Trust is a dangerous act - Posted by John Behle
Posted by John Behle on May 23, 2006 at 14:28:17:
That illustrates some dangerous and foolish business practices. FNAC and other national lenders have made some very costly mistakes the last few years.
It might help to illustrate just how dangerous it can be to buy notes nationwide or in an area outside of your own. I have avoided it for 30 years myself and taught my students to do likewise. When experienced and well trained buyers take large hits, imagine how bad a smaller company or an individual can be damaged.
“In their defence” might be the next sentence in a reponse like this, but not from me. The Lender’s actions were foolish and they set themselves up to be burned by the broker. From my quick read of the facts, they gave the broker money and he kept it instead of funding the note. They trusted him to do the closing.
Every time nationwide paper buyers start trusting their “brokers” they open themselves up to fraud, incompetence and losses. This same lender took a giant hit a few years back from over-extending credit to an easily recognizable flake. As the statement goes “first a peac-ock then a feather duster”. They bought into a broker’s hype, bravado and circus antics and lent too much to an in-experienced egotistical young punk. (sorry for the colorful terms, I never liked him - and I learned long ago to see through promoters.)
So, first problem.
1 - Out of state lenders have to trust someone. If they are smart, the person they rely on is an independent third party. An “in-house” closing with a broker is nuts. Third party professionals need to be used. Using a title company or closing attorney would have prevented the whole mess with this case you pointed out. In their previous losses with the young broker, they relied too much on documentation provided by the broker and he was reckless. When money is easy to get and a broker is making money on commissions, they can get very loose with their purchases or even resort to downright fraud (not saying that broker did).
2 - They try to cut costs. That is why they tend to want to find people to trust, so they can do the “due diligence” cheaper. That can be documents provided by the broker or work done by the broker or documents passed through them. Another case about ten or so years ago was another prima donna broker and a lender that prided themselves as being a “great” nationwide buyer and authority in the business. We’ll call the broker “Donna” and the Lender “Strauss”.
Donna brokers a note to Strauss. Strauss relies on documents provided by Donna. A title report/policy, closing documents, etc. Strauss seemed to be counting on Donna’s expertise or reputation as a mega broker. Donna took the documents at face value as provided by the note seller.
The trouble was, the documents were fraudulent. Letterhead and documents dummied up from a real title company, but not a real transaction. That’s an age old scam, that an inexperienced broker or lender does not need to fall for, but they do when they cut corners. Cutting costs usually means cutting corners. Trusting facts, figures or documentation given to you by the seller of a note is like asking a TV evangelist if he thinks you should send him money. No slam on evangelists, just an illustration of someone asking a loaded question that will receive only one answer and not one that is objective.
I guess I was “lucky” years ago to run into a little old gray haired lady who was a real estate broker. She seemed like everyone’s sweet grandma. Clara was trying to sell me a property. I was busy and said I would need an appraisal. She said “no problem” and came back the next day with an appraisal.
I know this little old grandma had cookies in her purse for the grandkids. She also had bottles of white out.
The appraisal she brought me was a photocopy. She had found an appraisal to match the value she needed and whited out the subject property and typed in the one she was trying to sell. I call this an “appraisal du Jour”.
So, I figured if a little old grandmother was going to try to perpetrate a fraud on me, that anyone would. I’ve also had numerous other appraisals brought to me where the appraiser was bribed, intimidated, duped or just plain incompetent. And I’ve had a ton of other documents brought to me that were phoney, altered, etc.
So, you don’t trust documents and information provided by someone trying to sell you something. It may provide information that helps you in your due diligence, but it should not be relied on solely. Even an appraiser hired by someone else should usually be thrown out, taken with a grain of salt or audited for accuracy.
In the case ten years ago, Strauss could have even made one phone call to the title company that would have revealed the documents provided were fruadulent. Instead, they trusted the broker, who trusted the seller who scammed them both. Then they sued the broker and of course the seller of the non-existant note was long gone.
Finger pointing after the fact did no good. The lender felt the broker should have done the due diligence (wrong) and the broker felt if was not their job or responsibility (wrong). To me they both messed up. Strauss took a loss and backed way away from their nationwide lending. The broker went on to develop an even bigger brokerage and crash that company with the same sloppy procedures and policies.
In my local market, I turn down notes, properties and deals all the time from people I know of by reputation. You can’t do that as easily if you are trying to cover a whole nation. I or an assistant check out deals carefully that can not be done on a national basis.
Here’s another example. My biggest local competitor about 20 years ago was a thrift and loan. We had a good relationship and did some deals together. I enjoyed going to lunch with one of them and we had an interesting conversation one time when he told me about a scam that had come their way.
Someone had gotten out of prison and jumped right into the scam they had hatched while there. They set out looking for properties with “Citibank” loans on them. They would buy the property and then turn around and sell it again for a low downpayment on a contract. They then sold the contract. Their claim was that they were a lender out of another state that had had to foreclose, so they were just doing a “quick sale” on the property. The title policy showed to the paper buyers that the note was in a first position and that the Citibank loan had been paid off. I think they particularly targeted institutional note buyers knowing they would just rely on title insurance. Don said to me - too bad they didn’t bring a deal to you John, you would have found their con much earlier. Don had a copy of my book and knew that I did a quick abstract of title on any note deals. An abstract would have shown their “story” about being a lender was bogus. Title insurance companies took a loss in the millions when a year later Citibank finally figured out that someone was fraudulently reconveying documents. I think the scammer even had the signature down of someone at Citibank that “could have or would have” signed the reconveyances. Once again, relying on documentation is dangerous.
There are also many cases where values have been erroneously inflated through fraud or speculation. It takes seconds to pulll some comps and not waste time or money on an appraisal. Much of the time when I go to pull comps, they property the note is on comes up for sale or shows several recent sales.
The type of due diligence I can do in a local market is much better, cheaper and easier than what someone can do on a national basis. It’s safer. I truly believe only the most experienced pros should consider investing outside their area and then as we’ve seen, even some of them get burned. The two national lenders I referenced have some higly trained and respected people involved. They aren’t amateurs - just pros who cut corners.
I don’t know all the details of Metropolitan who was the biggest nationwide buyer. They went down the tubes. From what I have been able to read in their local business journals, etc. it had much more to do with bad real estate deals that they did than with bad note deals. They couldn’t find enough paper to keep them happy nationwide so they started doing some very speculative real estate transactions in their local and surrounding markets. Nepotism was their true problem. The second it changed hands it was doomed.
Any time you begin to trust someone with your money, or the security and safety of your money, you are making a mistake. One of the greatest elements of note investing is that you do not “HAVE” to trust someone. You can verify documentation and valuation and the property will always pay you if the people don’t. When people stray from that it is dangerous.
I had a student that was going gangbusters. He was a shining star and doing profitable note deals. He began to think he could branch out and started buying car paper. That can be riskier, but still can have some good collateral. I don’t recommend it for the average note investor to consider. He did OK with the car paper he bought, but then a “dealer” wanted to do more. He expanded and did more deals with the dealer and trusted the documentation brought to him by the dealer. Now remember, this is a used car dealer we’re talking about. The dealer started providing phoney titles to non-existant cars and the student took a big hit and spent years digging out when the dealer took off. If you can’t go kick the collateral - and don’t do so, it isn’t investing, it’s speculation. If you don’t absolutely, positively KNOW the collateral is worth enough to be sold and pay you if need be, then it is a deal you should not do. You never loan to a person, you loan against collateral. I’d rather have a million dollars of collateral than a millionaire.
Sorry to ramble on, but your post brought up an important point about brokering notes nationwide and the potential risks.