Reinstitutionalizing Equity-Based Lending, Part II by Lane T. Bacon

by 03 Oct 2008
This is the second part of our two-part series which was originally published in our September 2008 issue of TNR. Solution Part 1 ? Loan Origination An efficient wholesale equity based loan origination platform must be created and designed to source loans from a multitude of viable markets, targeting those which are densely populated. The loan origination platform (?Company?) must be dedicated to the principles of EBL. These principles are: 1) conservative valuation of the collateral with an independent third party review; 2) substantial equity remaining in the property after the new loan is funded (typically a minimum of 30% and preferably at least 40%); 3) a tangible net benefit to the borrower; 4) diversification geographically, by collateral type, and by borrower; 5) proactive, high-touch loan servicing that tries to help the borrower re-establish credit and refinance; and 6) a lack of prepayment penalties, so that the borrower is free to transition to a new, lower rate loan. Benefits  Wholesale model allows for faster dissemination of information to the marketplace.  Creates diversification, to limit exposure to a particular market, market segment (asset/collateral type), and borrower.  Third party independent valuation reviews is a best practice designed to ensure accurate and conservative valuations as well as reduce the risk of appraisal fraud.  40% remaining equity in the collateral ensures the borrower retains a vested interest in the asset and the performance of the loan.  Proactive servicing and loan counseling helps communication and increases the likelihood of an early loan repayment  A lack of a prepayment penalty increases the probability of the borrower quickly refinancing and realizing a lower payment and increased savings sooner. Solution Part 2 ? Investment Vehicle In order to satisfy the need of equity based lenders to offload production, an investment vehicle must be created with sufficient capacity to purchase up to $100 Million of product inflow per month. This would mean the development of an investment vehicle with an Assets Under Management (AUM) of nearly $3 Billion. The investment vehicle or hedge fund (?Fund?) must be able to effectively manage performing and non-performing assets and maintain the ability to acquire Real Estate Owned (REO) properties from other institutions. The above strategy creates a twofold revenue stream to investors; 1) the generation of income through monthly interest payments and loan origination fees, and 2) significant capital appreciation created through gain on sale due to the conservative loan to value (LTV) limitations. If properly managed, the Fund should realize annual gains, net of fees, greater than 15%. Benefits  Creates liquidity for Equity Based Lenders.  Creates opportunities for companies and individuals to tap equity during the Credit Crunch.  Saves many borrowers from losing their property.  Generates substantial gains for investors in the Fund.  Constant deal flow. Both the hedge fund and loan origination platform must be managed by the same General Partner, thus ensuring proper quality controls and the performance of the loans. Implementation Implementation of the solution is not easy as Equity Based Lending professionals are rare, and one must gather a significant number of them to effectively implement the solutions. Implementation Step 1 Obtain startup capital so the proper loan origination licensing and infrastructure may be created. Implementation Step 2 Establish and license the loan origination company. This process takes a minimum of 3 months and may take as long as 12 months, depending on the state licensing entity. Also, the loan origination company must employ several licensed persons to act as a ?Designated Broker? or ?Responsible Individual? as required by various states. Implementation Step 3 Create the ?Fund.? This is an arduous process and involves many attorneys and experts, as there are many different ways to structure a fund. Typically, this process takes up to 6 months and may cost between $50,000 and $250,000. There are many firms that specialize in the formation of hedge funds. Implementation Step 4 Raise capital into the fund. Be careful, as you cannot advertise this investment. Failure to abide by Securities and Exchange Commission regulations can result in penalties including fines and in the case of egregious or deliberate violations, incarceration. Raising capital is not undedicated. Be prepared to give away a sizeable equity piece of the General Partner (GP) for seed investors. In order to properly launch any fund, you will need initial funding that covers your anticipated monthly production levels and a procedure to source and secure new investors on a consistent basis. It is important to match fund raising capabilities to loan origination levels to ensure efficient cash utilization. Implementation Step 5 Begin loan origination operations, so that all entities may establish a track record. Implementation Summary The creation of the entities is difficult and time consuming. Typically it takes one year or more to get the ball rolling. The learning curve is steep, and most people and companies fall off prior to completion. Summary The Re-institutionalization of Equity Based Lending (hard money lending) will satisfy a grossly underserved niche and help protect property owners and those dependent upon them. Many businesses and homeowners would be able to avoid losing their prized assets. ?Best Practices? must be adhered to, so that we do not experience failure like so many others did during the Credit Crunch. The re-institutionalization process will take time; however with the experts and professionals at Advantage Capital Equity Solutions, the timeline to implement the solution can be shortened. Lane T. Bacon is the founder of Advantage Capital Equity Solutions, Inc. and managing director for Advantage Capital Equity Fund I, LLC, a private equity fund, and Advantage Capital Equity Fund II, LP, a hedge fund. Having originated over $1 Billion in equity based loans, managed private investment funds, and managed several warehouse lines of credit, Mr. Bacon proves to be a veteran of asset based and hard money lending. Mr. Bacon is a graduate of University of Colorado, Boulder, Leeds School of Business, and is a former US Navy sailor., 800-985-0341


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