The Future of Lending after COVID-19
2020-05-02 · Guest: — · 63:09
Bob Zadek discusses the profound shifts in the lending industry following the COVID-19 pandemic, contrasting traditional secured lending with the Fintech and MCA models. He explores the regulatory landscape of “created scarcity,” the impending devaluation of commercial office space, and the urgent need for a modernized, digital system for UCC lien clearance.
Topics: Lending, COVID-19, Fintech, Secured Lending, UCC, Commercial Real Estate, Regulatory Scarcity, Inflation, Merchant Cash Advance (MCA)
Speakers: Cole, Bob Zadek
Introduction [00:00]
Cole: Oh, hey everybody. Come on in, join us. Dare Capital Dialogues, our talk number three. Today we have our good friend, Mr. Bob Zadek, who I have known since 1996. If you’re in factoring or ABL or banking, you probably know Bob’s name. You probably heard him talk before and we’re very lucky to have him today. Bob has been a lawyer for the industry at least 27 years and has—
Bob Zadek: No, 55.
Cole: 55. I was trying to make you a little younger. But Bob has been with Buchalter Nemer for 27 years. He’s been a board member of the AFA and the IFA and the Secured Finance Network for many years. He co-authored the revision to the UCC. He has been an entrepreneur at Lenders Funding, providing capital directly to other factors and ABLs for the last 20 years. He’s been a libertarian podcaster and radio host of his own show, The Bob Zadek Show. He’s an expert witness and he’s an all-around pleasure to listen to. We’re very lucky to have Bob here today.
Today I’m going to preview just a little bit of what we’re going to be talking about with Bob and we’ll get right into it. First, we’re going to talk about the history from past crashes and recessions. How does this compare? What does it look like? How Bob thinks lending is going to change after this thing recedes and what we’re already seeing change today. Some of the regulatory backdrop that would not exist without some of the previous recessions and market crashes and what we expect in the wake of all this. How banks and factors and other lenders should change their approach to capital right here, right now, today, both short-term and long-term considerations. Then we’re going to get into some of the inflationary concerns, some of the economic changes, who gets to rewrite history or write history, if you will. And also, we’re going to cover one of Bob’s pet projects, which is thinking up ideas for various Fintechs. I had the pleasure of sitting next to him at the president’s meeting in Costa Rica in January and he previewed this idea, which I thought was brilliant. It’s one of those things that’s sitting in front of everyone and very obvious, also very hard to change, but would be a game changer for the business. So for those of you who have inclinations on starting other businesses, etc., this is a brilliant idea and we’re going to preview that topic today. But without further ado, we’re going to go ahead and get started with Mr. Bob.
Comparing COVID-19 to Past Recessions [03:51]
Cole: So tell us, Bob, in terms of history, how does this thing compare with past crashes and recessions?
Bob Zadek: Well, the only comparable previous recession, depression, decline is probably the Great Depression. Not in terms of magnitude—I’m not trying to be scary—but the reason I pick that as a parallel is that what this present economic problem has is that it is the function, it is created not by the economy itself, not by any financial event, but by totally external factors, that is the virus. If we go back to what has been called—I don’t like to use the term because I don’t think it’s descriptive—the Great Recession of 2007, 2008, that was a recession caused by economic factors, albeit governmental economic factors. That whole discussion is for another day. But it was failures in the economy and in the marketplace that caused the Great Recession. The same with the recession in the late 1980s. That was the economy itself was a contributing factor. With COVID-19, the economy was as robust as anybody can remember, and an existential factor, the virus, a non-economic factor, invited itself to the economic party and everything turned for the worse for the minute. And that distinction will come up again and again during this conversation because it will dictate how fast, in my opinion, the recovery is, and it will dictate what the lessons, both economic and governmental, are from this crisis. So that factor, the fact that it’s existential, that is non-economic, will come back over and over again during this conversation.
Cole: Gotcha. What do you think of these comparisons to the Spanish Flu? Is that an apt—?
