How Well Do You Know Your Collateral?
by Wayne H. Frederick
The WFA Group
Houston, Texas
The story of another apparently fraudulent accounts receivable activity has been circulating around the news media and has resulted in several millions of dollars in losses to investors in Northeast Texas.
According to the news story, this activity started with a factoring company (we’ll call it ABC Co.) located in Little Rock, Arkansas, which received a bank line of credit to fund its factoring operation. ABC Co., in turn, purchased invoices from various businesses at a discount and funded these invoices for their customers. ABC Co. also convinced certain investors that the rate of return on this type of investment was high yield with minimum risk. The investors then opened their own bank lines of credit to purchase invoices.
The majority of these loans do not start out as planned conspiracies, but many end up as losses just the same because it is easy to deceive and cover up collateral deficiencies when all a borrower has to do is generate more paper. The verification and valuation of collateral is a must.
As is usual with this type of financial venture, it rocks along until the cash flow no longer flows, and then everyone wonders where the money went. By then, the losses are in the millions, and people are left holding fraudulent invoices. The greed factor wins again. What never ceases to amaze me is the lack of due diligence on the front end of these loans, as well as the lack of on-going monitoring programs to keep the honest people honest and to minimize the loan loss. Even knowledgeable investors will look the other way or rely upon their bankers to perform the necessary due diligence which they normally do on the financial end but neglect to do on the collateral end. You cannot rest solely upon personal guarantees or a UCC filing on the collateral if you have a loan secured by moveable assets. An astute guarantor may even look to the lender in the event of a loan loss if the lender did little or nothing to monitor the loan.
Loans and lines of credit secured by accounts receivable as the primary collateral, captive finance companies, insurance premium finance companies or others generating lines secured by paper require a pre-funding field exam and subsequent exams on a periodic basis, as well as internal bank monitoring of the credit.
The field exams must be performed by people skilled in this area who are able to interpret their findings from a lender;s viewpoint. They must be able to show where the lender is vulnerable.
The majority of these loans do not start out as planned conspiracies, but many end up as losses just the same because it is easy to deceive and cover up collateral deficiencies when all a borrower has to do is generate more paper. The verification and valuation of collateral is a must. You either do it yourself or hire a responsible third party to do it on your behalf.
Bankers have told me they do not make loans to people they do not trust. I say, “To trust is good - to verify is better.” Third party due diligence is not proving up the trustworthiness of the borrower, although that may be one of the the benefits. The primary reason is proving up the integrity of the collateral !
