How a Goldman Sachs Ethicist Became a High-Rate LenderZeke Faux and Max Abelson
Steven Mandis was working on a book about whether Goldman Sachs Group Inc. put profit above principles when he hit upon a new way to make money.
The former Goldman Sachs banker decided two years ago to get into lending money to struggling small businesses, a niche on Wall Street where brokers offer loans with interest rates that can climb past 100 percent to dentists with bad credit and pizzeria owners behind on their bills. To some, it’s the new face of subprime.
A few of the people Mandis met on his search for investment opportunities had trouble relating to a banker who vacations in the Bahamas and describes himself as intellectually curious. His reference to a Goldman Sachs connection fell flat at a call center in midtown Manhattan. He was the only person wearing a blazer at a brokerage whose co-founder was sentenced to probation for insider trading.
Mandis, 44, wasn’t shaken. He invested in two lenders before starting his own firm, Kalamata Capital LLC, late last year. In October, Harvard Business Review Press published his book, “What Happened to Goldman Sachs,” which describes the firm drifting from the doctrine of putting clients first.
“If I’m going to do something, I want to focus on a really big problem so it would mean something,” Mandis said. “And small businesses, I mean, this is the heart of everything.”
Small-business lending has yet to recover from the financial crisis. Loans of less than $1 million are down 22 percent from 2007 because of tighter lending standards, Federal Reserve research shows. Even as banks have pulled back from funding businesses directly, Wall Street investors funneled at least $1.7 billion in financing over the past two years to the high-rate lenders rushing in to fill the gap, according to data compiled by Bloomberg.
Investors seeing a chance to profit from the risky loans include Chase Coleman’s Tiger Global Management LLC, early Facebook Inc. backer Accel Partners and Doug Naidus, a former head of mortgages at Deutsche Bank AG, whose World Business Lenders LLC charges as much as 125 percent. RapidAdvance, one of the companies Mandis invested in, was sold in September to Cleveland Cavaliers owner Dan Gilbert’s private-equity firm.
Businesses that take the loans often have bad credit, little collateral or maxed-out credit cards. Borrowing at high rates can trigger bankruptcy instead of growth for entrepreneurs who lack alternatives. The unlicensed brokers who target them with cold calls are paid more the higher rates go.
“This is like a payday loan for a business,” said Pat Fossett, a bankruptcy lawyer in Corpus Christi, Texas, making a comparison to costly cash advances for workers. “Unless they’re making a large profit to pay that high interest, they’re shooting themselves in the foot.”
The way Mandis describes it, while some of his business-lending competitors may take advantage of borrowers in distress, he’s driven by something loftier than profit.
“There’s this obligation to try to do something to solve a problem in America in my own way,” he said. “Providing capital to people to grow their businesses and to give jobs to people is I think a good thing.”
Mandis said he’s funding Kalamata entirely with his own money and that he chose the name because of his family’s Greek heritage to evoke an olive branch extended to customers.
Sheila Stiles was one of his first. Her family has collected used motor oil from auto shops in Tennessee and turned it into fuel for more than 60 years. She said they try to run Goins Waste Oil Co. by Christian principles. With business dropping, they took a Kalamata loan in November because they didn’t want layoffs before Christmas.
“Everybody here is family except for two people, and they’re like family because we’ve known them all our lives,” said Stiles, the Chattanooga-based company’s treasurer. “The way they present it, it’s so tempting, especially when you know you’re in such a bind.”
Stiles said she sought out Lendio, an online platform that matches borrowers and lenders, which referred her to Kalamata. Goins borrowed $122,000, agreeing to pay back $165,920 in about 11 months, according to a copy of the contract. While Stiles was aware of the loan terms, she said they turned out to be more onerous than she thought. Goins furloughed employees so it could afford the sums that Kalamata took daily and then weekly from the company’s bank account, she added.
“I don’t think it’s fair,” Stiles said. “He’s taking advantage of the small-business owners because of the interest rate that he charges.”
The Goins contract shows a rate of 36 percent. When calculated as an effective annual percentage rate -- like the ones credit-card or mortgage loans are legally required to disclose -- it would jump to 72 percent, said Marco Lucioni, a vice president at nonprofit lender Opportunity Fund. The U.S. Truth in Lending Act requires that rate be stated on loans to consumers, not businesses.