Bob Zadek: Well, I wasn’t around then, so you have me here because since I’m older than many of the people, I remember more. But unfortunately, my memory is not that great to remember stuff that predated my birth. So the Spanish Flu, I don’t have a lot of firsthand knowledge on the Spanish Flu. I do know that the Spanish Flu was much more, if there are degrees of pandemic-ness, the Spanish Flu was much more pervasive, killed many more people. The medical science was obviously far inferior to what it is today. The ability to understand and cope with it was far greater. So there are a lot of differences, including how the world reacted, both for the better and for the worse, during the Spanish Flu epidemic and economic crisis that followed. So there isn’t much to be learned economically, which is what we care about today in this webinar, isn’t much to be learned from the experience of the Spanish Flu.
The Fintech “Final Exam” [08:24]
Cole: Gotcha. After this thing recedes—and we don’t know when that is, but when it does—what changes in the lending market do you see happening and do you see happening already as a result of all this?
Bob Zadek: Well, there will be some, in my opinion, really profound changes in the economy. And the question is, will they be changes for the better or for the worse? And as to that question, the big question, the jury is out. It’s hard to predict. I tend to be profoundly optimistic. I always am. It’s a function of my own life experiences. So I like to think that the changes will be far more positive than negative. Let me give you an example of both and what will affect and what will dictate whether the changes are for the better or are for the worse.
We are going to be, when we are on the other side of this crisis, whatever that means, but it’ll be in the next three or four months, it’ll be behind us. Not that the virus will have been conquered, but life will be back to much closer to what we now call before-the-virus normal. We’ll be much closer to that in three or four months than we are now, obviously. So what will dictate whether we have learned all there is to learn from this virus from the standpoint of economics and more specifically lending and what you and I do, Cole, which is short-term lending as opposed to long-term investing? We are short-term lenders and my focus is always on the basis of what it means to short-term lenders because that’s how I’ve chosen to spend my life.
So what are we going to be sorting out in terms of lessons? Well, the key question will be who will get to write the history? It is at—and that’s a really interesting question because the spinners of the world, those who say, “Look back and say what has happened in the recent past proves I am right or proves that they are wrong.” And the question will be whether the lesson is how dependent we are on tight government regulation, on almost the closest we have come, certainly in my lifetime, to martial law in the United States. Not that we were close, but we were closer than almost ever before. So whether or not the lesson was once we imbue state and local officials with very broad discretion on how to govern and maybe I should say rule their dominions, states or cities, whether this proves that that was the secret sauce that got it through this, or whether we learn by abandoning burdensome regulations, that’s what got us through. And we’ll discuss that more during today’s broadcast. Whichever lesson we decide is the right lesson, that will dictate whether we come out of this wiser economically and politically or dumber economically and politically. And so the jury is still out on that. I will point out how in the past we have negatively learned. During the crisis of ‘06 and ‘07, the lessons we took from that were the wrong lessons: more regulation, more control over the economy, more control over capital, looking around for demons and then punishing them with regulation. That was the wrong lesson. I am hopeful that the lesson we learn is the opposite: that innovation and the free market and the absence of control will get us out much faster. Whether we go to learn from the imagination and innovation of millions of independent entrepreneurs or whether we learn from the mere power and control of government that that was the solution, whichever lesson we learn will dictate whether we come out of this for the better or for the worse.
Secured Lending vs. Algorithm-Driven Models [13:56]
Cole: Got it. As far as what, you know, we’re seeing right this second—and we could dig in again a little bit more into that topic when we’re previewing your ideas—but some of the things that seem to anecdotally be occurring to me right now is that some of these Fintechs who were lending very aggressively seem to not be doing that other than making PPP SBA loans into the extent that that’s happening, I’m not sure as well. What are your experiences with what you’re seeing just in the marketplace right this second as far as activity goes with the—?
Bob Zadek: Well, it’s quite interesting, Cole. It’s really interesting because we are in, right now, we are taking the final exam in a course called short-term lending. And here’s what I mean. This is the final exam. What I mean is this: when you and I make short-term loans and we do documentation and we do underwriting, in a strong economy, which we have been experiencing in the recent past and even not-so-recent, the economy’s been booming. It’s been a great time to be a short-term lender. Well, a rising tide raises all the boats, as we all know to paraphrase that old saw. And more specifically, during good economic times, bad underwriting, bad documentation is not punished because when the economy is good, everybody honors their obligations because they’ve got plenty of money and the advent of credit defaults and of fraud is much lower. And all lenders sort of pat themselves on the back, “Oh my god, how smart am I? I have great returns, I have price competition, but no big deal. But I haven’t done anything wrong in a long time. I haven’t lost any money in a long time.” And all lenders are patting themselves on the back at how smart they are. Well, it didn’t matter whether you underwrote smart or not. It didn’t matter whether your documents were horrible or were state-of-the-art. It didn’t matter about anything because you got paid back because people had plenty of money and the tactic of not paying back your loans and honoring your obligations wasn’t necessary.
