27 ms·

My only question is, if the lenders are part of who's getting scammed, why do they keep lending? Do they end up getting paid enough by the predatory looting tha

by _bxg1 7y ago

My only question is, if the lenders are part of who's getting scammed, why do they keep lending? Do they end up getting paid enough by the predatory looting that it works out?

musicale 7y ago
I think so; the company is saddled with massive debt and interest payments and pays back more than the original loan while never making much of a dent in the principal.
miketery 7y ago
Its a one way function, while the going is hot and good, the facilitators get a cut. When things go south, the cut isn't taken back.
valuearb 7y ago
Lenders only lend if they believe it’s going to be profitable. The vast majority of their loans are successful, and they charge enough interest to cover the losers and still make a reasonable return. And predatory looting is mostly mythical. No one is going to give you large loans and allow you to loot the assets and walk away. The loans have lots of restrictions to prevent that. What happens is that many PE firms like to use loans to leverage up their investments to increase returns. If you buy a company, fix it up and sell it for double in 7 years that’s a 100% return but only 10% a year. Borrow half the money at 7%, and now you only net a 75% return on the purchase price, but a 150% return on your investment, or 14% a year. Try to borrow 80% and you can boost your returns nearly to 20% a year. Like a mortgage there is a natural tension between what lenders will lend you. They want to lend as much as possible, without assuming too much risk of default. Sometimes the natural greed of the PE firm and the lender go to far, and you get a failed deal and a default.
- youngtaff 7y ago
  One of the problems in UK retail (before CV) is PE buyers, acquiring retailers and then loading them with debt Debenhams (about to go bust this week) is a classic example - until 20yrs ago it owned it's premises, PE bought it, loaded it with debt and then split off the property into a separate company and signed the stores to ever increasing rents Debenhams can't service the debt and the ever increasing rents (and they've lost their way as a business) PE debt killed Toys r Us, and many other retailers in the UK too PE leveraged buyouts are generally bad for everyone except the PE firm, and in some cases lenders
  - JamesBarney 7y ago
    Amazon killed Toys R Us.
  - valuearb 7y ago
    Toys R Us was killed by the internet. When you own a dying business, spinning off its properties makes perfect sense. Real estate has long term value the business no longer has. And of course rents rise over time, why would your real estate business subsidize the dying business with below market rates?
    - youngtaff 7y ago
      In the US maybe, in the UK there are toy shops (Entertainer, Smyths Toys) that successfully operate retail premises as well as internet sites Smyths very much looks like a better Toys R Us
  - valuearb 7y ago
    BTW, you are dead wrong about PE leveraged buyouts, they are generally good for everyone including the firm. I don't know much specifically about Debenhams, but what often happens in situations like that goes like this super simplified example. An entrepreneur builds a successful business and eventually tires of getting up at 5 am or just wants to secure the massive wealth they've built. So they endeavor to sell what they built and shop it to interested parties, and the best price comes from a PE firm. That's good #1, because of the PE firm the entrepreneur was able to get the best price for their life's labor. Lets say the business had annual sales of $100M, and profits of $4M, and the winning bid was $40M (10x earnings). But the PE firm knows that the firm owned all of it's buildings and paid no rent. Market rents would have been $2M a year, so the actual economic profit of the business was only $2M. The PE firm doesn't want to tie up $40M, so it goes to a bank or a consortium of lenders to see how much they can borrow against the purchase value. Lenders not being stupid, won't let the PE firm spin out the properties into another company if they give a large loan, so the PE firm breaks up the company into two parts, real estate and stores, and gets loans for each. The real estate arm now gets $2M in income every year from the stores at current market rents, so lenders loan it $15M at 8% interest, costing $1.2M a year in interest. The stores now have a $2M annual profit after paying rent, they also borrow $15M at 8%, and both subsidiaries net $800,000 a year after paying interest. The new owner, the PE firm, takes the $30M in loan proceeds, reducing their total investment to $10M, and they earn around $1.6M in annual dividends from the company, or a 16% return. If they hadn't leveraged up, they would have made $4M a year on $40M, only a 10% return. Ten years pass. Rents in the areas of the store locations have doubled (a 7.2% annual increase) because those locations were so well selected by the founder to be in areas that saw a higher increase in population and traffic. Now the stores subsidiary has to pay $4M a year in rent. But the problem is store earnings haven't kept pace, sales have grown to $150M a year, but profits before rent and interest have only grown to $5M a year, because there is now also more competition from Walmart, Sprouts and Whole Foods. Now they can't afford to keep up their interest payments, and the CEO of the stores subsidiary asks the PE firm to make the real estate subsidiary give them substantial discount on their rent, after all, the PE firm owns both of them, why favor the real estate subsidiary when the stores are at risk? But the CEO of the real estate subsidiary argues the opposite. Their real estate is valuable, if the stores go out of business he can quickly rent their spaces to new tenants that will gladly pay full rents, and will diversify her portfolio of tenants to