“Every time you make a payment you’re reducing the amount of money you had available to work with,” said Lucioni, whose nonprofit group helps entrepreneurs find affordable loans. “When I’m telling you a dollar amount you have to pay on a daily basis, that’s always going to sound so little and affordable. Don’t fall for these gimmicks.”
Asked about his rates, Mandis said more than 20 percent “would be high for us.” The Goins case was an exception because the borrowers run a seasonal business, he said.
After Stiles and Mandis were interviewed for this story, Stiles complained to Kalamata. The company told her she could pay back the loan more slowly, lowering her payments by about $1,000 a week, she said in a second call.
“Although we had no legal obligation to do so, we did this without imposing any penalty,” Mandis said. “We hold ourselves to the highest ethical standards and compliance with applicable lending laws.”
Mandy Calara, who runs the Forever Yogurt frozen-yogurt chain in Chicago, said his Kalamata loan worked out. He borrowed to cover payroll and rent in November when harsh weather cut demand. Calara said he found Kalamata through another online platform called Biz2Credit and doesn’t remember the terms of his deal. He didn’t have time to apply for a bank loan, he said.
“It’s sort of the best of the bad loans,” Calara said. “It was still pretty aggressive as far as what our deal was.”
Mandis said he wants to make his company the first that small-business owners call when they need financing. So far, Kalamata is still a small business itself, with two employees in Bethesda, Maryland. It has provided $6 million, he said, to borrowers including a Georgia gas station, a Florida doctor and a donut shop in Illinois.
Kalamata sued the owner of a New Jersey liquor store for defaulting after borrowing $100,000 in February. The eight-month loan, which shows a 17 percent rate in its contract, effectively costs 53 percent a year, according to Opportunity Fund’s Lucioni.
“When you put it in a percentage, it sounds big and eye-popping, but you need to have a relative sense of it all,” Mandis said. “Should we let that company just go bankrupt?”
Mandis said the rates are justified because the businesses are risky, post little collateral and can’t get the money elsewhere. Borrowers have an average of $3.4 million in annual revenue and 25 employees, he said.
What Kalamata does isn’t subprime lending because the term refers only to consumers, Mandis said, and its customers are businesses. The people who own the companies have credit scores on average well above subprime, he added. Sometimes the money he advances isn’t really a loan at all, he said, it’s financing.
That’s the legal position most new small-business lenders take. Rather than advancing money at interest, they’re buying a portion of someone’s future sales at a discount, they say, and therefore don’t have to follow state usury laws that cap interest rates or be licensed by state regulators.
Kalamata’s rates are relatively low for the industry, according to Rohit Arora, co-founder of Biz2Credit, who said rates have topped 200 percent. Arora said he tries to avoid lenders who charge more than 30 percent.
“It’s both an ethical thing, but also every state has a usury law,” said Arora. “Right now, it’s not very clearly defined on how much small-business lending is covered.”
Jared Hecht, the 27-year-old co-founder of Fundera, an online loan marketplace that’s planning to work with Kalamata, said the industry is “in the first inning.”
“Ultimately, the good side will be that small-business owners should theoretically be able to run a competitive process and get the lowest rates,” he said.
Mandis has long positioned himself in some of Wall Street’s most profitable businesses. He joined Goldman Sachs’s mergers and acquisitions department in 1992 after graduating from the University of Chicago, where he was written up in the New York Times for disarming a gang member as part of a student patrol group. The story said he went by the codename “Professor.”
He switched to the firm’s Special Situations Group, whose bets with the bank’s own money became so profitable that its head quit because his $70 million pay wasn’t enough, the Wall Street Journal reported in 2007.
Mandis, who describes his career as a search for meaning and challenges, left Goldman Sachs in 2004 for a hedge fund, then advised consulting firm McKinsey & Co. and was chief of staff to Citigroup Inc.’s president after its bailout.
“If I’m choosing something to do, there has to be some intellectual curiosity related to it, because that’s how I’m driven,” Mandis said.