And then the economy turns and then the analogy again is like the tide. When the tide washes out, it—and when the water recedes, it exposes all the bad practice. And as soon as business takes a downside, all of a sudden the weaker credits fail, the bad documentation causes the lender to lose money, and all bad practices are exposed. And all of the bad operators lose money or lose a lot more. And they’re exposed and there’s nowhere to hide. Now, why am I mentioning that? There has been, in my opinion, a profound economic battle between short-term lenders who are somewhat old-fashioned—and I say that to their credit and not as a derogatory comment—they rely upon collateral and underwriting, stuff that has worked for a long time. And the theory of collateral being a secured lender is what happens to the borrower doesn’t matter, you always have your collateral so long as you have your collateral, as long as you did a competent job. And at that time, credit defaults were then the final exam. Borrower failed, who cared? If you did a good job with documentation, a good job in underwriting, you always have your collateral and either you don’t lose money or you lose a lot less. That’s one approach.
Then along comes the Fintech world, speaking very broadly, and they rely infinitely less upon collateral and in reality not upon collateral at all. They rely upon digitized, algorithm-driven, scientific, big-data-driven credit decision-making. And they were convinced that that they could do it, in effect ignoring collateral but relying upon other external credit factors would be a reasonable substitute for collateral. And they were making a lot of money, or they seemed to be making a lot of money. And they were drawing a lot of investment capital. But of course, I would sit back and would—when I would make presentations and I would be asked to comment, my opinion was that no one has a clue whether that model works because they haven’t been tested in bad times. They haven’t had, to follow the metaphor, the final exam yet. Along comes COVID-19, Cole, it’s the final exam. And what have we seen? The those lenders are sitting taking the final exam and they’ve all stopped lending. In other words, they flunked. So the model was—has not been tested until today under unusual circumstances, the final exam, and they all stopped lending.
Now, Cole, in our world of secured lending, we haven’t stopped lending one bit. We’ve gotten a bit more careful, so we’ve gotten 10 or 15 percent more careful. Careful is good. But we haven’t—the secured lending industry has not lost enthusiasm, stopped lending, and has not suffered losses. Now, they will suffer some losses, but they’re not going to stop lending. You just get through it because losses are part of the game and it’s—and if you price your product right, it’s built into the product. So on the other side of this, I am intensely curious how the capital providers will look upon the product of Fintech, i.e., unsecured lending. Whether they will be as comfortable with it, whether they’ll be totally uncomfortable, somewhere in between, whether the model itself will have to change, or whether it’s just a model that only works if times are good but doesn’t work if times are bad. It is fascinating to me because we get a chance to test the theory. And so far, it’s early in the game, so far, my takeaway is this is unbelievable vindication for the strength of the short-term collateral-driven secured lending factoring ABL product. This is the vindication. And the short-term lending stars are clearly those folks who stuck to their knitting, underwrote carefully, documented carefully, and behaved the way they should with the concept of collateral is and remains king.
Cole: At all these conferences we’ve both attended, we, you know, have all been sitting around wringing our hands asking the question what happens when, and now I think we have the answer. It’s like when Warren Buffett said when the tide goes out you can see who’s been swimming naked. So I think we are—we are seeing that now. That’s been our anecdotal experience as well.
Bob Zadek: And Cole, you and I have sat next to each other at those conferences and scratched our head and saying, “No, no, you and I are not curious at all. We have a pretty good sense of what’s going to happen when the tide goes out.”
Cole: Yeah. I think you saw it in some of the default rates even in good times that didn’t seem sustainable. But that’s—it will be interesting post to see again, like you said, how these capital providers will—will view that market. So I know I’ve gotten a lot of calls on the investment banking side asking if we need capital to go into, you know, this recovery, which I—which again I find very interesting and and I think a very positive sign.
Government-Created Scarcity and Regulation [22:29]
Cole: So back to the regulatory question, you know, what would not exist, you know, without previous recessions and market crashes? And then what do you expect, you know, in in the wake of COVID-19 in regards to new regulations?
