The Future of Lending after COVID-19
Only when the tide goes out do you discover who’s been swimming naked.” — Warren Buffett
Algorithm-backed high-tech finance has failed its final exam — the tough times brought about by COVID-19.
Learn how asset-based lending has continued to flourish and lend money even during the current downturn, and what’s coming next. Bob was recently the guest on a webinar put on by Dare Capital, a factor and asset based lender. Join us for a conversation about lending after COVID-19.
The Future of Lending After Covid-19
Cole Harmonson: Today we have our good friend, Mr. Bob Zadek, who I have known since 1996. If you’re in factoring or ABL or banking, you probably know Bob’s name. You have probably heard him talk before and we’re very lucky to have him today. Bob has been a lawyer for the industry 55 years. He has been with Buchalter Nemer for 27 years. He has been a board member of the AFA and the IFA and the secured finance network for many years. He co-authored the revision to the UCC. He has been an entrepreneur at lenders funding, providing capital directly to other factors in AVLS for the last 20 years. He’s been a libertarian podcaster and radio host of his own show, the Bob Zadek Show.
He’s an expert witness and an all-around pleasure to listen to. We’re very lucky to have Bob here today. This is brought to you by your good friends here at Dare Capital to provide working capital for growing companies in the form of asset-based loans and the form of factoring of accounts receivable. We’re in a couple of niches. One of those is white label. It’s for backroom services for deal flow sources. We have several portfolios that we service for other folks and we provide the credit and operational expertise needed for folks who don’t want to spend five years building up expertise and spending money doing that. We’re also in the funds control services business for construction subcontractors. Along with all the other things we do. Today, I’m going to preview just a little bit of what we’re going to be talking about with Bob.
First, we’re going to talk about the history from past crashes and recessions and how does this compare and what does it look like? We will talk about how Bob thinks lending is going to change after this thing recedes and what we are already see changing today. Some of the regulatory backdrop that would not exist without some of the previous recessions and market crashes and what we expect in the wake of all this. How banks and factors and other lenders should change their approach to capital right here, right now today, both short term and long term considerations. And then we’re going to get into some of the inflationary concerns, some of the economic changes, who gets to rewrite history or write history, if you will. And also we’re going to cover one of Bob’s pet projects, which is thinking up ideas for various fintechs.
I had the pleasure of sitting next to him at the President’s meeting in Costa Rica in January and he previewed this idea, which I thought was brilliant. It’s one of those things that’s sitting in front of everyone and very obvious, also very hard to change but would be a game changer for the business. So for those of you who have inclinations on starting other businesses, et cetera, this is a brilliant idea and we’re going to preview that topic today. But without further ado, we’re going to go ahead and get started.
A Non-Economic Cause of the Covid-19 Recession
Cole Harmonson: So tell us, Bob, in terms of history, how does this thing compare with past crashes and recessions?
Bob Zadek: Well, the only comparable previous recession, depression, decline is probably the Great Depression, not in terms of magnitude, I’m not trying to be scary, but the reason I picked that as a parallel is that this present economic problem is created not by the economy itself, not by any financial events, but by totally external factors, that is, the virus. If we go back to what has been called “the great recession” of 2007/2008, that was a recession caused by economic factors, albeit governmental economic factors.
That whole discussion is for another day, but it was failures in the economy and in the marketplace that caused the great recession. The same with the recession in the late 1980s, that was the economy itself which was a contributing factor. With Covid-19, the economy was as robust as anybody can remember. An existential factor, the virus, a non-economic factor invited itself to the economic party and everything turned for the worst for the minute. That distinction will come up again and again during this conversation because it will dictate how fast in my opinion the recovery will be and it will dictate what the lessons, both economic and governmental are, from this crisis. So the fact that it’s existential and non economic will come back over and over again during this conversation.
Cole Harmonson: What do you think of these comparisons to the Spanish flu? Is that apt?
Bob Zadek: Well I wasn’t around then. You have me here because since I’m older than many of the people I remember more. Unfortunately my memory is not that great to remember stuff that predated birth. So I don’t have a lot of first hand knowledge on the Spanish flu. I do know that the Spanish flu was more pervasive and killed many more people. Medical science was obviously far inferior to what it is today. The ability to understand and cope with it is far greater. So there are a lot of differences including how the world reacted, both for the better and for the worse during the Spanish flu epidemic and economic crisis that followed. So there isn’t much to be learned economically, which is what we care about today in this webinar.
