Background from my notes on TAD credit risks. Remember that ACRT does NOT lend money, they purchase inventory that they teach their clients how to create--the TAD transaction. There is a subtle difference.
Actrade's Default Rate or Non-Payment of TADs Is Now Approximately 0.11%,
Near 1/10th of One Percent. How Can It Be So Low?
This is a critical section for potential investors to read, understand and verify in their due-diligence.
Since inception of the TAD Program, sales from the second half of 1993 to the first nine months of FY 1997 have totaled $26,939,746. I estimate approximately $6 million more TAD business has been generated during April and three weeks in May which would bring a total of about $33 million of TAD revenues to date. To date, only $36,000 of TADs has not been paid (Actrade's credit insurance covered the losses) which gives Actrade a default rate of about 1/10th of 1 percent-far exceeding management's expectations.
Capital takes very little risk in purchasing TADs from a Buyer. Actrade's two risks would either be 1) having TADs non-payment exceed its $3 million loss limit from American Credit Indemnity ("American") or 2) having losses in an amount that would cause American to drop its insurance coverage. At Actrade's current default rate of 0.11%, Capital could generate $2.7 billion of TAD revenues before exceeding this limit. Of course, I would expect this default rate to increase as Revenues grow, but Actrade's diversifica-tion of Buyers would offset this risk. By accepting TAD's issued by a large number of customers, the risk of loss is reduced. Each Seller typically deals with TAD's from many unrelated companies. Therefore, the extent of Capital's exposure from nonpayment by any company is limited.
Capital has many protections against loss and non-payment of TADs as explained below in order of importance.
1. The Power of the Instrument, the TAD
Elimination of Commercial Disputes
An investor, after reading the prior section on Commercial Paper, understands that TADs eliminate any commercial dispute. Essentially, the TAD Program separates the financial from the commercial transaction between Buyer and Seller.
For example, if a Seller delivers computers to a Buyer, then the Buyer inspects the computers, finds
them OK and signs and returns the TAD to the Seller, the Seller is then considered paid. (The
Seller's Accounts Receivable is replaced with a payment-see accounting for TADs section). If the
next day, the computers are found to be inoperable or defective, the Buyer cannot LEGALLY stop
payment on the TAD like a check. Remember that a Buyer could legally stop payment on a check
if that buyer has a commercial dispute regarding the goods of the Seller. Though TADs are
processed like checks, they are like, "a leasing agreement." If you lease a car, you have no legal
right to not pay the leasing company if you are unhappy with the car. Your dispute is with the car
manufacturer.
In this example, the Buyer would have to settle with the computer manufacturer's warranty
company or the Seller.
The Psychology of The Buyer or Signatory of the TADs
When a Buyer has signed a TAD, he/she understands that the TAD will be automatically debited from his/her company's bank account on the due date, unless he/she requests and receives an extension from Actrade. The transaction is psychologically very different than being able to pay on open account terms. Here the Buyer feels like he/she has written a check or made payment. If the Buyer has cash-flow problems as the due date of the TAD approaches, the Buyer will typically stretch out his other open account payables to be able to pay promptly on the TAD.
For example, a Seller's credit manager does not have to hear from the Buyer, "Sorry, can you give
me two more weeks to pay?" or "the check is in the mail." Collection is between the Buyer and
Actrade.
Actrade's management reports a historical 98% payment rate on TADs; on the 2% bounced (insufficient funds) TADs, the Buyer will usually replace the TAD with a certified check as soon as possible. Why? Actrade analyzes the Buyer's cash balances and wants each TAD to be a small portion of that Buyer's payables.
For example, the Buyer might have to pay $100,000 to his open account vendors while also having
a $10,000 TAD to pay, yet the Buyer only has $60,000 cash available. In this instance the TAD
amount is 1/11th of the Buyer's total payables and the Buyer knows that Actrade can really hurt
him/her. What Buyer wants to go to court to fight Actrade, pay legal expenses and then lose? The
Buyer will pay the $10,000 out of his available $60,000, while delaying payment with his/her
remaining $50,000 in cash. Actrade has in its possession a signed TAD from the Buyer as evidence
of payment and a contract signed by the Buyer waiving ALL rights to commercial dispute. Also,
Actrade can accelerate payment on all the other of the Buyer's outstanding TADs purchased by
Actrade.
Actrade is the first payable to be paid by a Buyer of an ongoing business. The opposite occurs if the Buyer declares bankruptcy. Actrade has no underlying security or asset behind the TAD. Asset-based creditors would be paid ahead of Actrade in the event of a Buyer's bankruptcy, but Actrade will collect from the insurance company in the event of a Buyer's bankruptcy. In the rare case where the Buyer is not insured, then Actrade ALWAYS has recourse to the Seller. This usually occurs when the Seller has a strong credit history and is willing to accept the credit risk, but the Buyer is unable to qualify for insurance.
2. Rigorous Credit Analysis of the Buyer, The Seller's Relationship with the Buyer and the
Underlying Transaction.
Actrade's concern is mainly with the Buyer
Since the Buyer has to pay the TAD, Actrade will do a comprehensive and rigorous credit check on the Buyer. This analysis includes but is not limited to: UCC-1 Filings, D&B Reports, Lien Searches, Trade References, Signature Verification, Financial Statements, Officer's Certificate and the Buyer's average monthly cash balances. Actrade does not wish to accept a TAD that is too large a percentage of a Buyer's
average monthly cash balance.