Bob Zadek: Wow, what do I expect? For that, it’s a question going back to what I said earlier: who gets to write the narrative? Here’s what I optimistically expect. First, what has happened? Well, the crisis hit and the immediate—the government’s immediate reaction was to make sure that let’s cut off the supply of goods. I have found government by its behavior, one of government’s primary roles—I don’t know why they got this role, but their primary role is to create scarcity. Our government especially, in times of unbelievable comfort and wealth creation and high standard of living, government set about—and I’ll explain what I mean—to create scarcity. Look at the crisis. The first thing they did was shut down the economy, creating scarcity. We have existing regulations that have been put on the books for the purpose of creating scarcity. And some of them are on the screen right now for our viewers. We had very rigid and frankly pointless licensing regimes where we limited the supply of labor. Remember, government creates scarcity. It limited the amount of people who can provide healthcare by, for example, having medical licenses at the state level not being respected through reciprocity from one state to another, as if a doctor trained in New Jersey would kill somebody in New York because they don’t know how to do it the New York way to practice medicine. So that creates a scarcity because doctors can’t move from state to state. It also creates a scarcity because in so many occupations, when you move from state to state, you cannot practice your occupation, thereby creating a scarcity. It happened as an aside, it profoundly hurts the military. Military couples move from state to state quite often, more than perhaps any other occupation. And the trouble is the non-military member of a family who is, let’s say, a therapist, when her husband is transferred from one state to another and she’s a therapist or anything else in one state, she cannot practice her profession in the new state. So it creates a scarcity.
And other examples: the government creates the scarcity of healthcare. We have when the virus hit, we had a shortage of hospital beds. It was all over the news. “No, we don’t have enough beds, don’t have enough beds.” And we made decisions, healthcare decisions to quote “flatten the curve” dictated only because we didn’t have enough hospital beds, not because it was good medicine or good economics. Well, many states have Certificate of Need laws, which says you cannot build a new hospital unless you can prove the community needs another hospital. And you have to get other hospitals to agree there’s a need. It’s called a competitor’s veto. That is, believe it or not, in America, the land of free markets allegedly, you could have your competitors veto your building a hospital. So no hospitals are built because the competitors won’t allow it. What happens? We have a virus, shortage of hospital beds, we close down the economy because we don’t have enough hospital beds, not because it’s good medicine. And so all of these regulations got in the way of supply because government creates scarcity. And all those regulations fell by the wayside. They all got repealed quietly and quickly by the states. The question, Cole, is the virus recedes, what happens to the regulations? Do they come back or do they stay away because they make no sense? That will be part of the battle for the hearts and the minds of the politicians. The way that turns out will either encourage or discourage me. We know that regulations have been repealed by the Trump administration with—he hasn’t gotten enough—the administration hasn’t gotten enough credit, but it’s happened and it’s profoundly affected to the better the economy. If that now happens at the state level, state by state, there is reasons to be profoundly encouraged that states have realized they have to get out of the business of legislating scarcity. That’s a big battle yet to be fought.
Influencing Policy at the State and Local Level [28:03]
Cole: Got it. And what do you think we can do about that, those of us who probably lean more libertarian, more free markets? What’s an action we can all take, if any, that you see towards making ourselves heard and influencing around those specific issues?
Bob Zadek: People at the state level tend to be—at the state level, we tend to underestimate the profound influence that state law has on the economy. We tend to think of the economy as national in scope, which of course it is, but it is also very much a state and even county level issue. And if we pay attention to economic issues at the state and local level instead of only at the national level—and by the way, at the state level, we have far more control. You know, the closer government is to the people, the more power people have over the government. And we have more power over the states than we do over Washington, more power over the cities than we do of the states. If we pay attention, we can have a turbocharged influence on state economy and local economy. And once we do that, the states that have a robust economy will show the way for the other states, and the states with a more controlling economy, a less free market, will learn the obvious lesson when their voters vote with their feet and leave. They will get the message loud and clear. So this battle of economic scarcity of creating scarcity by government can be won at the state level easily. And I’m highly encouraged.
Cole: I’m curious, you’re in the conservative bastion of San Diego, California. Relative bastion. What are you hearing just sort of boots on the ground there? I know I’ve seen some videos, I’ve seen some request—it seems more right-leaning or libertarian-leaning than anything I’ve ever heard out of California in the recent past because of this. Is it your sense that it will move that way or is it your sense that it will move towards a more sort of draconian sense?
