[memorifa]

Hello there,

I am new to the forum (which I think is brilliant).
I have been reading several great posts and and articles and ACH daily debiting is a recurring theme which has been looked at in many angles.

Yet, given its novelty, there is really very little quantifiable information on its worth, specially in helping reduce credit risk.

Does anybody have an idea on how much using ACH daily debiting helps reduce credit risk?

If it could be quantified, we could really understand which is the lower bracket FICO score one could consider for funding.

Cheers

Memo

[MCNetwork]

I think you have to separate the first position ACH loan merchants from the merchants that have ACH stacks in place. The criteria to be approved for first position ACH loans is much higher than split funding programs, so by nature the credit risk is already minimized. Merchants with ACH stacks on the other hand tend to have a riskier credit profile and the high factors reflect this.

[memorifa]

Hi MCNetwork,

Thanks for the reply. You are right in your point of view. Pre-stack is less risky the post-stack.

In the site´s magazine, Sean discusses the ACH daily debiting phenomena as the secret sauce to enter this risky market. Which, as an ex-banker, my common sense suggets it is right.

I just wonder, how much does it really help? I mean, will it take 500 FICO score people and make them good? What about 450? Any studies of quantifiable information would be valuable for all.

Cheers and thanks again.

Memo

[MCNetwork]

I don't think Sean was singling out ACH daily debiting as the secret sauce. He's lumping in the daily remittances from credit cards and the ACH debits together. Both programs involve a daily payment to the lender and THAT is what mitigates risk, as opposed to waiting for a monthly payment like in a typical bank loan. With a daily micropayment or credit card remittance, you start seeing a return on your investment from Day 1. This enables you to immediately reinvest your proceeds in the marketplace and turbocharge the compounding interest in your portfolio.

An ACH loan does not make a 500 FICO person "good". In fact, the majority of sub-500 FICO merchants are auto declined anyway.

[funding pro]

To add to MCN, issues that may arise with a merchant's ability and/or willingness to follow the terms of the advance can be identified the day you have a reject instead of having to wait till that once a month that the payment is due. At that point it may be too late to help.

[memorifa]

Hello,

Thanks for the replies gentlemen.
I completely agree with both of you. The daily remittances from credit and ACH together give you several benefits:

1.- You get to see sooner any problem with your client, compared to waiting for a whole month
2.- You get to see a return from day one, which allows you to reinvest the proceeds into more deals, thus compounding your income
3.- It is a way to have more control over your client

In addition to these benefits, I believe one of the benefits is that you are "intervening" the cash flow of the client which allows the funder to decrease the risk of the person not voluntarily going to the bank and paying the financing.

This sort of mechanism is similar to what you do when you try to finance a highway: the banker which finances the highway gets an agreement with the local/federal government that the bank will intervene the tolls (cash flow) of the highway. The result is that every time a car passes the toll, an amount of cash goes to the operating costs and an amount goes to the bank. I oversimplified, but it is more or less the mechanics.

What I am trying to grasp, is that by intervening the SMEs cash flow (bank account) though daily debits, how much less risky will a customer become?
Guys like Ondeck are readily financing SMEs with 500 FICO scores. So besides the algorithm which they promote (which I am sure is a key to their success in screening bad from terrible) I believe the collection method also can help the riskiness of a small borrower. And I believe it helps in a greater way than thought. I am wondering by how much?

Thoughts?

[MCNetwork]

Good question. I really don't know how you can quantify that. I think each merchant carries his own inherent default risk. A lender needs to have faith that his underwriting criteria can weed the majority of the high risk merchants out of the portfolio so the default rate will be at a respectable level (i.e. 10%). As long as the funding assets are deployed strategically in a way that diversifies risk among all your merchants, then your portfolio should perform well. Survival in this business as a funder revolves around proper asset allocation and minimizing default risk through disciplined underwriting. Having a great collections department helps the bottom line as well.

[memorifa]

Hello,

Great point MCNetwork. Indeed, one of the best ways to minimize risk is through portfolio theory. If you can rank them by risk tiers (problem is when they dont have a score), you can construct a portfolio which should give a good return with a decent risk.

Just to further exemplify the point of the unquantified benefits of ACH -
There is a Telecom, which if you get a 2 year plan which includes data, voice and a mobile phone, it will charge you a 20% extra for the financing it provides.
If you allow them to directly debit your account in a monthly basis, they waiver the 20% financing cost.

I believe they have realized the benefits of ACH debit in decreasing the collections cost plus reducing credit risk (thus not needing the 20% interest income to compensate and adjust risk).

I think this phenomena must be what ventures like Ondeck have realized. If not, how could they grow so rapidly and with so little defaults in what could be thought of as a subprime market.

Cheers

[MCNetwork]

I'm not sure if On Deck has so little defaults. Most likely they are also in the 10% default range just like any other somewhat conservative lender.

[memorifa]

I watched an interview of the CEO and he stated that "their default is in the single digits". Amazing for a lender in such a risky space. Makes me think their secret sauce is made of ACH debiting and some wacky algo.

