Inside Small Business Lending: Short Q&A With An Industry Chief Executive

With Goldman Sachs (GS) and Warren Buffett sponsoring a $500 million loan package for small businesses in the wake of this year’s largest bankruptcy, that of small- and medium-sized business lender CIT Group, lending to the nation’s little organizations has never been a hotter topic than it is now. With this in mind, I spoke with Dan Drechsel, chief executive of Atlanta-based small-business financial solutions boutique Financial Transaction Services (FTRANS) earlier today to get a behind-the-scenes view of the market.

FTRANS provides short-term credit management facilities for small businesses against their accounts receivable. What makes FTRANS more competitive than others in the small business lending arena, Drechsel says, is its ability to credit-score the customers of its own clients on an individual basis; that process allows it to determine what percentage of a customer’s accounts receivable it can safely lend against.

According to Drechsel, this is a function that’s in high demand right now:

This week a client of mine who owns a telemarketing firm called and said that his customer had moved payment from 15-day terms to 60-day terms. In reality, that means it now takes nearly four months before the guy gets paid. The tricky part with this is that the telemarketing company has to pay employees for a sale from month one.

For this reason, “I tend to think of the current market cycle as a sponge,” Drechsel explains:

In the case of the telesales guy, effectively the vendor moved 45 days of sales onto his balance sheet. Now, even if the guy goes out and sells new business, he can’t afford to finance his own growth. That’s the way the economy is getting hit: all the available liquidity is getting sucked up by a cash shortage and no one can afford to go out and hire new people to service new business.

What are the sectors that are least attractive right now in terms of lending?

We don’t do anything with real estate, or healthcare delivery. The healthcare market is just crazy from a credit standpoint: if a dentist sends out an invoice, more than 50 percent of the time it’s not for the right amount. We do very little in the construction sector too, since a lot of invoices go out to a general contractor, who has told the company doing the work that “we are going to pay you when we get paid.”

Still, you might be surprised to learn that the business of lending to small companies is a number one priority for regional banks these days — so much so that it may eventually form part of the sector’s core earnings, says Drechsel. That’s because as banks’ revenue from commercial real estate lending has collapsed, they need a business to replace it with in order to grow. According to research which FTRANS undertook recently, a whopping 86 percent of regional and community banks said that small-business lending would become a key profit center for them within the next 10 years.

The entry of thousands of regional banks into the small- and medium-sized business lending arena should help the industry to grow to over half a trillion dollars in the next five years, from around $200 billion today, Drechsel adds. To underline that point, he says that FTRANS has grown 718 percent in size from 2005 to 2008.

Could small business lending work for Goldman Sachs then, as I speculated it might earlier this week? Drechsel thinks so:

Three or four years ago, I would have said no, but with Goldman and Morgan Stanley (MS) switching to bank holding companies, it may make some sense for them. The deposits that follow that business would be a very attractive set of relationships for Goldman as well, because where credit goes, deposits follow.