology and maintain connectivity with merchants via CRM tools and with established servicing / resolution teams and processes will have a competitive edge in doing so.

Poor performance caused by the pandemic has also led warehouse facilities to breach covenants or take-out partners to pause purchases unless platforms pledge additional skin in the game or pay higher interest rates to go forward with covenant modifications or resume purchases. They may also increase monitoring requirements and the level of oversight they apply.

deBanked: Conversely, is the pandemic creating any opportunities for funders and brokers as the situation develops?

Gunes Kulaligil: Indeed. While the near-term outlook is grim, a lot of relief and stimulus is working its way through the economy. The U.S. Government is intent on providing support as states are starting to re-open as quickly and as safely as possible. In retrospect, nobody had a pandemic playbook and programs like PPP were designed, deployed and funded on the fly with collaboration from both banks and non-bank lenders during volatile markets.

Non-bank lenders’ success in being able to reach truly small businesses, as well as the speed and efficiency in deploying the funds, has not gone unnoticed. The PPP experience also highlighted stark differences between the types of clients that large commercial banks serve versus those served by non-bank lenders. As deBanked reported, banks focused on larger clients whereas non-bank and fintech lenders assisted much smaller businesses in comparison. Origination fees on PPP loans were not insignificant either. SBA pays PPP lenders a 1% to 5% origination fee depending on the funded amount. For example, Ready Capital reported a gross revenue of $100 million on $2.1 billion funded. Notably, Ready Capital’s average PPP loan size was approximately $70,000 compared to an average of more than $500,000 for JP Morgan Chase for approximately $15 billion the bank funded in round one of PPP.

Small business activity is not only a leading indicator of distress but also at the center of any significant economic recovery. Small businesses account for 45% of GDP with 88% of these businesses employing fewer than 20 people. There is no meaningful recovery without small businesses getting back on their feet. As businesses re-emerge, their financing needs will vary widely in timing, amount, frequency, term, etc. depending on industry and many other factors. Continued involvement from the federal government whether in the form of deploying more low-interest rate loans, forgivable loans or loans with some sort of guarantee is likely. Lenders who can continue to serve their clients either by extending a suite of bespoke private credit or by facilitating the deployment and servicing of government funds will succeed.

Brendan Garrett was a Reporter at deBanked.