make her business more secure. The partners at the PE firm by this point know full well what the real problem is. Despite the boom in population, the stores aren't reaping proportionate increase rewards because they simply can't. The founder was brilliant at buying real estate but that covered for flaws in the stores business model. Maybe they never had the necessary size to compete with bigger chains, maybe they were always poorly run, or maybe the PE firm dropped the ball in who they put in charge. It doesn't matter what the cause is, in the end the PE firm lets the stores file for bankruptcy and surrenders it's ownership to the lenders. The lenders will fire sale the inventory to get as much of their loans back as possible, but still take a large loss. But the real estate firm is now making $4M a year renting to new, stronger tenants in great locations, likely paying higher wages (good #2). The PE firm made around $15M in dividends from both subsidiaries before the stores went bankrupt, and at same time they sell their real estate firm for $40M (minus $15M in loans). So in the end their $10M earns a gain of $30M over ten years, despite the bankruptcy. That seems like a huge gain, but it's only an annualized return of somewhere between 15% and 20% a year depending on how dividends were paid. That's a very good return, but not a world beater. The PE firm lost because the stores failed. If they had just maintained their original value so they could be sold for the $20M that they cost in the original purchase. Now their gains are $50M, and their annualized returns are above 20%. Very few PE firms go into deals like this planning for the main business to fail, and to make up for it with asset sales. It greatly reduces your long term returns or can even leave you with huge losses. If the founder had never sold, the same problems likely occurred. Maybe he runs the stores better, but he would still have to deal with higher levels of competition, and finding good new locations would have gotten harder. Eventually he would have had to wonder whether splitting the business made sense, that he had a dynamite set of real estate properties being held back by struggling stores rapidly being overtaken by larger and better funded competition. The day the stores start losing money would be the day he would be forced to take drastic action similar to what a PE firm would do.
- rmrfstar 7y ago
  Your argument is basically: "market pricing reflects reality", which you clearly don't believe because you go by the handle "valuearb". Credit markets are appallingly inefficient at pricing risk. Lenders are aware of bailouts. They are explicitly factored into credit ratings! Leverage is heavily subsidized by the tax code. The current level of corporate leverage is absurd and has massive negative externalities. https://www.youtube.com/watch?v=qs1DhA91fm0 https://www.youtube.com/watch?v=qs1DhA91fm0
  - valuearb 7y ago
    Hard to respond to a smorgasbord of irrelevant tangents, but I'll try. I believe the public capital markets are often efficient, but not always. I have no doubt that credit markets are less efficient. How they are or aren't, and whether they reflect bailouts, is immaterial. Lenders have to make smart lending decisions or they will cease to exist as lenders, they have every incentive in the world to properly assess risks. The fact that some times some lenders do a poor job at it doesn't change that fact. The market, red in tooth and claw, will eventually chase down and devour dumb lenders. It's true leverage was heavily subsidized by the tax code, the interest paid was subsidized about 40% when the federal corporate tax rate was 35% (plus whatever state corporate income tax you were subject to). Ironically when Trump signed the new tax cut bill, by cutting corporate rates he reduced that subsidy to only 25%. The best solution for ending that subsidy is simple and hugely beneficial for everyone in our country. Stop taxing corporate income, and increase tax rates on dividends and capital gains to compensate. No longer would we be taxing reinvestment creating better jobs and raising productivity faster, and we could start taxing investors investment incomes in proportion to their incomes, restoring a lot more progressively to the tax code.
rmrfstar 7y ago
In my experience there are two major factors at play. (1) No one gets fired for buying IBM. The prestige money pools like Ivy-league endowments invest in leveraged loans. If leveraged loans have a nice run and you haven't invested in them, then you will get fired. You will be fired before the bubble pops. If you make big losses on leveraged loans but the prestige money pools did as well, you will not lose your job. Fads and herding are real things. See, e.g. mortgage market 2000-2007. Jeremy Stein wrote about the career aspect of this mechanism in the 1980s. [1] (2) Bailouts. People are aware they exist. Credit ratings agencies explicitly factor the likelihood of a bailout into credit ratings [2]. Creditors know they can hold a government hostage by threating to force a critical industry/company into bankruptcy. Sometimes they explicitly frame it as "bail me out or I put X critical company in bankruptcy" [3]. Also, please read about the leverage ratchet effect [4]. [1] https://scholar.harvard.edu/stein/publications/herd-behavior-and-investment https://scholar.harvard.edu/stein/publications/herd-behavior... [2]https://www.moodys.com/researchdocumentcontentpage.aspx?docid=pbc_186998 https://www.moodys.com/researchdocumentcontentpage.aspx?doci... [3] https://www.latimes.com/archives/la-xpm-2001-jan-16-mn-12864-story.html https://www.latimes.com/archives/la-xpm-2001-jan-16-mn-12864... [4] https://www.gsb.stanford.edu/faculty-research/working-papers/leverage-ratchet-effect https://www.gsb.stanford.edu/faculty-research/working-papers...
travisoneill1 7y ago
They aren't getting scammed. I used to work for a mezzanine lender (a type of lender who mostly lends to PE deals).