Bob Zadek: Well, if I can harken back to June of 1944, San Diegans and Californians in general are, to borrow a phrase from the past, we are storming the beaches, Cole. Now, we’re going—we’re coming backwards, we’re going from the shore to the sea, but we’re storming the beaches nonetheless. And even Governor Newsom is getting a little concerned from his bunker in Sacramento that the citizens are reclaiming the beaches. So I am in a very brightly red state, I am encouraged.
The Shift to Liquidity and Balance Sheets [31:38]
Cole: Very nice. Very nice. All right, turning kind of our eye a little bit towards the future in terms of how banks or factors, commercial lenders, or companies should change their approach just in terms of how they think about their own capital. What does that look like in this environment in your mind?
Bob Zadek: It’s very—it’s a very interesting question. And what has happened during the—the virus period, if I can use that phrase, what has happened is you and I and our clients and friends and the people who occupy the niche that we occupy, they have changed their attention, as they should, from the P&L, making profits, to the balance sheets, preserving liquidity, which is, in my opinion, the right call. I’ve never been so happy about watching outstandings creep down as I am right now. Normally, outstandings creep down, lenders say, “Uh-oh, I’m losing sales, I’m losing business, I’m not going to make so much money.” In these times, that is a basis for elation. The money is coming in, I’m putting this liquidity right where it’s handy to me, it’s available, it can’t be lost. And when we hit the other side—and we are probably weeks away, not more than that, on the other side—it will be such a profoundly lender’s market. And the reason I say that is we have seen a lot of people describe what government has done with the nationwide shutdown of the economy as putting the economy into a coma. And I think that’s an apt metaphor, except it’s not as neutral as a coma sounds. But—but the economy is going to wake up like Rip Van Winkle, but that was 20 years, this is just going to be maybe 20 weeks, but you’re going to wake up and it’s going to go back, in my opinion, to business as usual. The economy is crying, “Let us get back to work.” And when you have all of that pent-up demand—not demand for goods, but demand to go back to work—the demand for goods is still there. People still want their stuff and they want their entertainment. So the demand is all there right now behind a barricade. When you open up that barricade, there will be like Black Friday, a rush for the goods. People will be stepping on each other with shopping bags rushing for goods. And producing goods will require capital. And the profits will be there, the capital will be well-rewarded. And all of us with capital to make—to do what we do best, make sensible secured loans, we will not be experiencing a borrower’s market. It will be a lender’s market because capital—there’ll be less of it, a lot of capital has been lost. And it will be halcyon days for lenders who are—have the capital, who have survived the crisis, have the capital to put out there and employ it sensibly. So I cannot wait because that will be a very—we will then put our attention back on the P&L and less on the balance sheet. It is going to be fascinating times. And those of us who have survived with our capital intact and our bank lines intact will enjoy some really pleasant quarters.
Cole: How do you think this compares to, I know 2000—thinking back to the last recession, 2009, 10, 11, 12 seemed banner years, but it wasn’t V-shaped. So do you feel like this is more of a—?
Bob Zadek: It’s a huge difference, Cole. In the crisis you alluded to, the problem was the consumers didn’t have any money. They had over-invested in real estate, real estate was inflated, and then in what seemed like a few short months, all of the make-believe, but it was believed to be there, equity in homes, all of the good times are here forever disappeared. Consumer confidence was in the toilet, nobody had any disposable income. It was a consumer-driven recession. This is not a consumer-driven recession. And I think the government has done not nearly as good as—as could have been done, and the method they used for distributing money to the consumers was greatly flawed, the distribution system was terrible, but the money got out to consumers. So the consumers—they’re out of work right now, but that will change, that will change quickly because the demand will be there, because the money is there. So this downturn in the economy is not consumer-driven. And when you have the demand to be asleep but about to wake up, the supply side, which has always been there, will just power up, and I think faster than some of the more pessimistic above us believe the economy will fire up.
Cole: What basis do you have to believe that on, Bob? What’s your thought process there?