[MCNetwork]

That's funny...there's another thread on the forum that stated On Deck is chastising some ISOs because their respective merchant portfolios have 20% default rates.

[Chambo]

I watched an interview of the CEO and he stated that "their default is in the single digits". Amazing for a lender in such a risky space. Makes me think their secret sauce is made of ACH debiting and some wacky algo.

Or...he blatantly lied. Wouldn't be the first time an MCA has lied about their default rates or renewal rates.

Of course, if they go public...then they have to produce these rates every three months for all the world to see. No more posturing on TV

[MCNetwork]

True. On Deck is NOT the model to follow if you're concerned about being a highly profitable funder. It IS the model to follow if you're just looking to grow market share.

[Ryan Shiroky]

Or...he blatantly lied. Wouldn't be the first time an MCA has lied about their default rates or renewal rates.

Of course, if they go public...then they have to produce these rates every three months for all the world to see. No more posturing on TV

apparently i repped you too much lately or i have to rep other ppls stuff first... but if i could, i would have repped this comment...

[MCAVeteran]

It's no secret that fixed daily or weekly repayment models come with more risk in any downturn economy or per merchant basis. Workouts to lower the payment often will occur when sales drop and a fixed repayment is the platform. Although the product has allowed a ton of new sics and opportunities, the bad debt is yet to be uncovered as everyone is close to the vest on their data. Some funders have seen a fixed repayment eat into 30-40 perc of a merchants gross sales during a downturn when it was written at a much lower perc of gross. This is why the Mca split model works well in many situations still. Sure, the funder will have a longer repayment duration but they won't choke a merchant if sales drop. You can automate and do all the due diligence in UW but you can't predict a hiccup in cash flow or future sales. Fixed repayments have to be monitored carefully and the daily at least allows for early predictions of issues.

[Sean Cash]

It's no secret that fixed daily or weekly repayment models come with more risk in any downturn economy or per merchant basis. Workouts to lower the payment often will occur when sales drop and a fixed repayment is the platform. Although the product has allowed a ton of new sics and opportunities, the bad debt is yet to be uncovered as everyone is close to the vest on their data. Some funders have seen a fixed repayment eat into 30-40 perc of a merchants gross sales during a downturn when it was written at a much lower perc of gross. This is why the Mca split model works well in many situations still. Sure, the funder will have a longer repayment duration but they won't choke a merchant if sales drop. You can automate and do all the due diligence in UW but you can't predict a hiccup in cash flow or future sales. Fixed repayments have to be monitored carefully and the daily at least allows for early predictions of issues.

<---- huge fan of split funding.

[Benchmark]

<---- huge fan of split funding.

Same here! Split funding is the way to go.

[memorifa]

Hi gentlemen,

Indeed, Ondeck could/maybe have straight-up lied.
I like to think that given that some sophisticated investors like Google Ventures piled in Ondeck, they must have some nice looking numbers which passed their stringent due diligence.

I still think it is important to understand how good ACH daily debits are at reducing Credit Risk.
MCAVeteran made a great point. A dip in sales (which you cant avoid) will make you restructure the size of the daily debit.
Nonetheless, that same dip in sales would affect their repayment even in a normal (monthly payments without ACH) situation and make you restructure the deal. As Sean and Benchmark mentioned, split-funding is a great tool and its obvious it reduces credit risk.

It would be great to make a small experiment - grab a large and non-correlated portfolio of clients with similar FICO scores and divide them in three groups. First group gets ACH daily debits, second gets split funding and third pays by bank deposits to a referenced account.
Which group will have more defaults?

Cheers

[Chambo]

Hi gentlemen,

Indeed, Ondeck could/maybe have straight-up lied.
I like to think that given that some sophisticated investors like Google Ventures piled in Ondeck, they must have some nice looking numbers which passed their stringent due diligence.

I still think it is important to understand how good ACH daily debits are at reducing Credit Risk.
MCAVeteran made a great point. A dip in sales (which you cant avoid) will make you restructure the size of the daily debit.
Nonetheless, that same dip in sales would affect their repayment even in a normal (monthly payments without ACH) situation and make you restructure the deal. As Sean and Benchmark mentioned, split-funding is a great tool and its obvious it reduces credit risk.

It would be great to make a small experiment - grab a large and non-correlated portfolio of clients with similar FICO scores and divide them in three groups. First group gets ACH daily debits, second gets split funding and third pays by bank deposits to a referenced account.
Which group will have more defaults?

Cheers

Google most likely got involved to get access tot he data to cross with their other ventures.

[MCNetwork]

The group that will have more defaults would probably be the ones with the relatively weaker bank statements and higher monthly loan/advance payments as a percentage of gross sales. Collection method and FICO scores are not as important when it comes to rates of default. Weak cash flow and overextended merchants causes defaults. I have sub-500 FICO merchants that are outperforming 700+ FICO merchants because they don't bite off more than they can chew.