A Post-Covid 19 Lending Market
Cole Harmonson: When this thing recedes, if and when it does, what changes in the lending market do you see happening as a result of all this?
Bob Zadek: There will be some really profound changes in the economy. The question is, will they be changed for the better or for the worse? And as to that question the jury is out. It is hard to predict. I tend to be profoundly optimistic. I always am. It is a function of my own life experiences. So I like to think that the changes will be far more positive than negative. Let me give you an example of both, and what will dictate whether the changes are for the better or worse. When life goes back to normal in three or four months, what will dictate whether we have learned all there is to learn from this virus from the standpoint of economics and specifically short-term lending as opposed to long term investing. We are short term lenders and my focus is always on the basis of what it means to short term lenders because that’s how I’ve chosen to spend my life. So what are we going to be sorting out in terms of lessons? Well the key question will be who will get to write the history? That’s a really interesting question because the spinners of the world, those who look back and say that what has happened in the recent past proves I am right or proves that they are wrong.
The question will be whether the lesson is how dependent we are on tight government regulation on almost the closest we have come, certainly in my lifetime, to martial law in the United States. Not that we were close, but we were closer than almost ever before. Once we imbue state and local officials with very broad discretion on how to govern their dominions States or cities, whether this proves that that was the secret sauce that got us through this, or whether we learn to abandon burdensome regulations, that got us through. This writing of history will dictate whether we come out of this wiser economically and politically, or dumber, economically or politically. And so the jury is still out on that.
I will point out how in the past we have negatively learned. In 2007 and 2007 we learned the wrong lessons. More regulation, more control over the economy, more control over capital, looking around for demons and then punishing them with regulation. I am hopeful that the lesson we learn this time is the opposite–that innovation and the free market and the absence of control will get us out much faster. Whether we will learn from the imagination and innovation of millions of independent entrepreneurs, or whether we learn from the mere power and control of government, will dictate whether we come out of this for the better or for the worse.
How Fintechs are Coping with the Crisis: Collateral is King
Cole Harmonson: As far as what we’re seeing right this second, and we could dig in again a little bit more into that topic when we’re previewing your ideas, but some of the things that seem to be occurring to me right now is that some of these fintechs who were lending very aggressively seem to not be doing that other than making PPP SBA loans. And to the extent that is happening I am not sure as well. What are you seeing in the marketplace this second as far as activity is concerned?
Bob Zadek: We are taking the final exam in a course called short term lending. And here’s what I mean. This is the final exam. When you and I make short-term loans, and we were doing documentation and underwriting in a strong economy. The economy has been booming. It’s been a great time to be a short term lender. Well, a rising tide raises all the boats as we all know to paraphrase that old saw, and more specifically, during good economic times, bad underwriting, bad documentation is not punished because when the economy is good people honors their obligations because they have got plenty of money. The advent of credit defaults and fraud is much lower at all.
Lenders pat themselves on the back. I have great returns. I have price competition, but no big deal. But I haven’t done anything wrong and I haven’t lost any money in a long time. And all lenders are patting themselves on the back and how smart they are. Well, it didn’t matter whether you underwrote smart or not, it didn’t matter whether your documents were horrible or state of the art. It didn’t matter about anything because you got paid back because people had plenty of money. The tactic of not paying back your loans and honoring your obligations wasn’t necessary. And then the economy turns. And then the analogy again is like the tide. When the tide washes out, the water recedes and exposes all the bad practices. And as soon as business takes a downside, all of a sudden the weekend credits fail, the bad documentation causes the lender to lose money and all bad practices are exposed. All of the bad operators lose money or lose a lot more and they are exposed.
There’s nowhere to hide. Why am I mentioning that? There has been, in my opinion, a profound economic battle between short-term lenders who are somewhat old fashioned, to their credit because they rely upon collateral and underwriting–stuff that has worked for a long time. The theory of collateral, of being a secured lender, is that what happens to the borrower does not matter because you always have your collateral, so long as you have your collateral, as long as it’s there, you did a competent job and at that time credit defaults were the final exam. Borrower failed, who cared, if you did a good job with documentation, a good job at underwriting, you always had your collateral, and either you don’t lose money or you lose a lot less. That’s one approach.
