Though fewer in number, the ethically challenged still need watching

Railway Age, Oct, 1997 by Anthony Kruglinski

Over the years, we've written several articles seeking to promote a higher ethical plane for business dealings involving the financing of railroads and rail equipment. And over the years, we've seen a major decline in what might otherwise be called business practices of the ethically-challenged. These include fewer apparent "bait and switch" schemes by intermediaries and brokers. Fewer instances of clients "shopping" advisors' ideas and structures. More honesty concerning equipment condition.

Did this column make a difference? If it did, it was probably because we continue to preach that the railroad industry is really a small community when it comes to information flow. Everyone seems to know about everyone's deals, including which deal cratered and why. Who helped. Who hurt. Who screwed up. Word does get around--believe me.

That's why the following story told at a recent industry meeting was unnerving:

It seems that a financial advisor was in the market seeking to place some equipment financing. The borrower's credit was excellent. The equipment was used, but posed no issue as collateral. However, we're told that while the transaction's structure was somewhat unique, it raised no issues that impaired the credit or collateral. (And we're told that this fact was highlighted to all potential funders.)

Now on these few facts, you--the reader--should be in agreement with this writer that this seems to be one of those deals that is going to get done by identifying the right funder that can tolerate the deal's structure, without becoming too greedy in pricing its funding.

Let me give you a little more detail:

The funder that this advisor identified had actually closed a similar transaction on the same credit in the recent past. In fact, the existence of recently negotiated documentation was a plus from the client's point of view. Pricing was agreed to and the transaction was awarded to this funder, but not before the advisor and client both asked the funder whether it (the funder) was intending to hold the transaction for its own account or intended to sell it to a third party.

Did the client object to a participation or sell down?

Not really, if it resulted in a better rate passed on to the client. The real problem was a desire on the part of both the client and advisor that the sale of the transaction occur after closing and funding to avoid having to satisfy two credit committees and two sets of lawyers.

When asked a direct question, the funder stated explicitly that if a sale of the paper occurred, it would occur after closing and would be transparent to the client.

"Are you sure?" was the question. "Yes," was the answer.

Guess what?

After missing several deadlines for approval, the funder admitted that it planned to sell the deal off at closing and that the ultimate funder had questions and issues that would delay the transaction's closing by several weeks.

The transaction was taken away from the funder and ultimately closed with another party.

What happened here? Was the funder somehow misled? According to the advisor, the funder was carefully walked through the transaction's structure, and before the transaction was awarded the funder indicated it was confident it could get the deal done. Did the client or advisor fail in their due diligence as to the funder's market reputation or asking the right questions before the award? No, in fact, our source indicates that they knew this funder sold off much of its output and asked the right questions to determine if this funder's funding would be an issue for the closing.

No. It appears the funder provided an inaccurate answer when asked a direct question. There are a lot of other words to describe this situation, but we don't need to use them. You get the point.

We asked the advisor what it had learned from its lesson in the waste of time and money. Not surprisingly, it will likely be some time before this funder is invited to bid on transactions marketed by the advisor. Ditto (we're sure) for the client.

What is the identity of this mystery funder?

Well, because we can't assume that all parties to this apparent funding fiasco see it exactly the same way, it would be unfair to get too specific in this column. On the other hand, we hear stories like this time and again.

How do borrowers and lessees avoid problems of the type described above?

To begin with--never assume. Never assume that, if a marketing officer in the field tells you something (even if it's only a prediction or a point of view), you would get the same information from headquarters.

Check it out. If you are doing a transaction with another party for the first time, get as much of the communication as possible in writing. And what if you're working with a source you have already vetted? Pray they don't pick your deal to suddenly get squirrelly!