For example, A Buyer may have excellent credit and want to sign a $200,000 TAD, but the Buyer
only has $75,000 average cash balances. Actrade would ask the Buyer to accept five $40,000
TADs spread out over a period of time where the terms of payment are similar to what the Buyer
originally wanted. A $40,000 TAD has a greater probability of clearing than a $200,000 TAD.
The Seller
Actrade will investigate the Seller's trade references and complete a reference check on the company and its owners. Actrade wants to be sure that the Seller is a legitimate company.
The Underlying Transaction
Actrade wants the TAD to represent a payment on a trade or liquid asset. There is a legitimate purpose for the transaction and the TAD is not used to pay, say, for an apartment building, mortgage or other illiquid asset. Actrade wants the Buyer to have a cash stream to pay the TADs. Typically, the Buyer pays with a TAD to get a good that is sold for cash which will be used to pay the TAD on its due date.
Actrade's management believes its tough credit standards and resulting low default rate are important in building a strong future with the insurance industry and lowering premiums with its insurance company, American. The Company wishes to be recognized as a good customer in the insurance industry. Other major insurance carriers like AIG have expressed to Actrade an interest in insuring TADs. Insurance is important for Actrade, especially as it develops new markets for TADs. Actrade currently has discretion to extend credit for up to $50,000 for each of the Seller's customers. If the Buyer seeks to sign TADs in amounts greater than $50,000, then American has discretion to give final approval.
3. Co-insurance with the Seller
20% Coinsurance
Capital retains a 25% reserve of the full face value of the TADs against non-payment. Capital also earns the interest on this reserve while it is retained. Insurance will cover 90% of the losses on TADs for Actrade while Actrade provides the Seller, if given insurance protection, 80% of the losses on TADs. This gives the Seller an incentive to give Actrade credit-worthy customers. Actrade will usually insure its TADs but may not, in all cases, give insurance to the Seller.
Cross-Collateralization of the Seller's TADs
If several TADs are outstanding, Capital can halt repayment of the reserves (25%) on all of the Seller's TADs, if one TAD is overdue. Likewise, if one of the Buyer's TADs is not paid, Capital can accelerate payment on all of the Buyer's other TADs.
Personal Guarantees
Capital may require personal guarantees of payment in some cases, The Seller may require the Buyer to pledge personal assets as protection against default.
4. Insurance
Actrade has L/C protection from major international banks and insurance protection for 85% of all its TADs. The other 15% is always recourse to the Seller provided the Seller has a good relationship with Actrade and passes a thorough credit check (Milton International is one customer who would apply). The percentage of uninsured Buyers is declining as Actrade grows.
As of May 1, 1996, Actrade's TADs are insured through American Credit Indemnity Company (Rated A, Excellent in 1996 by BEST'S Insurance. Call 900-555-BEST for the latest Best's Ratings). American underwrites accounts receivable credit insurance, which guarantees payments to policyholders for goods shipped or services rendered. BEST'S reports that American continues to maintain superior capitalization and favorable long-term profitability enhanced by salvage recoveries. American had Policyholders' Surplus of $80.3 million in 1995.
Actrade pays $30,000 a year for credit protection to cover $25 million in TADs for a $3 million loss limit with a $40,000 deductible.
In a few cases, Actrade will not insure TADs if the recourse is to the Seller and the Seller has the credit standing to be accepted by Capital's credit department.
5. Diversification of Sellers and Buyers prevents concentration of risk.
Actrade has approximately 100 clients (Sellers) active in its TAD ProgramT. Each client has averaged about 5 to 20 customers (Buyers).
As Actrade's customer base expands in customer size, industry and geographical location, the risk of percentage non-payment will lessen to Actrade's insurance company. While there will be more Buyers going bankrupt and not paying TADs on an absolute number basis, however, as long as Actrade maintains its credit standards, the relative risk should decline.
Actrade's management believes that as its TAD business grows it will be able to securitize pools of TADs in amounts of $20 million or greater. Securitization could allow Actrade to turnover its capital faster and earn origination fees.
Summary
My first research report (July 16, 1996 ACRT-$3.50) mentioned that Actrade's default rate on TADS was 3/10ths of 1% (0.3%). Since July 16th until now, there have been NO additional defaults on TADS. The extremely low TAD default rate has actually improved. The long-term strength of Actrade's business depends upon it's ability to originate business while maintaining its credit standards.
Actrade will insure 85% to 90% of its TADs by credit insurance or be secured by a letter of credit from a major U.S or international bank. In certain cases, 10% to 15% of TADs may be uninsured but Actrade would have full recourse back to the Seller who would have an excellent credit history and relationship with Actrade. In other words, Actrade is always protected.
Just an outline of the above:
Actrade's Default Rate or Non-Payment of TADs Is Now Approximately 0.11%, Back in July 1997.
Near 1/10th of One Percent. How Can It Be So Low?
1. The Power of the Instrument, the TAD
Elimination of Commercial Disputes
The Psychology of The Buyer or Signatory of the TADs
2. Rigorous Credit Analysis of the Buyer, The Seller's Relationship with the Buyer and the
Underlying Transaction.
Actrade's concern is mainly with the Buyer
The Seller
The Underlying Transaction
3. Co-insurance with the Seller
20% Coinsurance
Cross-Collateralization of the Seller's TADs
Personal Guarantees
4. Insurance
5. Diversification of Sellers and Buyers prevents concentration of risk. |