Then along comes the FinTech world, and they rely infinitely less upon collateral and in reality not upon collateral at all. They rely upon digitized algorithm driven scientific big data-driven credit decision making. They were convinced that they could do it. That in effect, ignoring collateral but relying upon other external credit factors would be a reasonable substitute for collateral. And they were making a lot of money. They seem to be making a lot of money. They were drawing a lot of investment capital. But of course I would sit back and when I would make presentations and I would be asked to comment, my opinion was that no one has a clue whether that model works because they haven’t been tested in bad times. They haven’t had the final exam yet. Along comes covid-19, the final exam, and what have we seen?
Those lenders are sitting taking the final exam and they have all stopped lending. In other words, they flunked. So the model has not been tested until today under unusual circumstances. They all start blending. In our world of secure lending, we haven’t stopped lending one bit. We’ve gotten a bit more careful. So we’ve gotten 10 or 15% more careful. Careful is good, but the secured lending industry has not lost enthusiasm, stopped lending and has not suffered losses. Now they will suffer some losses but they’re not going to stop lending. You just get through it because losses are part of the game and if you price your product right, it’s built into the product. So on the other side of this, I am intensely curious on how the capital providers will look upon the product of FinTech, i.e.unsecured lending, whether they will be as comfortable with it with it will be totally uncomfortable somewhere in between, whether the model itself will have to change or whether it’s just a model that only works if times are good but doesn’t work if times are bad.
It is fascinating to me because we get a chance to test the theory and so far my takeaway is that this is unbelievable vindication for the strength of the short term, collateral-driven, secured lending, factoring ABL product. This is the vindication, and the short term lending stars are clearly those folks who stuck to their knitting, underwrote carefully, documented carefully, and behaved the way they should, where the concept of collateral is and remains King.
Cole Harmonson: At all of these conferences we both attend. We have all been sitting around wringing our hands asking the question, “what happens when…?”, and now I think we have the answer. It’s like when Warren buffet said “When the tide goes out, you can see who’s swimming naked.” So I think we’re seeing that now. That’s been our anecdotal experience as well.
Bob Zadek: We have sat next to each other at those conferences and scratched our heads and said, no, no, we, you and I are not curious at all. We have a pretty good sense of what’s going to happen when the tide goes out.
Possible Post-Covid Government Regulatory Response: The Writing of History
Cole Harmonson: Yeah. I think you saw it in some of the default rates, even in good times that didn’t seem sustainable but that will be an interesting post to say again, like you said, how these capital providers will view that market. I know I’ve gotten a lot of calls on the investment banking side asking if we need capital to go into this recovery, which again I find very interesting and I think is a very positive sign. So back to the regulatory question. You know, what would not exist without previous recessions and market crashes and then what do you expect in the wake of Covid-19 in regards to new regulations.
Bob Zadek: Wow. What do I expect? It’s a question going back to what I said earlier, who gets to write the narrative? Here’s what I optimistically expect. First, what has happened? Well, the crisis hit and the immediate, the government’s immediate reaction was to make sure to cut off the supply of goods. I have found that the government creates scarcity. Our government, especially in times of comfort and wealth creation and high standard of living. Look at the crisis, the first thing they did was shut down, creating scarcity. We have existing regulations that have been put on the books for the purpose of creating scarcity. Some of them are on the screen right now for our viewers.
We had very rigid and frankly pointless licensing regimes, where we limited the supply of labor. Remember, the government creates scarcity. It limited the amount of people who can provide healthcare by having medical licenses at the state level not being respected through reciprocity from one state to another, as if a doctor trained in New Jersey would kill somebody in New York because they don’t know how to do it the New York way to practice medicine. So that creates a scarcity. It also creates a scarcity because in so many occupations when you move from state to state, you cannot practice your occupation.
It profoundly hurts the military. Military couples move from state to state quite often, more than perhaps any other occupation. The trouble is the non-military member of a family who is, let’s say a therapist, when her husband is transferred from one state to another and she is a therapist or anything else in one state, she cannot practice her profession in a new state.
