Community banks looking for new ways to generate income and help small-business owners who don't qualify for credit can try factoring virtually risk-free, thanks to a new program offered by $1 billion State Bank in La Grange, TX.
Factoring, also called accounts-receivable financing, involves the selling of a company's receivables at a discount to a factor-in this case, the bank. The factor then assumes the account debtors' credit risk and makes money as they settle their accounts. Startups and cash-strapped firms in manufacturing, wholesale and transportation industries often use this type of financing to solve cash-flow problems.
State Bank's tiered program, run through its Working Capital Finance Group and aimed at community banks, offers three options. In the "zero risk" option, banks looking to gauge market potential or to offer factoring services for commercial clients without investing anything can refer business to WCFG and receive 10 percent of transaction revenue.
A "participation" option offers more revenue and risk, with the bank buying a 10 percent to 50 percent stake of WCFG-referred transactions. There's a one-time fee of $10,000 and the bank can sell its stake at any time and revert to the "zero risk" option.
The "turnkey" option helps banks bring business in-house and assume full control of accounts after they've matured through participation or zero-risk options for at least six months. The bank buys them at par from WCFG and can sell them back at any time. WCFG helps the bank set up operations, facilitating everything from staffing to selecting software for a cost of $50,000. "If you're going to be in the factoring business, you need account managers, portfolio managers, auditors, software, computers, business development people," says Cole Harmonson, the State Bank svp who authored the program. "So to get it to where it's going to make you some money, you can leverage someone else's back room and experience [through our program]."
Ostensibly, a bank can run a factoring portfolio in-house, participate with WCFG on deals too large to fund directly and earn risk-free income on referred transactions that don't jibe with its credit policy. Although intended primarily for small banks, Harmonson is also targeting private-equity and venture-capital firms. "This program...basically will allow some of our banks to get their feet wet before they leap into a factoring program," says Steve Scurlock, evp at the Independent Bankers Association of Texas. Factoring isn't a widespread practice among Texas community banks, he says.
State Bank has been factoring since 1996. Harmonson focuses on companies with $1 million to $20 million in annual sales. "The ultimate customer is probably $3 million and under and specializes in transportation, manufacturing, wholesale or service industries," he says. That's because deals aren't too big and allow for a diversified portfolio. Also, smaller businesses tend to get ignored by larger factoring firms, he says.
Other factoring companies in Texas offer a program similar to WCFG's, such as Austin-based Numina Factoring Services, says Brett Goldberg, executive director of the International Factoring Association. However, he isn't aware of other community banks with this kind of program.
As factors, Goldberg has seen many banks founder and cautions against relying on traditional lending expertise. "The reason companies go into factoring is because they're not qualifying for a bank loan," he says. "So to look at them like a typical banker and look at their financial strength doesn't make sense because they don't have any. Also these companies are a little tighter on cash and, as such, they need to be monitored correctly."
Factoring is losing its stigma as a credit of last resort for businesses in dire straights and going mainstream, as companies seek alternative financing sources and financial services providers look for new ways to attract and keep customers, says Matthew Emerson, spokesman for the Commercial Finance Association. "Almost all of the major banks have asset-based lending divisions and are doing factoring." CIT, GMAC, SunTrust, HSBC and Wells Fargo are dominant players, he says.
Factoring data is incomplete because the industry is unregulated, but CFA's most recent figures put total factoring volume in 2003 at $96 billion, up 0.34 percent from 2002. Of that total, $157.58 million (0.16 percent) was uncollected after 90 days and $307.32 million (0.32 percent) was written off as uncollectible.
Harmonson is discussing deals with several banks, but none had signed at press time.