by _bxg1 7y ago

My only question is, if the lenders are part of who's getting scammed, why do they keep lending? Do they end up getting paid enough by the predatory looting that it works out?

musicale 7y ago

I think so; the company is saddled with massive debt and interest payments and pays back more than the original loan while never making much of a dent in the principal.

miketery 7y ago

Its a one way function, while the going is hot and good, the facilitators get a cut. When things go south, the cut isn't taken back.

valuearb 7y ago

Lenders only lend if they believe it’s going to be profitable. The vast majority of their loans are successful, and they charge enough interest to cover the losers and still make a reasonable return. And predatory looting is mostly mythical. No one is going to give you large loans and allow you to loot the assets and walk away. The loans have lots of restrictions to prevent that. What happens is that many PE firms like to use loans to leverage up their investments to increase returns. If you buy a company, fix it up and sell it for double in 7 years that’s a 100% return but only 10% a year. Borrow half the money at 7%, and now you only net a 75% return on the purchase price, but a 150% return on your investment, or 14% a year. Try to borrow 80% and you can boost your returns nearly to 20% a year. Like a mortgage there is a natural tension between what lenders will lend you. They want to lend as much as possible, without assuming too much risk of default. Sometimes the natural greed of the PE firm and the lender go to far, and you get a failed deal and a default.