Bob Zadek: The thought process is that this—the supply side is—has been shut down. The demand side is still there, there’s just no way to satisfy the demand. There is pent-up demand right now. People have postponed all kinds of purchases. It’s not that they don’t have the money, they can’t buy it. You can’t—there’s only so much you can spend sitting at your computer. And you can’t—we’re a consumer-driven economy, the consumers have been told, “If you try to spend money, you’re going to go to prison.” So nobody can spend any money. Well, that demand is still there. So long as the demand is there, nobody doubts the supply will power up almost immediately. If America, if the world, but America for sure and our trading partners are good at one thing, it’s figuring out how to satisfy demand really fast. We are really good at that. We have always been good at that. And we will be satisfying demand like crazy once people are allowed spend.
Cole: In the face of unemployment where it is today, do you still believe that’s true?
Bob Zadek: Of course, of course I do. Unemployment, let’s take one tiny segment. Let’s take the entertainment industry, whether we’re talking about sporting events, whether we’re talking about going to a pub, whether we’re talking about going to a restaurant. Everybody wants to go to a restaurant. Now, it’s not going to be immediate because people will be a little more cautious, people will have to sort of organize their thinking a little bit better. And even that’s going to recede. The danger will decline and the discomfort with social distancing will not be as necessary. It’ll be necessary to some degree, but we all know the need—people will not be careless, they’ll be sensible. People will sensibly go out, will learn how to do it, and will gradually visit restaurants, spend money, go to Home Depot. The Governor of Michigan will not criminalize the buying of paint. You can buy paint, repaint your house, and we will—some segments will go back faster than others. But when you have pent-up demand, no one doubts America will satisfy that demand. And satisfying demand produce a robust economic recovery.
Inflationary Concerns and Relative Currency Value [40:14]
Cole: As far as the inflationary concerns go, the sort of knock-on effects of all this government intervention, etc., what are your thoughts surrounding that?
Bob Zadek: Inflation is an interesting concept, Cole. Inflation means the value of a dollar—the purchasing power declines. Now, I have no doubt that there will be—that a dollar will—a US dollar will—there’ll be a fear it will buy less. There will be some inflation. It’s almost inevitable one would think when you have so much debt and so much money washing through the economy from the debt. I happen to be of a different view. If a dollar is going to decline, it has to decline relative to another currency. There’s no such concept as the buying power of a dollar of all currencies inflating at the same degree because inflation is always a relative concept. And if all the world’s currencies—and it almost is inevitable—if there’s too much of every currency, then yes, things will cost more in absolute dollars. Whatever cost $2,000 will cost $2,300. But since inflation is on the whole in all the trading economies, that means salaries will have to go up and income goes up commensurate with the inflation—the cost of goods going up. The only ones who will lose in inflationary times are those people who either have their investment as cash because cash, $100 will buy less. But if your wealth is tied up in home values, is tied up in securities, is tied up in commodities, whatever it’s tied up in, whatever your money is in other than money itself will appreciate at the same rate or depreciate at a lower rate, which means nobody is going to feel it, in my opinion. So since it’s not just the US, it’s the world, I think the negative effects on inflation will be only noticeable, “Gee, that used to cost 200, now it costs 220,” but you’re making 10 percent more, so who cares? The relative buying power of a dollar is going to be the same.
The Future of Commercial Real Estate and the Office [43:17]
Cole: And as far as economic changes that are happening across the country, across the world, offices, cities, what happens in your mind?