The government creates the scarcity of healthcare. When the virus hit, we had a shortage of hospital beds. It was all over the news. We made healthcare decisions to flatten the curve because we didn’t have enough hospital beds, not because it was good medicine or good economics. Well, many States have certificate of need laws, which says you cannot build a new hospital unless you could prove the community needs another hospital. And you have to get other hospitals to agree there’s a need. It’s called the competitors’ veto. That is, believe it or not, in America, the land of free markets, allegedly, you could have your competitors veto your building hospital. So no hospitals are built because the competitors won’t allow it.
What happens, we have a virus, we have a shortage of hospital beds and we close down the economy because we don’t have enough hospital beds, not because it’s good medicine. And so all of these regulations got in the way of supply because the government creates scarcity. All these regulations got repealed quietly and quickly by the States. The question is, when the virus leaves, do the regulations come back or do they stay away? That will be the battle. We know that regulations have been repealed by the Trump administration. He hasn’t gotten enough credit but it has happened and it has profoundly affected, to the better, the economy. If that now happens at the state level, state by state, there is reason to be profoundly encouraged.
Cole Harmonson: What do you think we can do about that? What’s an action we can all take, if any, that you see towards making ourselves heard and influencing around those specific issues?
Bob Zadek: People at the state level tend to underestimate the profound influence that state law has on the economy. We tend to think of the economy as national in scope, which of course it is, but it is also very much a state and even county level issue. And if we pay attention to economic issues at the state and local level instead of only at the national level, we can assert more control over these state economic issues.
The closer the government is to the people, the more power people have over the government. We have more power over the States that we do have a Washington, more power over the cities. And if we pay attention, we can have a turbocharged influence on the state economy and local economy. Once we do that, the States that have a robust economy will show the way for the other States and the States with a more controlling economy and less of a free market will learn the obvious lesson when the voters vote with their feet and leave. They will get the message loud and clear. So this battle of creating scarcity by the government can be won at the state level easily. I’m highly encouraged.
Cole Harmonson: You’re in the conservative bastion of San Diego, California. What are you hearing? Just sort of boots on the ground there? I know I’ve seen some videos. I’ve seen some requests. It seems more right leaning and libertarian leaning than anything I’ve ever heard out of California in the recent past because of this. Is it your sense that it will move that way or is it your sense that it will move more draconian.
Bob Zadek: If I can hearken back to June of 1944, San Diegans and Californians are, to borrow a phrase from the past, we are storming the beaches. We are coming backwards. We’re going from the shore to the sea, but we are storming the beaches nonetheless. Even Governor Newsom is getting a little concerned from his bunker in Sacramento that the citizens are reclaiming the beaches. So I am in a very brightly red state.
Cole Harmonson: Very nice. Turning our eye a little bit towards the future in terms of how banks or factors, commercial lenders or companies should change their approach in terms of how they think about their own capital. What does that look like in this environment, in your mind?
Bob Zadek: It’s a very interesting question. What has happened is during the virus period, you and I, and our clients and friends and the people who occupy the niche that we occupy, have changed their attention as they should from the P and L to the balance sheets, of preserving liquidity, which is, in my opinion, the right call. I’ve never been so happy about watching outstandings creep down as I have right now.
Normally outstandings creep down and lenders say I’m losing sales, I’m losing business, I’m not going to make so much money. In these times, that is a basis for elation. The money is coming in, I’m putting this liquidity right where handy to me it’s available. It can’t be lost. And when we hit the other side, and we are probably weeks away, it will be such a profoundly lenders market.
And the reason I say that is that we have seen a lot of people describe what government has gone with the nationwide shut down of the economy as putting the economy into a coma–putting it to sleep for a while. And I think that’s an apt metaphor, except it’s not as neutral as a coma sounds, but the economy is going to wake up like Rip van Winkle, but that was 20 years. It’s just going to be maybe 20 weeks, and you’re going to wake up and it’s going to go back in my opinion, to business as usual. The economy is crying. Let us get back to work. And when you have all of that pent up demand, not demand for goods, but the man to go back to work. The demand for goods is still there. People still want their stuff and they want their entertainment, so the demand is all there right now buried behind a barricade.
When you open up that barricade, they will be like black Friday, a rush for the goods. Producing goods will require capital and the profits will be there. The capital will be well rewarded. All of us have capital to do what we do best, to make sensible secured loans. We will not be experiencing a borrower’s market. It will be a vendors market for lenders who have the capital to put out there and employ excessively. So I cannot wait. We will then put our attention back on the P and L and less on the balance sheet.
