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FICO -- Once Powerful, Now Weakened

Date: Jan 19, 2016 @ 07:00 AM
Filed Under: Risk Management

There was a recent news media revelation that the Federal government has now meddled in the FICO score operation by imposing a series of regulations. The upshot is that FICO scoring has become politically correct. Thus it is no longer a true and accurate indicator of whether or not an individual has quality credit. Apparently, politicians were embarrassed that some 40% of the American population has what is considered to be bad or problematic credit. So if the government now prohibits that certain criteria were not to be made part of evaluating FICO -- this provides many of these people in question with an artificial boost.

For many years, FICO was an important consult source used to base all sorts of decisions on installment payments, car loans, mortgages and the like. Now lenders and businesses offering credit will have to turn to some alternatives as a basis of minimizing their risk.

The data from a well-known brand-name agency once looked upon as an icon of credit reporting, is almost worthless today. I use it to merely verify that the person actually exists, lives at a particular address, operates a business at a certain address, and has a valid phone number.

From my perspective as a national factor, I now ask: what are we to do? I cannot rely too heavily on these services. After all, the business owners who come to me are typically facing some problem or issue with their credit for these business owners. There is some red flag which prevented a traditional bank from approving a loan or credit line. Especially during the past seven years after Dodd-Frank, government regulators and auditors keep banks on an extremely tight leash. This has resulted in a major reduction in their lending approvals. Unless a prospect carefully fits a defined cookie-cutter loan, the bank must reject it. And if the bank is going to approve an application, they must have a detailed documentation trail to demonstrate to a bank examiner that they followed all of the steps, took no shortcuts and having shown no favoritism.

So, what are the signals I study which are consistent with “best practices” codes of commercial finance for a quality factoring transaction posing the least amount of risk? I want to study how an applicant pays their bills, their operating habits and their history. Are they slow? Have they missed payments?

Of course, I want to see bank statements for at least the last six months, an audited financial statement by a C.P.A., and tax returns. On the financials I want to see whether or not there are undisciplined allocations or irresponsible expenses and payouts on their books (e.g. a relative on the payroll, payments made for personal household expenses or money spent for indulging in luxuries). I want to look at corporate books, including history of the entity and any past or related entities.

What I have just described is my perfect world. In reality, I rarely receive a “complete package.” There is always some information missing and sometimes it is even sketchy at best. I am so used to this that if I actually am provided with a comprehensive package, it arouses my suspicions as to the motives of the applicant. Why, I ask, am I so lucky to get this deal?

For the past several years, I have been leery about an applicant who has used merchant cash advances before they come to me. Do they have a regularly scheduled ACH coming out of their account? I am mindful that some merchant cash advance firms are charging as much as 50% to 70% interest on an annual basis. Why did the applicant go this route? I am scrupulously checking the UCC forms to see if someone is getting into the second, third or fourth positions!

In today’s culture merchant cash advances are no longer just for those in desperation. There could be valid reasons to use merchant cash advances such as equipment purchases or as a down payment for acquiring commercial real estate. There are many business owners and entrepreneurs considered prominent or prestigious who are using it.

I run a credit check to see if there are any outstanding judgments, liens or recorded debts. Will I be secured and in first position if I must liquidate?

Once I know an owner is facing a debt crisis, it is unlikely factoring will be a solution for them. I want to help owners who are trying to grow their business where a bank is not moving fast enough to support their expansion or fails to understand their needs.

The condition of the economy and the prospect’s industry sector are important (e.g. publishing, oil, jewelry, software, apparel). If necessary, I will use a field examination and an appraisal of inventory that may need to be liquidated to satisfy what is owed to me.

I will be evaluating the prospect’s performance to properly fulfill producing the materials or providing the services as requisitioned in the generated invoice. I will be evaluating the quality of the receivable and its terms. I will explore the profitability of my transaction from the prospect and their customer who is paying the invoice.

All of this is “Commercial Finance 101”. Certainly, you have read these universal principles many times before. In the end as an independent factor who is entrepreneurial in my own right, and generally not confined nor sheltered under the cover of government regulation, I cannot rely on empirical evidence as the basis of my decision to fund. This has become more of a science and learning process based on my experience quotient. In the final analysis, I must look my prospect in the eye and gain a sense of confidence and trust. My choice gets based on my gut instinct combined with my threshold for risk.

James L. DiCamillo
Executive Vice President | RMP Capital Corp.
James DiCamillo is the Executive Vice President of RMP Capital Corporation, headquartered in Islandia, NY with offices in several other state. Launched thirteen years ago, RMP Capital handles about $80 million annually in factoring deal flow.
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