MCA Loans: Today’s Sub Prime - Don’t Get Caught
In 2007 I was merrily building multi-million dollar spec homes until June of that year. Bloomberg had an article describing how the brokerage houses were packaging mortgages in books and doing Moody’s work qualifying them for sale.
I knew right then we were about to experience a collapse. I changed course immediately and reduced the price on all inventory. Everyone thought I was nuts – I survived the crash – many builders were swamped.
I have been telling anyone that will listen that MCA loans are poison for the small business industry. However, I was not aware of the size and scope of the combined book. This NY Times article set me straight!
This final draft is compelling and it is a good read – yes it is long, but it is long to substantiate for those new to the game for why the outcome is predetermined. Enjoy your reading!
I built my first spec home in 1971. In 1972, Denver-based Capital Federal Savings agreed to finance an 1,800 square foot chalet-styled spec house I was proposing to build in Evergreen, Colorado. At the time, Cap Fed was a go-to financial source for small builders in the Denver-area market, and “small” defined me perfectly. I built that house almost single-handedly, sold it for a whopping $33,000, paid back my loan—and made a profit, too. Needless to say, times were different back then.
As the eighties approached, the savings and loan industry, hungry for bigger game and bigger profits, convinced the political powers of the day that the industry was overregulated, that it was being held back by burdensome, restrictive and outdated rules and laws that were limiting the industry’s potential growth. Development at the time was, in fact, being impaired by a considerable amount of market resistance to rapidly rising interest rates, and the savings and loan industry wanted and was granted the ability to overcome this resistance by joint venturing with their builder-borrower clients. This lowered the borrowing costs for the joint venturers and also lowered the profit margins for the lenders, but it increased the industry’s volumes and its stock prices, and as a result more good times were had by all—for a while. If you’re not old enough to remember the savings and loan collapse that eventually ensued, Mark Singer wrote a great book about it called “Funny Money.” If you don’t have time to read the book, I would synopsize it for you this way: The money may have been funny; the collapse was not.
Although the savings and loan industry’s financial wounds were significant, the United States Congress, as infatuated with deregulation then as it is now, passed something called the Alternative Mortgage Transaction Parity Act of 1982, which allowed for the creation of adjustable-rate mortgages and other non-traditional loan products. Congress then followed that up with the Tax Reform Act of 1986, which remade residential mortgages into the only consumer loans with tax-deductible interest and had the unintended consequence of encouraging homeowners to borrow against their home’s equity to pay for personal consumption.
These two seismic financial “adjustments” were sold to the public as a means of offering the American Dream of homeownership to the less affluent. Wall Street, however, saw these adjustments for what they really were and understood that Congress had just created a conduit for the Street to tap into America’s home equity as well. Investment bankers wasted little time in placing their “off the books” accounts into new market facilities of their own creation. And then, when the Housing and Community Development Act of 1992 came along, an act of a still-compliant congress that required Fannie Mae and Freddie Mac to loosen their purchasing standards, Wall Street now had a friendly deep-water port to sail into and offload all of its winnings.
The party was on. Investment banks and brokerage houses began to incorporate automated underwriting into their business models, which allowed for the underwriting to be adjusted indiscriminately, and also began to ramp up the bundling and securitization of mortgages, which allowed for the resale of multi-credit, weighted loans to outside investors—thus turning book value into cash like a wankel engine. Stir into this recipe the Bush ownership society policies of 2001 to 2006 and the stage was set for us all to ride a dragon with a needle in our arm.
In 1996, Dave Harder, a former Colorado National Bank E.V.P., hired me to start a construction lending division for the mortgage company he now owned. Dave saw clearly what made sense about hiring someone with a homebuilding background like mine, and Dave’s approach was simple: He’d teach me the banking side of the business, and in return he’d get a seasoned builder running his construction division, not a banker, who (as Dave liked to say) wouldn’t have a clue about what he’s looking at.
Dave was an exceptional teacher. He opened up every aspect of underwriting to me, including the assembly and sale of correspondent loans, and together we successfully steered the construction portfolios of a Who’s Who of Denver banks.
At the same time, the subprime mortgage market was just beginning to find its footing, and I witnessed the cascade of underwriting compromises that followed, all geared toward finding ways to close loans that just a few years earlier would never have had the slimmest hope of being funded. The brokerage compensation these subprime loans generated was three to six times greater than the compensation tied to conventional mortgages, so I’m sure it will come as no surprise that making these loans was simply too tempting to ignore. In a flash, seemingly every independent mortgage company had a subprime division. Our company was no exception, and fittingly, our subprime division was run by two former car salesmen.