It is going to be fascinating times and those of us who have survived with our capital intact and our bank lines intact, will enjoy some really pleasant quarters.
Economic Rebound Forthcoming?
Cole Harmonson: How do you think this compares to 2009–12, the same banner years, but it wasn’t V-shaped?
Bob Zadek: In the crisis you alluded to, the problem was that the consumers didn’t have any money. They had over-invested in real estate. Real estate was inflated and then it would seem like a few short months, all of the make-believe equity in homes disappeared. Consumer confidence was in the toilet. Nobody had any disposable income. It was a consumer driven recession. This is not a consumer driven recession. And I think the government has done not nearly as good as could have been done.
The method they used for distributing money to the consumers was greatly flawed. The distribution system was terrible, but the money got out to consumers. So the consumers are out of work right now, but that will change. That will change quickly because the demand will be there because the money is there. So this downturn in the economy is not consumer-driven. When you have the demand asleep, but about to go up, the supply side, which has always been there, will just power up faster than some of the more pessimistic of us will believe.
Cole Harmonson: What basis do you have to believe that on Bob? What’s your thought process there?
Bob Zadek: The thought process is that the supply side has been shut down. The demand side is still there. There’s just no way to satisfy the demand. There is pent up demand right now. People have postponed all kinds of purchases. It’s not that they don’t have the money, they can’t buy it. There’s only so much you can spend sitting at your computer. We’re a consumer driven economy. The consumers have been told if you try to spend money, you’re going to go to prison. So nobody can spend any money. Well, the demand is still there. If America and our trading partners are good at one thing it is finding out how to satisfy demand. We are really good at that. We have always been good at that and we will be satisfying demand like crazy once people are allowed to spend.
Cole Harmonson :In the face of unemployment, and where that is today, do you still believe that’s true?
Bob Zadek: Of course. Of course. I do. Unemployment. Let’s take one tiny segment. Let’s take the entertainment industry. Whether we’re talking about sporting events, whether we’re talking about going to a pub, or whether we are talking about going to a restaurant. Everybody wants to go to a restaurant now, it’s not going to be immediate. Of course people will be a little more cautious. People will have to sort of organize their thinking a little bit better and even that is going to recede. The danger will decline and the discomfort with social distancing will not be as necessary. It will be necessary to some degree, but we all know the need. People are not going to be careless. They’ll be sensible. I have profound faith in individual decision-making. People will sensibly go out. We’ll learn how to do it and we’ll gradually visit restaurants, spend money, go to Home Depot. The governor of Michigan will not criminalize the buying of paint. You can buy, paint, repaint your house, and some segments will go back faster than others, but when you have pent up demand, no one doubts America will satisfy that demand and satisfying demand produces a robust economic recovery.
Cole Harmonson : As far as the inflationary concerns go because of all this government intervention, et cetera, what are your thoughts surrounding that?
Bob Zadek: Inflation means the purchasing power of a dollar declines. I have no doubt that there will be some inflation. It’s almost inevitable. One would think when you have so much debt and so much money washing through the economy from the debt. I happen to be of a different view. If a dollar is going to decline, it has to decline relative to another currency. There is no such concept as the buying power of a dollar if all currencies are inflating at the same degree. Because inflation is always a relative concept. If all the world’s currencies are inflated, things will cost more in absolute dollars. Whatever costs $2,000 will cost $2,300. But since inflation is on the whole, in all the trading economies, that means salaries will have to go up and income goes up commensurate with the inflation of the cost of goods going up.
Bob Zadek: The only ones who will lose in inflationary times are those people who either have their investment as cash because a hundred dollars will buy less, but if your wealth is tied up in home, values are tied up in securities or tied up in commodities. Whatever your money is in, other than money itself will appreciate at the same rate or depreciate at a lower rate, which means nobody is going to feel it, in my opinion. So since it’s not just the U.S. I think the negative effects on inflation will not make much of a difference in the value of your dollar.
Will Cities and Offices become Unnecessary?
Cole Harmonson: As far as economic changes that are happening across the country, across the world, offices, cities. What happens in your mind?
