My heart softened a little too much as "Dave," a small-time construction company owner told me his story. He was a reformed drug addict and a discharged bankrupt who had found religion, literally, and turned his life around. He came to small town northern BC to make a go of it, and had quickly proven that he could produce a substantial stream of cash flow, fuelled by his high-energy approach to life. He breathed in opportunity and exhaled profit.
I overlooked his sketchy credit history and made an exception to lending policy, granting his short-term financing requirement as he expanded his business to include a piece of heavy equipment. I had something I valued even more than policy - a firm handshake, solid eye contact, and a promise.
Especially in the north, construction companies often take on itinerant employees who see opportunity in the periodic labour shortages of remote boom towns. Dave called a few weeks after I made the loan to tell me he was sending in one of his staff to cash a company cheque for $1000. She had no identification, but policy (then and today) allows us to identify our clients based on our personal knowledge. (Of course, account documentation was fully in order, and the cheque duly signed by Dave.)
But in this case, my client asked me to meet her on the bank side of the teller line-up and identify her by a tattoo below the front of her left shoulder. Awkward.
It turned out to be a G-rated reveal, but none of us knew that until she was done taking off her coat and adjusting her top to allow us to make the ID.
Red-faced, I walked back to my office to hear the phone ringing. It was Dave. "Hold that thought!" he cried out. "She's ditching me! Can you catch her?"
I ran back out just in time to see her scurrying out with the cash in hand. Short of running and tackling her it was too late. This, and a few similar mishaps, resulted in the first loan write-off of my early career.
I ran in to Dave about eight years later in a different town where he had resettled. He was cordial, if sheepish. I invited him in to my office, sat him down and reminded him that, years before, he had looked me in the eye and made a promise. About a month later, a cheque arrived in the mail, paying off the debt in full.
Investors as Quasi-lenders:
Investors can't often look their target in the eye, but they can employ some simple banker rules to avoid the most expensive sort of tuition - a write-off.
1) Cash Flow:
Our best predictor of getting repaid 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.
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. And get this: the lion's share of those write offs were to one very aggressive Canadian real estate family.
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 3-to-5% and sleep better 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 fixed-income investments you hold.
2) Payment 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:
Whether through dividends or on the fixed income side, look at the track record and the unique features of the issue. Not all guarantees or dividends are created equally.
It's your money. Put on your banker's shoes and invest with care.
Mark Ryan is an advisor in Prince George with RBC Wealth Management, Dominion Securities (member CIPF) and can be reached at [email protected].