Bob Zadek: That—that is if you enjoy thinking about that stuff, the pure activity of thinking about it and using your brain and your knowledge of economics to see into the future, your question that you just raised is so delicious. Here’s what I think is going to happen. And I haven’t seen a lot written about it, so big warning: this is Bob thinking, not somebody really smart. But here’s my opinion. We have seen what Amazon has done to retail real estate. It decimated it. Not—and I say Amazon, I don’t mean the company, but of course the company, but I mean Amazon as a concept. Retail space was valuable and malls and and brick and mortar was the way of life in America for 150 years. And in 20 years, it all changed. It all changed because of Amazon specifically and a concept in general. Now, how does that answer your question? I am working from home and have been as everybody else has, and I have said to myself, “My goodness, what was I thinking? Going to an office is so retro. It’s like going to a department store.” People don’t even know what a department store is anymore. Going to the department store is so absurd. Two hours to buy a dress shirt? Don’t be ridiculous. I’ll spend 20 seconds and buy it online. And going to a store is absurd. Cole, going to an office is going to be the same. Now, what does that mean? That means office buildings become excess. And we’re going to see—I’ll exaggerate it to make a point—high-rise office buildings with plywood on the windows. No one wants to—no one wants to work there, no one and you can’t figure out a use for the space. Let’s tear down a high-rise office building and put a park there because office buildings will stop making sense. So that means the real estate goes down in value. That means that cities stop making sense. Cities only make sense as a place to work. And once a place to work doesn’t make sense, the city doesn’t make sense. And then looking into the future and really allowing yourself intellectual imagination, you say to yourself, “Cities stop making sense except as cultural centers.” And then that rejiggles all the real estate values. And that causes a massive reallocation of capital. And the result is everybody is better off. And now politically, what does that do when cities no longer become population centers? Because cities—the draw of cities is people want to live where they work for convenience. That’s how San Francisco—the real estate became so valuable. The—the techies who wanted to work for the tech companies wanted to live where they worked, wanted to walk to work. So they all go to San Francisco and Silicon Valley and the like. Once the concept of going to the office disappeared, it makes profound political changes. And then you’re off to the races in terms of what happens when. But is it going to happen? You betcha. Of course it’s going to happen because I can’t be the only one to say it makes no sense to go to work. Now, I’ll go to work, go to the office, I’ll have my desk, but I suspect I’ll be there less. It’s just too nice to work from home and too sensible. And it’ll be like going to Macy’s to buy a shirt. Going to the office just to power up the same laptop kind of doesn’t make sense. And so that to me is going to be the most profound economic byproduct of the virus. And people will sit back and saying, “Why did it take so long? This makes so much more sense.”
Cole: I think there’ll be a strong correlation between the people who go back to work and the number of small children they have in their home. I think a lot—I see a lot of posts regarding how quickly people want to go back to get away from their kids. But hopefully they’ll go back to school.
Modernizing the UCC and Lien Clearance [48:29]
Cole: Let’s shift over and talk about your idea. You and I visited in January in Costa Rica at the president’s meeting where you previewed this idea for our lunch table, which I thought was a—I’ve been thinking about it ever since, which was a great conversation. There are many aspects of the way in which we lend to our clients and the way in which we do business that have been digitized, made much more efficient, etc. One of those areas that has not done so is the clearing of liens, quote-unquote, of UCCs. I know that’s not a noun in your book, but folks need to have that. If we have collateral, we have to have first position. And there’s, as you pointed out, no way that that can be done unless you manually work on the process. And so I want you to talk about your idea there and I want you to also kind of weave in, you know, the the conversation that we began earlier regarding who gets to rewrite history in terms of a collateralized lender or a non-collateralized lender, as I think it’s a fascinating topic and I think the person who does figure this out can really make lending in a collateralized environment much easier.
Bob Zadek: We had great conversations, Cole, you and I, about this issue. And this is really the clash of two credit cultures. And this is—this is so interesting. And what I’m alluding to is the following. As I said earlier in our talk this morning, the Fintech world, the world of algorithm-driven credit decisions, which I do not at all question the value, the intellectual honesty of it, it’s sensible as far as it goes. But what’s interesting is the—the Fintech world, the MCAs, the merchant cash advance industry, they are all offer speed. Get your money in hours, a couple of mouse clicks you get 50k, pay it back daily for the term. And they offer speed and convenience. Now, which is sensible? People like speed, they like convenience. That has great marketing appeal. It is frankly quite sensible. Now, what’s interesting is all or almost all of the MCA world—and I use that in the broadest sense to be those—those institutions that make instantaneous credit decisions and they rely upon and they are taken to the bank their ability to predict credit default and to underwrite credit. And I have no question they are—their AI, artificial intelligence approach is sensible and it is the way of the future. However, what’s interesting is these lenders, these Fintech, these algorithm-driven underwriters, they also take a security interest. Now, they don’t behave like secured lenders, they don’t even know what it means to have collateral, but they take collateral and they perfect their security interest, some of them do, by filing. So they are secured lenders in the sense that they take a lien, but they’re unsecured lenders because they don’t have a clue what the collateral’s worth, nor do they really care. But they take it.
