It had been three years since he had last made a loan payment, and my client had no clear plans to tackle the debt load burdening his fledgling fishing enterprise. He lived several hours away in a remote coastal location that offered no prospects for off-season employment; thus, he had no realistic prospects to catch up his payments. This left me with the unpleasant task of seeking repossession of his boat. Since he lived so far away, the cost of sending a collection team to him was prohibitive. We had no choice but to ask his co-operation.
When I made the ominous call, a sweet little girl, maybe four years of age, answered the telephone. I can still hear her voice as I asked for her father: "Daddy, it's for you!" Her bright, cheery disposition made my heart sink.
He responded to the news with an astounding display of integrity. "I'm going to need a couple of days to gather up my gear so I can bring it all to you properly."
A week or so later he chugged in to town, docked the fully-geared boat at a local shipyard and brought me the keys. I walked down to the waterfront with papers in hand. The law required that we post the official notice on the boat. I felt eyes piercing my back like so many knives as I walked around the docks (dressed conspicuously in suit and tie) to find his vessel and post the "Notice of Repossession." I pondered my ability to swim in my bank loafers in the event that solidarity-minded seamen should throw me in to the drink.
The burdens that debt can unleash are real. Sobering analysis should always accompany the contemplation of taking on a new loan. Easy credit reduces the concept to triviality, but, like the accumulated consumption of so many burgers, it has resulted in an economic obesity that weakens the knees of the entire free world.
Lenders use common sense industry credit-criteria, or ignore these same guidelines at their peril. None of these concepts should come as a surprise; although, their broad application to investing might be a new twist for some readers. In these times of very skinny returns, investors might do well to think a bit like a banker:
Cash Flow: Our best predictor of successful loan repayment is quite simply a solid track record of positive cash flow. If we don't have that, the answer is often: "No."
As Canadian bankers, we really did all we could to take the excitement out of lending. One borrower, who had recently returned from making his fortune in U.S. real estate, literally yelled at me: "My dog could have written that loan proposal! Don't you guys take any risk?"
But the risks of a few bad loans could wipe out bank profits more quickly than a dog gulping down a bowl of gravy as it did in 1992 when a few huge, sloppy real estate loans swallowed the profits the offending Canadian and US banks would have enjoyed that year.
Investors: Make your own "lending" policy to invest in companies with proven cash flow. Don't think too highly of speculating. Think mainly of becoming a part-owner of an already-great company. Earn your yield of 4 or 5 per cent and sleep well at night.
Collateral: Even a proven business will run into hard times. If cash flow and payments run dry, back-up assets bring comfort to lenders and investors. With rare exceptions (see above), what seems like a ridiculous surplus of collateral when a loan is written is usually severely discounted by the time a failed business turns it over to the bank or investor.
Investors: When things go terribly wrong, you'll be glad if you have some guaranteed investments in the mix. Look a little deeper at the mix of guaranteed and non-guaranteed investments you hold. Most mutual funds and equities have no such guarantee. Study the reliability of the guaranteed product you hold.
Credit History: Some people always seem to find a way to pay their debt, as if the habit were written into their DNA. However, this trait is by no means universal. One of the best warning signals of default is... default.
Investors:
On the fixed income side, look at the credit rating of the issuer and the unique features of the issue. Not all guarantees are created equally. Anything rated below BBB- is considered below investment grade
It's your money. Put on your banker's shoes and invest with care.
Mark Ryan is an advisor with RBC Wealth Management, Dominion Securities (member CIPF) and can be reached at [email protected].