In 1999, Wall Street seduced the U.S. Congress into passing the Gramm-Leach-Bliley Act, which allowed for the consolidation of retail banks, commercial banks and investment houses. This newfound freedom, coupled with the relaxed lending standards of the previous decade, gave the financial freethinkers what amounted to a turbocharged flow of money to invest. And they invested it in what was euphemistically called “unconventional mortgage facilities,” facilities that could and would generate untold billions in fees for the brokerage community. This subprime lending machine, created by Wall Street alchemists, was designed to convert long-term investments in mortgages into real estate’s version of day trading. And the live-like-there’s-no-tomorrow lending did just as it was designed to do, churning out fortunes in the process—that is, until it ran out of a sufficient number of qualified applicants and began feeding on itself by refinancing troubled loans it had previously made, loans that never had a chance of being paid back. The greater-fool game of musical chairs was underway, speed-dancing into the new Millenium. Michael Lewis brilliantly captured the culture of unfettered greed that followed in his book “The Big Short.” I’m not going to synopsize this book for you. If you want to be more fully prepared for what’s coming, take the time to read it.
The good news, however, is that having lived as a country through one mortgage-related debacle after another over the last 50 years, we’ve learned our lesson, right? Our mortgage industry is now stable, equities are in good shape, and all of Wall Street’s shell-game maneuvering is in the past, right? Oops. Sorry. Not so fast. Because this is the United States of America we’re talking about, even as I write this, new self-devouring schemes are being designed and put in position to find a new crop of suckers.
The lifeblood of the U.S. economy is its massive number of small businesses. Small businesses supply corporate America virtually all of its goods and services, and because corporate America has figured out how to use its size and clout to get away with not paying its bills for 60 to 90 days, America’s small businesses are now effectively financing the first quarter of the year, year after year, for America’s big businesses.
I am a factor. My company, US Invoice Funding, is a factoring company. Factoring, if you don’t already know, is a financial transaction whereby my clients sell me those 60-day and 90-day invoices at a discount. Why? Because my clients need to make payroll and pay their vendors in a timely way, while waiting on their corporate customers to make good. As a result, my factoring business is a thriving business.
Many of my clients come to me hemorrhaging money to MCAs (Merchant Cash Advance companies). If I believe I can save these clients, I consolidate their debt at interest rates and terms that are far more reasonable than those they are currently faced with. What do I mean by “reasonable?” MCAs typically lend money at an APR of 40% or more. No, that is not a typo. MCAs also require automatic daily or weekly withdrawals from a borrower’s operating accounts. That means that if—no, when—the MCA has depleted a borrower’s account, it will offer to “help” the borrower by suggesting an additional MCA to pay off the first on time. For the MCA borrower, this is the beginning of a doom-loop, and it is anything but reasonable.
Neither was the subprime mortgage fiasco reasonable. But the same mindset that gave us that fiasco is now engineering the MCA’s explosive growth—growth that I predict will be short-lived and end badly. On December 27, 2024, the New York Times published an investigative piece by Rob Copeland and Maureen Farrell titled “Wall St. Is Minting Easy Money From Risky Loans. What Could Go Wrong?” (hyperlink here). The article describes a market of risky small businesses that are signing up for predatory loans. Why? Because these small businesses believe they have no other choice. The article also describes the billions of dollars being invested by institutional organizations looking for an outsized return.
In the 1990s, Wall Street created high-return mortgage loans for high-risk borrowers. Wall Street packaged these loans for sale pretending that the packages contained more than enough quality loans to offset any potential loss from those (rare) loans that might seem to be sketchy—when, in fact, more often than not, the entire package was sketchy. The book value of these loans was packaged and sold at margins of 105% to 108%. This freed up the principal portion of the loans to be recycled into new loans and new packages, and the faster the Wall Street players turned the principal, the more money they made. And, of course, the more money they made, the more money they wanted to make. Eventually, the game got so big and so far removed from its somewhat humble beginnings, Wall Street was securing commitments on packages of loans yet to be even assembled. Wall Street’s customers for these packages of loans were big banks, pension funds and insurance companies, all of whom wound up suffering enormous losses. Even so, today, Wall Street is again gathering funds from big banks, pension funds and insurance companies for the extension of predatory loans to high-risk small businesses.
In 2008, the “creative mortgage” shell game collapsed, and the then-Secretary of the Treasury, Henry Paulson, a seasoned and knowledgeable former investment banker, handed congress a three-page ransom note that demanded all available currency reserves be made accessible to the Treasury Department if congress wanted to avoid the second Great Depression. The reason? Wall Street had provided economy-shattering high-yield mortgage loans to borrowers who could not repay the loans. Today, Wall Street is again providing high-yield MCA loans to small businesses that most likely will not be able to repay the loans.
But it doesn’t have to end badly this time, thanks to factoring. Factoring is perfectly positioned to provide an alternative form of financing to the small business customer. And unlike an MCA lender, a factor will not devour its host, the borrower.
Factoring has been around for centuries. It works because it fills a need while remaining conscious of all three parties in the transaction: the client, the client’s customer, and the factor. In this way, factors are similar to financial partners—because, like a financial partner, the factor has an incentive to promote good business practices and to promote those good business practices in a way that is less costly to the client. A factor demands no equity. Which means, of course, the client does not have to give up any equity.
As a former business owner, I relied on factoring to exponentially grow two separate businesses that otherwise would have struggled to grow at all.
Bottom line: a good factor is
concerned for the client’s profitability.
Underwrites the creditworthiness of its clients’ customers,
and modifies the client’s return structure to accommodate the client.
And I am proud to say US Invoice Funding is a good factor.