JD's Lending No-No's: #1a and #1b

Juggles has his investment commandments, I've got my Lending No-No's, and it's all you need to manage the risk in your debt investments.
Lending No-No #1a: Consider the collateral. Never take stock as collateral for a loan if it's offered by the CEO of a company who is at the center of a multi-billion dollar securities fraud.

The ongoing Refco (Refco) Securities Fraud Stock Scandal hinged on CEO Phillip Bennett's status as an unreported debtor of $430mm to the company. When this came to light on Monday, Bennett repaid the $430mm with cash money. Where did he get this cash money from? Per this NY Post article:
On Monday, Bennett paid back the $430 million plus interest by pledging 43 million Refco shares in return for a loan from The Bank for Arbeit and Wirtschaft AG in Austria.
The Bank for Arbeit and Wirtschaft committed a classic lending no-no and forgot to consider the collateral. It is likely they hedged their position but it was still a bad loan.

Update: The $430mm loan was unhedged. Probably the worst loan ever.

Lending No-No #1b: Consider the collateral. That trademark which is part of your security package? If you ever need it, it will have no liquid value.


Frequently, companies with trademarks will include them as collateral in loans. So a company such as The Gap Stores would hire a third party to perform a valuation of their brand and come up with a figure say $XYZmm dollars. We all know that $XYZ dollars is a lot of money, but that brand's value is really only a barometer for how well the company's stores are doing. If you ever needed to sell that trademark to make a recovery on your high yield bonds or whatever paper you foolishly hold, you can expect to get $XYZmm - $XY0mm for it. That would leave you with just $Zmm left over (see our earlier research on $Z); you can't win with math like that, which is why you always have to consider the collateral.