Now, so if they’re relying upon collateral, they have to have a first lien. And they have to—or at least they have to know the value of their collateral and they have to monitor the collateral. Now, why don’t they take a first lien? Because the system of getting a first lien is 50 years or 75 years or 100 years old. It is a manual system that cannot be made more efficient. It requires negotiation, understanding what the prior liens are, and there are countless prior liens. They are complex. And as you and I know, Cole, because that’s our life, getting a first lien is a pain in the butt and it takes time. And you cannot speed up the process because everything is manual. So if you say to a merchant cash advance company or a Fintech lender in the broader sense, “Are you secured lenders?” “Yes.” “Well, do you have a first lien?” “We don’t have a clue.” “Why not?” “Well, it takes too long.” And when they have to make a decision, do we make a decision to make a loan and roll the dice on collateral, or do we go slower in making the loan, offer less efficiency, and be in first position? Which model do we pick? They have made a rational, conscious decision: we vote for collateral—or we vote for the algorithm-driven credit and we will subordinate our need for collateral.
In our world, Cole, we are collateral lenders. We and we live with, we do not offer speed. Now, we can do some things fast, but we can’t give the money out fast because we have to clean liens. So we have opted for slowness, but slow and sure and have collateral. The bottleneck, the fascinating bottleneck, is the Uniform Commercial Code, which was written in the 1950s, enacted in the 1960s, meaningfully revised in the 1990s, revised again in 2010 in a minor way. But the one thing that never changed is the filing system, which is done at the state level. It is not national and it’s not privatized, it’s at the state level. And the system I’ve described where getting a first lien is a two-week process and cannot be made faster, cannot be made faster, it’s impossible. That will be the way it is until there is a process of lien clearance which is as efficient as getting a credit report, which is instantaneous. That’s in my opinion a decade or more away and requires a massive entry—a massive nationwide campaign involving all 50 states and either the federal government—perish forbid—or a private or semi-private system which is national, where everybody records their liens in some private company like the Depository Trust Company for securities or the system for recording interests in mortgages, which is a semi-private system. Until we have that, every lender will have to decide: is your model speed and efficiency or is your model having a first lien? And every single lender on the planet has to make that decision. MCAs say we’ll do the best we can with collateral and we’ll rely upon the algorithm. You and I say no, we’ll take our time, take our first lien, and because we know that’s a proven test. The MCA hasn’t been proven until last week, and it’s been proven to have a fatal flaw. It’s got a defect. And the defect is it’s not immune to viruses.
If I may, one more thing. I think I don’t dare predict what the non-collateral, unsecured, speed-and-efficiency credit world will be like. Whether it will draw capital or not, whether it will be capital-starved, whether investors will say, “No, no, we can’t roll the dice on unpredictable cataclysmic events,” and whether the model will fail, whether it will come back in a different form, whether they will be unsecured lenders but far more restrictive in their credit granting, I have no idea. But they are not on this webinar and they are sitting in meetings right now trying to figure it out because I don’t think anybody knows. It’s going to be fascinating to watch. And I think, I think factoring, if there was a battle, factoring will have outlasted and shown that safe and sure has won the race. That’s what I think, but we’ll find out.
Final Thoughts on the Industry [57:33]
Cole: Well, we’ll see what happens. I think that should be a topic for all of our industry associations to take up. You’ve been—Bob, on that note, we had a quick question here that came through asking when you said it’s going to be a lender’s market, do you see an industry most people will be lending into to help out when we come out of here?
Bob Zadek: I don’t—it’s a little hard to say because I have never felt that any industry was more of a—had created more of a demand for factoring. I mean, some do, but our product has such usefulness to every industry. And we know there are some segments that are harder to factor or harder to lend to than others. But you know what? Hard is good because that means if you take the trouble to learn how to do it, you have fewer competitors. So I will just say there’s no bad industries. They’re all good.
Cole: I like that. All right, Bob. Well, thank you. You’re a true gentleman, you’re a class act. You always have great thoughts regarding our industry and just in general, you know, your libertarian leanings are always appreciated by those of us who are so inclined for free markets and capitalism, etc. So thank you for all the heart.
Bob Zadek: Cole, I remember when you came to my office in 1966. I remember watching you from my window get out of the school bus.
Cole: ‘66 or ‘96?
Bob Zadek: ‘96. I remember seeing you with your backpack leave your school bus and come to my office.
Cole: Oh man. Well, I appreciate everything you’ve done for us in the industry and I’m sure we’ll talk soon. Thank you for your time. Thanks everybody. Thank you for everybody for joining.
Bob Zadek: Thank you.