Tuesday, August 07, 2018

Bad Lenders

This Bruce Kelly article in InvestmentNews on two failed lenders raises some important issues.  The lenders are being investigated for loan fraud. I am not sure if the fraud is from the securities the two lenders sold to investors or the loans they made to small businesses.  For investors that likely lost their entire investment, it does not really matter.  One red-light-flashing issue to me is proper return for appropriate risk. Any investment that is paying 10% for a less than one-year hold period is risky; probably much riskier than the 10% potential return.  Assuming there is no fraud involved, I wonder how many investors would sign up if they were told that there is a better than 50% chance they could lose all their money to get 10%?  Not many. 

The second issue, and again assuming no fraud, is that lending and credit analysis is hard.  It is hard even for the biggest banks, which work in a strict regulatory environment with its own lending guidelines, and which have spent decades honing their credit analysis.  These banks are still far from perfect and they are considered the best.  Big private equity firms and their debt-focused divisions or competitors*, while outside of much of the regulatory environment facing banks, have established their own credit criteria and safeguards, but again these big non-bank money lenders are far from perfect.  Then you get down to firms like the fraudsters in the InvestmentNews article.  I can't imagine these outfits having credit expertise and procedures that approach even the smallest community bank.  Investors had no chance.

*Non-bank banks continue to grow and are an important part of the credit industry.  According to a recent Baron's article, private debt fund managers raised $107 billion in 2017. 


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