youngtaff 7y ago
One of the problems in UK retail (before CV) is PE buyers, acquiring retailers and then loading them with debt Debenhams (about to go bust this week) is a classic example - until 20yrs ago it owned it's premises, PE bought it, loaded it with debt and then split off the property into a separate company and signed the stores to ever increasing rents Debenhams can't service the debt and the ever increasing rents (and they've lost their way as a business) PE debt killed Toys r Us, and many other retailers in the UK too PE leveraged buyouts are generally bad for everyone except the PE firm, and in some cases lenders
- JamesBarney 7y ago
  Amazon killed Toys R Us.
- valuearb 7y ago
  Toys R Us was killed by the internet. When you own a dying business, spinning off its properties makes perfect sense. Real estate has long term value the business no longer has. And of course rents rise over time, why would your real estate business subsidize the dying business with below market rates?
  - youngtaff 7y ago
    In the US maybe, in the UK there are toy shops (Entertainer, Smyths Toys) that successfully operate retail premises as well as internet sites Smyths very much looks like a better Toys R Us
- valuearb 7y ago
  BTW, you are dead wrong about PE leveraged buyouts, they are generally good for everyone including the firm. I don't know much specifically about Debenhams, but what often happens in situations like that goes like this super simplified example. An entrepreneur builds a successful business and eventually tires of getting up at 5 am or just wants to secure the massive wealth they've built. So they endeavor to sell what they built and shop it to interested parties, and the best price comes from a PE firm. That's good #1, because of the PE firm the entrepreneur was able to get the best price for their life's labor. Lets say the business had annual sales of $100M, and profits of $4M, and the winning bid was $40M (10x earnings). But the PE firm knows that the firm owned all of it's buildings and paid no rent. Market rents would have been $2M a year, so the actual economic profit of the business was only $2M. The PE firm doesn't want to tie up $40M, so it goes to a bank or a consortium of lenders to see how much they can borrow against the purchase value. Lenders not being stupid, won't let the PE firm spin out the properties into another company if they give a large loan, so the PE firm breaks up the company into two parts, real estate and stores, and gets loans for each. The real estate arm now gets $2M in income every year from the stores at current market rents, so lenders loan it $15M at 8% interest, costing $1.2M a year in interest. The stores now have a $2M annual profit after paying rent, they also borrow $15M at 8%, and both subsidiaries net $800,000 a year after paying interest. The new owner, the PE firm, takes the $30M in loan proceeds, reducing their total investment to $10M, and they earn around $1.6M in annual dividends from the company, or a 16% return. If they hadn't leveraged up, they would have made $4M a year on $40M, only a 10% return. Ten years pass. Rents in the areas of the store locations have doubled (a 7.2% annual increase) because those locations were so well selected by the founder to be in areas that saw a higher increase in population and traffic. Now the stores subsidiary has to pay $4M a year in rent. But the problem is store earnings haven't kept pace, sales have grown to $150M a year, but profits before rent and interest have only grown to $5M a year, because there is now also more competition from Walmart, Sprouts and Whole Foods. Now they can't afford to keep up their interest payments, and the CEO of the stores subsidiary asks the PE firm to make the real estate subsidiary give them substantial discount on their rent, after all, the PE firm owns both of them, why favor the real estate subsidiary when the stores are at risk? But the CEO of the real estate subsidiary argues the opposite. Their real estate is valuable, if the stores go out of business he can quickly rent their spaces to new tenants that will gladly pay full rents, and will diversify her portfolio of tenants to make her business more secure. The partners at the PE firm by this point know full well what the real problem is. Despite the boom in population, the stores aren't reaping proportionate increase rewards because they simply can't. The founder was brilliant at buying real estate but that covered for flaws in the stores business model. Maybe they never had the necessary size to compete with bigger chains, maybe they were always poorly run, or maybe the PE firm dropped the ball in who they put in charge. It doesn't matter what the cause is, in the end the PE firm lets the stores file for bankruptcy and surrenders it's ownership to the lenders. The lenders will fire sale the inventory to get as much of their loans back as possible, but still take a large loss. But the real estate firm is now making $4M a year renting to new, stronger tenants in great locations, likely paying higher wages (good #2). The PE firm made around $15M in dividends from both subsidiaries before the stores went bankrupt, and at same time they sell their real estate firm for $40M (minus $15M in loans). So in the end their $10M earns a gain of $30M over ten years, despite the bankruptcy. That seems like a huge gain, but it's only an annualized return of somewhere between 15% and 20% a year depending on how dividends were paid. That's a very good return, but not a world beater. The PE firm lost because the stores failed. If they had just maintained their original value so they could be sold for the $20M that they cost in the original purchase. Now their gains are $50M, and their annualized returns are above 20%. Very few PE firms go into deals like this planning for the main business to fail, and to make up for it with asset sales. It greatly reduces your long term returns or can even leave you with huge losses. If the founder had never sold, the same problems likely occurred. Maybe he runs the stores better, but he would still have to deal with higher levels of competition, and finding good new locations would have gotten harder. Eventually he would have had to wonder whether splitting the business made sense, that he had a dynamite set of real estate properties being held back by struggling stores rapidly being overtaken by larger and better funded competition. The day the stores start losing money would be the day he would be forced to take drastic action similar to what a PE firm would do.
rmrfstar 7y ago
Your argument is basically: "market pricing reflects reality", which you clearly don't believe because you go by the handle "valuearb". Credit markets are appallingly inefficient at pricing risk. Lenders are aware of bailouts. They are explicitly factored into credit ratings! Leverage is heavily subsidized by the tax code. The current level of corporate leverage is absurd and has massive negative externalities. https://www.youtube.com/watch?v=qs1DhA91fm0 https://www.youtube.com/watch?v=qs1DhA91fm0
- valuearb 7y ago
  Hard to respond to a smorgasbord of irrelevant tangents, but I'll try. I believe the public capital markets are often efficient, but not always. I have no doubt that credit markets are less efficient. How they are or aren't, and whether they reflect bailouts, is immaterial. Lenders have to make smart lending decisions or they will cease to exist as lenders, they have every incentive in the world to properly assess risks. The fact that some times some lenders do a poor job at it doesn't change that fact. The market, red in tooth and claw, will eventually chase down and devour dumb lenders. It's true leverage was heavily subsidized by the tax code, the interest paid was subsidized about 40% when the federal corporate tax rate was 35% (plus whatever state corporate income tax you were subject to). Ironically when Trump signed the new tax cut bill, by cutting corporate rates he reduced that subsidy to only 25%. The best solution for ending that subsidy is simple and hugely beneficial for everyone in our country. Stop taxing corporate income, and increase tax rates on dividends and capital gains to compensate. No longer would we be taxing reinvestment creating better jobs and raising productivity faster, and we could start taxing investors investment incomes in proportion to their incomes, restoring a lot more progressively to the tax code.

