I’ll try to describe how tribal warfare plays out, and show it by running through an interesting, complex deal.
The deal was first done at Daiwa, where we established a very profitable niche creating bonds from the cash flows of loans and leases that weren’t in the mainstream.
This particular deal used loans against mobile home parks, a subsector of commercial mortgages. By coincidence, we were also working on a deal to securitize loans on mobile homes (excuse me – manufactured housing) at the time, so we found ourselves talking about the “pads” or the “boxes” to keep them straight.
Between the two, I think the parks made better collateral, although you do take on the business operator risk if the park is operated by a sloppy business owner.
Still, given the choice of an $80K loan against an $100K double wide that starts losing value the moment someone sleeps in it vs. a loan against the hundreds of pads the homes sit on, I’ll take the cement slabs and sewer hookups.
I looked at it this way:
A single borrower may get into trouble paying the $800 or so per month their mobile home mortgage may cost, and then you have the foreclosure (repossession) issue, and collateral that may not come close to selling for your loan balance. That same borrower may also be having trouble paying their park operator $100 a month space rental. That park owner can do something I can’t: turn off the water, or worse yet, the sewer hookup.
See what I mean?
Anyway, when we first did the deal in the early 90’s, it was a new class of asset, so the rating agencies were very conservative, and assumed the cash flows from the 54 parks backing the deal could decline over time. They required us to issue a very large unrated subordinated bond.
A mutual fund bought that bond at an attractive double-digit yield in a market where most rates were quite low, even for commercial mortgage-backed securities (CMBS) from the RTC.
Fast forward a couple of years. Daiwa had decided to get out of the mortgage business.
I had landed a job where I had all three main tribes (sales, trading and banking) reporting to me, along with the minor tribes of research and credit. A dozen or so of us from Daiwa had come to the new shop, so some of the customer relations had come with us, including the buyer of that unrated bond.
The fund manager was having some redemptions from his fund, and with Daiwa out of the business, the unrated, privately-placed mobile home park subordinate bond was a textbook orphan, with no prices available, and no one willing to finance it.
We were asked to help the customer out by saying what we would pay for the bond at the new shop. Under time pressure, we answered that the best we could do as a cash bid was around fifty cents on the dollar, but we’d be happy to work on finding a new buyer for it if we could have some time to work on it.
The fund manager had bought the bond at a discount originally, and had been getting a nice fat coupon for a few years, but we were still a little surprised when he said we could have it at a steep discount, which, if memory serves, was a price around 54 cents on the dollar, or $30 million for the bond.
It probably is worth noting that this all happened in one of those periods (1994-1995) when the financial press was declaring the structured MBS and CMO market dead, yet again. A well-known mortgage bond hedge fund operated by David Askin had blown up in March of ’94, and with interest rates screaming higher most of that year, everybody hated bonds. The more complex they were, the more they hated them.
Having bought the bond at a price we were pretty sure we couldn’t lose on, the next thing to do was figure out how we could sell it. First, of course, the trader for commercial mortgages had to hedge it, and plan on owning for some time.
Our credit team and relationship banker went through the painstaking process of re-underwriting every property in the portfolio, including checking each property’s space rental rates and local competitors for each property. Over the time since we had first done the deal, the space rental rates at the parks had gone up rather nicely, averaging 15% to 20% higher.
We hired third party specialized appraisers, and our senior credit analyst and “outside” banker went along on a number of the property appraisals. We eventually got audited financial results from every borrower except one.
That one had the funniest sections of an appraisal I think I’ve ever seen. The park operator had given up. All the mobile homes were gone, and an eight-foot chain link fence surrounded the property. In the sections headed “General Appearance” and “Deferred Maintenance,” the appraiser had written:
“As I approached the subject property I noticed it was not there.” He had fun with the maintenance review, as well, noting that the chain link fence was in good shape, and that the cement pads were doing fine, although there were some weeds growing up between them.
Our analytic team did the job of custom programming the cash flows of the loans, so we could handle any and all requests for bond performance analysis for just about any scenario the rating agency or a buyer of the bonds might dream up, at least for the remaining 53 properties.
Our “inside,” or execution bankers set up a new trust to take ownership of the bond and hired a Trustee, accountants, lawyers, etc. to get ready to issue new bonds. They also began discussions with the rating agencies to work up stress scenarios for the properties that would satisfy investment grade (BBB) stress tests. By then more mobile home park deals had been done, so the rating agencies had some historical performance data to draw upon.
After we got the subordination levels from running the Rating Agency BBB stress scenarios, the execution bankers and the analysts produced all the supporting documentation to create a new deal with a rated bond and an unrated bond, along with a “strip” of excess interest.
The new rated bond was worth nearly $50 million, and another salesman sold the entire bond to one well-known fund manager after about three days of calls. Each call led to custom stress analysis done by research, and all of it culminated in negotiations with the trader over his hedge unwind and final bond pricing.
We had spent about three months and nearly a million dollars in legal, rating, accounting and other direct expenses to do this single “trade.”
Tribal warfare became painfully obvious when bonus time came. Our group was being paid a third of its profit, and everybody had a very clear idea how much profit they had helped create.
When bonus time came, the trader sat in my office and said he knew we made $20 million on the trade, so he should get $2 million added to his bonus, or 10% of the profit. The “outside” banker, the salesman who bought the bond, and the salesman who sold the bond each said they should get $2 million in extra bonus for that deal, as well.
The execution bankers and the analytical team also deserved to get paid for working on the deal, though they didn’t have explicit requests tied to that deal.
I was sitting there, listening to it all.
It added up to around $9 to $10 million in bonus expectations, even though our one third profit share from that deal only added $6 million to the bonus pool, and that doesn’t even count the share of our annual fixed overhead that should be charged to that deal.
Basically, the team was convinced they deserved roughly twice what was actually paid to us for doing the trade. Even if I didn’t get paid a dime myself as department head, I was seeing each tribe discount the contribution of the other tribes toward our success.
Each was absolutely correct that we wouldn’t have made that money if they weren’t there doing their jobs.
Riding herd over members of several tribes is one of the least satisfying things you can spend your day on.
When I had the job of supervising people from all three main tribes, a big chunk of every day seemed to consist of listening to the salesmen say the traders were jerks that never took their customers’ excellent offers for bonds.
If it wasn’t that, then the traders were complaining that the bankers were worthless because they never finished the documents on time, or it was the bankers asking why we had a dozen analyst/programmers being paid so much when they just knew we could get kids fresh out of school to do that work faster and cheaper.
They were all convinced that I was short-changing them and paying the others way too much.