Bob Zadek: If you enjoy thinking about that stuff, the pure activity of thinking about it, and using your brain and your knowledge of economics to see into the future, the question you just raised is so delicious. Here’s what I think is going to happen and I haven’t seen a lot written about it, so big warning, this is Bob thinking, not somebody really smart, but here’s my opinion. We have seen what Amazon has done to retail real estate. It decimated it. I mean Amazon as a concept. Retail space was valuable and malls and brick and mortar was the way of life in America for 150 years and in 20 years it all changed. It all changed because of Amazon specifically and a concept in general. Now how does that answer your question?
I am working from home and have been as everybody else has and I have said to myself, my goodness, what was I thinking? Going to an office is so retro, it is like going to a department store. People don’t even know what at the department store is anymore. Two hours to buy a dress shirt. Don’t be ridiculous. I’ll spend 20 seconds and buy it online and going to a store is absurd. Going to an an office is going to be the same. Now what does that mean? That means office buildings become excessive. And we’re going to see high-rise office buildings with plywood on the windows. No one wants them. No one wants to work there. To get a figure out a use for the space let’s tear down a high rise office building and put a park there because office buildings will stop making sense.
So that means the real estate goes to that value. That means that cities stop making sense. Cities only make sense as a place to work. And once a place to work doesn’t make sense, then the city doesn’t make sense. And then looking into the future and really allowing yourself intellectual imagination, cities stop making sense except as cultural centers. And then that rejiggles all the real estate values and that causes a massive relocation of capital. And the result is that everybody is better off. And now politically, what does that do? When cities no longer become population centers? The draw of cities is that people want to live where they work for convenience. That’s how San Francisco real estate became so valuable. The techies who wanted to live where they work. Once the concept of going to the office disappears it brings profound political changes.
Once the concept of going to the office disappears, it makes profound political changes and then you’re off to the races in terms of what happens when. But is it going to happen, you bet you! Of course it’s going to happen. I can’t be the only one to say it does not make sense to go to work. Now I’ll go to work, go to the office, I’ll have my desk, but I suspect I’ll be there less. It’s just too nice to work from home and too sensible and it will be like going to Macy’s to buy a shirt. Going to the office just to power up the same laptop kind of doesn’t make sense. That to me is going to be the most profound economic byproduct of the virus. And people will sit back and say, why did it take so long? This makes so much more sense.
UCC Liens: A Rare Non-digitized Method of Securing a Loan
Cole Harmonson: I think there’ll be a strong correlation between the people who go back to work and the number of small children they have in their home. I see a lot of posts regarding how quickly people want to go back to get away from their kids, but hopefully they’ll go back to school. Let’s shift over and talk about your idea. You and I visited in January in Costa Rica, at the president’s meeting where you previewed this idea for our lunch table, which I’ve been thinking about in every sense. There are many aspects of the way in which we lend to our clients and the way in which we do business that have been digitized. One of those areas that has not done so is declaring lines of UCC’s.
I know that’s not a noun in your book, but folks need to have that. If we have collateral, we have to have first position and there’s, as you pointed out, no way that that can be done unless you manually work on the process. So I want to talk about your idea there and I want you to also kind of weave in the conversation that we began earlier regarding who gets to rewrite history in terms of a collateralized lender or a non-collateralized lender as I think it’s a fascinating topic and I think the person who does figure this out can really make lending in a collateralized environment much easier.
Bob Zadek: We had great conversations about this issue. This is really the clash of two credit cultures. This is so interesting. What I’m alluding to is the following. As I said earlier in our talk this morning, the FinTech world, the world of algorithm driven credit decisions, which I do not at all question the value and the intellectual honesty of it. It’s sensible as far as it goes. The FinTech world, the MCA’s, the merchant cash advance industry, they all offer speed. Get your money in hours, a couple of mouse clicks, you get 50K, you pay it back daily for the term. And they offer speed and convenience. What’s interesting is that all or almost all of the MCA world makes instantaneous credit decisions and relies upon their ability to predict credit default and to underwrite credit.
I have no question their artificial intelligence approach is sensible and it is the way of the future. However, what is interesting is that these FinTech algorithm driven underwriters also take a security interest. Now they don’t behave like secure lenders. They don’t even know what it means to have collateral, but they take collateral and perfect their security interest by filing. So they are secured lenders in the sense that they take a lien but they’re unsecured lenders because they don’t have a clue what the collateral is worth, nor do they really care. But if they’re relying upon collateral, they have to have a first lien, or at least they have to know the value of the collateral and monitor the collateral.