He enrolled in 2009 at Columbia University, where his work for a Ph.D. in sociology formed the basis for his book. He also teaches at the university’s business school and has tutored Harlem teenagers in financial responsibility. In a 2010 CNN segment about Mandis, one of the high school students compared their sessions to taking singing classes with Beyonce.
In “What Happened to Goldman Sachs,” Mandis described how the firm adopted a legalistic approach that enabled it to make more money. Unlike Greg Smith, the Goldman Sachs banker who quit in 2012 and wrote a New York Times editorial calling the firm toxic, Mandis said he isn’t blaming anyone for what he calls a slow cultural drift.
“Of course, the sense that one is doing God’s work or serving a higher purpose can easily transmute into a holier-than-thou attitude and an excuse for any behavior,” he wrote in the book.
Mandis recalled asking colleagues about small-business loans while working at Citigroup. Some were skeptical.
“They had heard the rates or they’d heard the word ‘subprime’ associated with it somehow,” Mandis said. “People didn’t want to talk about it, focus on it. I also thought that was the opportunity.”
He went on his tour of the industry in 2012 with Brian Nicholson, a vice president at Stripes Group. Nicholson, who joined the New York private-equity fund after co-founding a luxury menswear company named for a Cary Grant character, said the two of them stood out.
“Steve and I walk into a merchant-cash-advance business in midtown, and it’s a total boiler room with folks dialing for dollars,” said Nicholson, 32, who wouldn’t name the company. “Steve, in his tweed jacket, sweater and tie, begins talking about his tenure at Goldman and being a resource for ‘Hank’ during the financial crisis. The CEO responds, ‘Hank?’ as in ‘Hank who?’ It was a bizarre situation.”
Mandis worked on special projects for Henry “Hank” Paulson, the Goldman Sachs chief executive officer appointed Treasury Secretary by President George W. Bush, according to his book’s author note.
He also went downtown to one of the biggest loan brokers, Yellowstone Capital LLC. Its red-walled offices in the financial district used to be home to an illegal currency-trading shop run by a professional poker player.
Wearing a blue blazer, Mandis walked into a call center full of salesmen in jeans and t-shirts, according to David Glass, the firm’s co-founder, whose stint at a Long Island stock brokerage in the 1990s helped inspire the movie “Boiler Room.” Mandis said he had millions of dollars to invest in the industry and mentioned he taught at Columbia, Glass said. The meeting didn’t go well, he added.
“Most new players come into the business with high-finance backgrounds and have trouble adjusting to guys like me,” Glass said.
Mandis wouldn’t describe his visit to Yellowstone except to say that he met people who “would not traditionally work at a Goldman Sachs or a McKinsey.”
One of the lenders he invested in was Bethesda, Maryland-based RapidAdvance, which makes businesses sign over as much as 45 percent of their credit-card receipts in exchange for $15,000 or $18,000, according to lawsuits filed by RapidAdvance against borrowers who defaulted.
Mandis, who declined to say how much he invested, decided RapidAdvance could reach more clients with a catchy TV spot. He wanted the man who made the ads for J.G. Wentworth, a company that promises quick cash to lawsuit winners.
Mal Karlin, who made those spots, said he was reluctant to get involved because his small ad firm is bombarded by e-mail offers from lenders.
“Once they offer me money, I know it’s going to be an exorbitant rate,” he said. “I had a bad feeling about it.”
Mandis’s resume persuaded him, he said. The banker invited the goateed director to his Park Avenue co-op to pitch ideas last year. Karlin was taken aback when the client’s wife and two young daughters were waiting.
“My worst nightmare is for a kid to have an idea for a commercial,” Karlin said. “Everybody thinks that they’re an advertising expert because they watch television.”
The family wasn’t wowed by his ideas. The director tried again when Mandis was teaching in Madrid, singing a Broadway ditty into the phone for him. The former banker stopped him.
“I like that,” Mandis told Karlin.
In the spot, which aired last year, RapidAdvance delivers sacks of cash after a hairdresser, mechanic and chef dance in unison and sing the company’s praises.
Mandis said he’s proud of his work at that lender and his new firm. Kalamata’s website features a family history and a photo of him in a sweater and tie.
“What I thought I would do with Kalamata is say, ‘Here’s who I am, I’m a real person,’” he said. “You have to have the values and the brand that people will come back to.”