Ponzi Scheme: A Lender’s Story

As an investor or lender, if you ever said or thought the question “ Is this a Ponzi Scheme? “ then you understand that queasy feeling in the pit of your stomach as your mind wraps around that thought. The American public has heard the word “Ponzi” over the last four years so many times; that you might think it’s a new pasta dish at your favorite Italian restaurant, or a new lead character in a “Happy Days” type sitcom.

So what is a lender to do when you first suspect this is the case with one of your borrowers?

My story starts with the bank finding out through the local newspaper article. The loan(s) for this borrower had been past due in the past, and recently a demand letter(s) was sent, with payments received prior to the litigation start date. Shortly thereafter all their accounts were frozen with those loan payments being subsequently returned.

Of course our borrower stated when we met with him that this is a “witch hunt” and their story was not based in fact and a total misunderstanding of the course of events. A number of years ago I was at a banking conference and a gentlemen from the press, who was being vilified for recent articles written in contravention to what the conference group believe was their opinion, say when it was his turn to speak, “ Never pick a fight with a business that buys its ink by the barrel “. Subsequent articles slowly started a daily progression of what private investor (lender) gave money to our borrower and was promised to be paid in the near future. Lawsuits were started and the list of victims and dollar amounts started to grow to $30 million dollars + and continuing.

Fortunately for the bank, all our loans were secured by first mortgages on commercial properties, with four of the six properties having third party tenants, with adequate cash flow to support the loan(s). Other banks were not so lucky (or good).

The events are still on-going and things can change in a flash. But if I can offer some advice if this happens to you in the future, this is what the experience taught me:

1.) Immediately contact your borrower and requesting a meeting- We did not have our attorney there and they did not bring their attorney. This was a discussion on our loan(s) solely. Do not get drawn into the details of what is happening, unless it directly affects your loan. In our case it did not. Most of these people of Sociopaths who deluded themselves that they are the victim, why the entire world doesn’t understand their particular genius.
2.) Senior Management and Legal Counsel needs to be fully engaged- Sometimes the initial reaction is that this cannot be true and to go it alone to find out the facts. The more people involved in the discussion is good to fully vet all the options, crystallize your plan and have one point man to handle the situation with constant communication within the bank.
3.) Move quickly and decisively- Like a gun with a laser target, your aim should be right at their forehead. In the case I was involved with that meant requesting the borrower to appoint a Property Manager to collect the rents while all their accounts were frozen. Our attorney’s moved for a court-appointed Rent Receiver and began litigation immediately. Ultimately, it is our belief that the liquidation of our collateral position will repay the loan(s) so filing our Lis Pendens in an expedite fashion was a way to cut off the number of judgments and liens we would anticipate on the asset(s) when our foreclosure complaint progresses.
4.) Insurance- We received cancellation notice of the insurance to our loan asset(s). It is much cheaper to pay the premium of a lapse policy then to obtain “forced insurance”, with better coverage both in amounts and conditions.
5.) Limit the conversations with your borrower- Once we began litigation, all communication between the bank and borrower was to be made by their attorney to our attorney.
6.) Expect the unexpected- Events got very heated than slowed to a virtually stand still. In this case a number of banks were involved with this borrower with different assets from ours. A review of our financial information we received from the borrower, never disclosed these banks or loans. Granted, most of these loans were made after our last loan closing, but for the banks that made these loans, what due diligence did they perform? Verification of assets and liabilities from an outside source is something I learned as a junior lending officer.

There will probably be more that I can add to this list as events unfold, but in the age we live in events you read about that happen in different places and to different people, could one day happen right in your own backyard.