Why don’t they take a first lien? Firstly, because the system of getting a first lien is 50 years or 75 years or a hundred years old. It is a system that cannot be made more efficient. It requires negotiation, understanding what the prior lien are, and there are countless prior liens are, and they are complex. Getting a first lien is a pain in the butt and it takes time and you cannot speed up the process because everything is manual. So if you say to a merchant cash advance company or a FinTech lender in the broadest sense, are you secure lenders? Yeah. Do you have a first lien? We don’t have a clue because it takes too long.When they have to make a decision, do we make a decision to make a loan and roll the dice on collateral or do we go slower in making them a loan, offer less efficiency and be in first position?
Which model do we pick? They have made a rational conscious decision to vote for algorithms. They vote for the algorithm driven credit and we will subordinate our need for collateral. In our world, we are collateral lenders. We do not offer speed. We can’t give the money out fast because we have to clean liens. So we have opted for slowness, but slow and sure and have collateral. The bottleneck is the uniform commercial code, which was written in the 1950s, enacted in the 1960s, moderately meaningfully revised in the 1990s, and revised again in 2010 in a minor way. But the one thing that never changed is the filing system, which is done at the state level. It is not national and it is not privatized, it is at the state level.
The system I’ve described where getting a first lien is a two week process and cannot be made faster, it cannot be made faster. It is impossible. That will be the way it is until there is a process of lien clearance which is as efficient as getting a credit report, which is instantaneous. That’s in my opinion, a decade or more away and requires a massive nationwide campaign involving all 50 States and either the federal government or a private or semi-private system, which is national, where everybody records their liens in some private company like the depository trust company for securities or the system for recording interests in mortgages, which is a semi-private system. Until we have that every lender will have to decide is your model speed and efficiency? Or is your model having a first lien. Every single lender on the planet has to make that decision. MCA says we’ll do the best we can with collateral and we’ll rely upon the algorithm, you and I say, no, we’ll take our time, take a first lien, because we know that’s a proven test. The end game hasn’t been proven until last week and it’s been proven to have a fatal flaw. It’s got a defect. The defect is, it is not immune to viruses.
Cole Harmonson: Nice. Well we’ll see what happens. I think that should be a topic for all of our industry associations to take up.
Bob Zadek: I don’t dare predict what the non-collateral unsecured speed and efficiency credit world will be like, whether it will draw capital or not, whether it will be capital starved, whether investors will say no, no, we can’t roll the dice on unpredictable, cataclysmic events, and whether the model will fail, whether it will come back in a different form, whether there will be unsecured lenders but far more restrictive in their credit granting. I have no idea. But they are not on this webinar and they are sitting in meetings right now trying to figure it out because I don’t think anybody knows. It’s going to be fascinating to watch. And I think factoring, if there was a battle, factoring will have outlasted and shown that safe and sure has won the race. That’s what I think.
Cole Harmonson: On behalf of everyone at Dare I think you. You’ve been nothing but generous in giving and passionate about this industry over many years that I’ve been involved with it but you know, you were already mega experienced before. So as I think the definition of an elder statesman in our business, thank you very much. And with that, do you have any sort of parting words of advice for those of us who have been in this business for a long time and are staring down uncertainty and those sorts of things. What’s your parting words of wisdom?
Bob Zadek: Well, I owe my entire professional life to this industry I have been in. I have been involved full time in asset based lending and factoring since 9:00 AM on June 5th, 1962, my first day at work after college, and I’ve been doing nothing but this and I owe everything good in my life, as a direct line to this industry, to the commercial code and to all of the myriad of wonderful friends and business relationships that I’ve established. So you’re asking somebody with the most absurdly intense bias in the universe.
To me, this has been a massive vindication that we have a solid product. It has proven itself viable during all circumstances. I remember sitting at meetings when some factors were starting to despair that other lending products were starting to eat their lunch. This shows that despair was maybe sensible at the moment you had it but we have outlasted it, and this has been the proof that our product will basically be unaffected by this terrible economic event of the virus. We have survived and we are locked and loaded ready to start making buckets of money once we are released from our home prisons.