Forest for Trees
Sometimes Banks Can’t see the Forest for the Trees!
In my career as a bankruptcy lawyer, I’ve been amazed at how banks spend big on legal fees to make sure that their documents are airtight but forget to ask some simple questions about the collateral they take to secure their loans.
As I’ve mentioned before, my wife’s Uncle Paul “Buddy ” Lerman owned ATEC Liquidations for many years. He is one of the smartest persons I know who never went to college. Banks all over Missouri and elsewhere have hired him to liquidate loans. Unfortunately, not enough hired him to give an opinion on the collateral before they made loans.
There are many examples, but one of my favorites was a company that made concrete blocks in Sikeston Missouri about fifty miles south of Rush Limbaugh’s Cape Girardeau. I was asked by a bank to have a court appoint ATEC receiver to liquidate the inventory when the loan went into default.
When banks lend against working assets its known as “asset-based lending. “ Each week or month the borrower completes a form (“borrowing base certificate”) indicating how much raw material, work in process, finished goods and accounts receivable it has and that sets the credit limit on the loan. This loan, although in default because the borrower did not have the cash to make the monthly payment, was well within that borrowing base and the bank just wanted out.
When ATEC arrived on scene to take over the owner was pleasant and did not resist. He insisted there was plenty of collateral and his borrowing base certificates had been accurate. In this case he was correct and there was no fraud. (I’ll deal with fraudulent borrowing certificates in a later blog post)
What ATEC told the bank was that although there was plenty of collateral, there was limited demand for it within a 40-mile radius of the plant’s location. Why was forty miles so important? Because the cost to ship the blocks was more than that distance was more than they were worth! Thus, although there was plenty of collateral there was not enough demand for it. It was the equivalent of building a luxury hotel in the desert!
The story doesn’t end there. ATEC found a buyer for the business who would pay more than the amount of the bank loan. That purchase was financed by a nearby bank who did not want the company to cease operations.
The irony is that several years later the holding company which owned the first bank bought the second bank and ended up with this problem loan a second time! Of course, the business failed a second time and ATEC finally liquidated the assets.
Sometimes a little smartness is more important that a bunch of paperwork!