rmrfstar 7y ago

In my experience there are two major factors at play. (1) No one gets fired for buying IBM. The prestige money pools like Ivy-league endowments invest in leveraged loans. If leveraged loans have a nice run and you haven't invested in them, then you will get fired. You will be fired before the bubble pops. If you make big losses on leveraged loans but the prestige money pools did as well, you will not lose your job. Fads and herding are real things. See, e.g. mortgage market 2000-2007. Jeremy Stein wrote about the career aspect of this mechanism in the 1980s. [1] (2) Bailouts. People are aware they exist. Credit ratings agencies explicitly factor the likelihood of a bailout into credit ratings [2]. Creditors know they can hold a government hostage by threating to force a critical industry/company into bankruptcy. Sometimes they explicitly frame it as "bail me out or I put X critical company in bankruptcy" [3]. Also, please read about the leverage ratchet effect [4]. [1] https://scholar.harvard.edu/stein/publications/herd-behavior-and-investment https://scholar.harvard.edu/stein/publications/herd-behavior... [2]https://www.moodys.com/researchdocumentcontentpage.aspx?docid=pbc_186998 https://www.moodys.com/researchdocumentcontentpage.aspx?doci... [3] https://www.latimes.com/archives/la-xpm-2001-jan-16-mn-12864-story.html https://www.latimes.com/archives/la-xpm-2001-jan-16-mn-12864... [4] https://www.gsb.stanford.edu/faculty-research/working-papers/leverage-ratchet-effect https://www.gsb.stanford.edu/faculty-research/working-papers...

travisoneill1 7y ago

They aren't getting scammed. I used to work for a mezzanine lender (a type of lender who mostly lends to PE deals).