How a lender thinks: Part 2, behaviors
[Continued from yesterday’s Part 1.]
Yesterday we saw that lenders view the world in Aristotleian elements of money and paper, like to receive things from behind the sanctity of their desks, and think that surprises are bad, volatility is bad, and calm is good.
All my loans are current
To a lender, security trumps upside, and known pain hurts less than unknown pain.
Today we’ll look at what lenders do, starting with what they don’t do.
9. Lenders don’t own property. They own financial assets. So even though a mortgage is secured by a piece of property, for the lender the property is merely a means of extracting cash, preferably by persuading the borrower to make payments.
“We ain’t in the coke business. We in the cash business.”
– Kidnappers to Crockett and Tubbs, under cover as cocaine smugglers
For a lender, owning property means the financial instrument has failed, and the borrower has failed, and now there is no one standing between us and all that yucky risk and volatility and analog immeasurability. Ownership, in short, is bad — financing is good.
Useful principle: Give lenders a financial equivalent to foreclosure and they won’t foreclose. In this context, that means, give them 100% of the net cash flow toward debt service — at least for an interval of time, and perhaps in exchange for debt restructuring and a plan of recapitalization. A lender who believes he’s receiving all the lemon’s juice has absolutely no interest in owning the lemon, rind, peel, and all.
Give them the juice and you’ll have more a-peel
10. Lenders don’t manage property. They hire people to do that. Hiring means taking action (bad) and paying out money (worse; see Lenders receive things). Lenders do enter into receivership or trusteeship arrangements, specifically so they can have somebody do the tough, active work to their satisfaction but without their direct involvement in management.
Is there anything you require, lender?
Useful principle: Act like the lender’s agent and the lender will keep you in place. Unpaid voluntary servitude makes a lender happy on many counts.
11. Lenders don’t want to own because ownership means risk. Attendant upon direct involvement in anything is the operational and legal dirtiness that taking action means others potentially have ground for complaint against you. Lenders are at least theoretically at legal risk for each of the following:
· Lender liability. There’s a body of case law to the effect that if a lender exceeds its powers under the loan documents, and the result of doing so is to impair the borrower’s ability to own and manage its asset, then the lender is partially liable, and the remedy is that the loan instrument is downgraded into de facto equity [You’re oversimplifying — Ed. Hey, it’s a blog post! — Auth.], which means that many of the lender’s security blankets, like the right to foreclose, go by the boards.
· Environmental liability. Under 1980’s Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA, the Superfund legislation), a lender who actually takes ownership of a property steps into the “chain of title,” and everyone in the chain of title is legally liable for the cleanup. (For some good exposition surrounding environmental risk and its financial consequences, see the movie A Civil Action, probably John Travolta’s second-best role after Jack Stanton in Primary Colors.) CERCLA properties can have negative value, and of all the people in the chain of title, who is most collectible? The lender, naturally.
· Financial statement consolidation. All public companies report their financial operations according to GAAP, using SEC-approved protocols. These provide generally that the entity must show, in addition to earnings and cash flow, a balance sheet of assets and liabilities. Capital markets and rating agencies use balance-sheet ratios (e.g. working capital) in assessing a company’s financial risk, and hence in shaping the price of its debt, and indirectly its stock price. Lenders who make loans report only the loan on their balance sheet and income statement, but if a capital provider has an investment in a Variable Interest Entity (VIE), then under FASB Interpretation Notice 46 (”FIN 46“, full text here in .pdf) the capital provider must consolidate the whole property’s balance sheet. FIN 46 consolidation, as it is known, applies mostly to equity investments [You’ll do a post on this? — Ed. Okay, okay — Auth.], but can be extended to debt if the debt is ‘corrupted’ (by that nasty volatility I mentioned before).
Say “Fin forty-six consolidation” to a lender and he’ll recoil and run for the safety of the nearest lawyer.
Consolidate?
Unfortunately for the lender, the lawyer will intone “every case depends on its facts and circumstances” from deep in his diaphragm, a phrase that means “many hours’ worth of legal fees are required before we can say anything, and then you probably won’t like what we say.”
Useful principle: Alert lenders to potential risks and then offer to absorb those risks in exchange for forbearance or other financial concessions. These things are part and parcel of ownership, familiar and thus easily tolerable. However, no voluntary action is appreciated after the fact, so it’s important to raise one’s hand and secure recognition even as one shoulders the load.
12. Lenders understand that ownership costs money and means headaches. Ownership is analog, active (rather than receptive), unstructured, volatile, full of surprises, and tense. Given what we know of lenders already, is it any wonder they loathe being the owner?
Useful principle: Somewhere in the negotiations, get the lender to focus on what happens the day after foreclosure.
13. To a lender, numbers trump words. Financial instruments are, ultimately, nothing but numbers. Numbers speak to a lender in ways that words do not. Tell a lender a property is doing great and he hears it like B. Kliban’s dog (”bark bark bark bark 1.35 bark bark”). Tell the same lender 1.35x debt service coverage and watch his tail wag.
Say “point seven four coverage” and watch his ears droop.
It’s the watch list for me
When in doubt, turn things into numbers. When there are multiple numbers, conflate them. That’s why the rating agencies developed AAA, AA, BBB, and so on — because these synthetic metrics condense a broad and diverse range of information into comprehensible shorthand.
Useful principle: When reporting a complex situation, simplify it into a few key metrics — my favorite is green-yellow-red, because everyone understands intuitively what they mean.
14. To a lender, principal trumps interest trumps fees. Even though all flows are variations, lenders distinguish among principal, interest, and fees/ charges, and live in horror of losing principal. Sometimes it’s inescapable, but if given a choice, a lender will always waive penalty fees before interest, and restructure, reduce, or defer repayment of interest, if doing so offers the prospect of less loss of principal.
Useful principle: When restructuring, preserve principal, even on very soft terms.
15. Lenders want to be told there is a plan. Lenders think of the world as having a stable state of being ‘in whack’ (as opposed to ‘out of whack’), so any period where things are out of whack they consider transitory, and they want it over. Since the lender wants the borrower/ owner/ manager to fix the problem, the lender craves knowing that the borrower in fact has a plan to restore order — even if the plan requires pain — provided that pain is quantifiable and temporary.
As the operating system monitor program (think: lender) Tron said to user (think: sponsor) Kevin Flynn:
“If you’re a user, then everything you’ve done has been according to a plan.”
“I’ve got news for you, pal; you just keep doing what it looks like you’re supposed to be doing, no matter how ridiculous it seems.”
“That’s the way it is with programs, I thought users were different.”
“I hate to disappoint you pal but most of the time that’s the way it is for users too.”
“Stranger and stranger.”
Useful principle: Maintain the illusion you know what you’re doing.
Our figures stack up
