While reviewing yesterday’s entry, about the coming bailout for Spain, it occurred to me that many readers may be unfamiliar with how that kind of debt really works. And to me, I look at the arrangement as if it were a business loan or mortgage.
In that regard, the first question a knowledgeable lender would ask a prospective borrower is: How are you going to pay the indebtedness back? And if the transaction was a significant amount, they’d likely require a detailed plan supported by documentation showing that the information provided was true, accurate and represented a reasonable expectation of future results.
The reason for the diligence performed by lenders, however, isn’t simply a pile of information to fill folders and be stuck in a drawer to prove they asked all the right questions. That data’s needed to assess the likelihood of borrowers meeting their obligations as expected and agreed. And the most important question of all usually regards precisely where repayment funds will come from.
The derivation of funds to pay back loans ideally generates from a borrowers activities. Consequently, for businesses, lenders seek customers whose operations are growing and therefore additional equipment, supplies, or resources are needed to help accelerate future success. In the case of a bigger mortgage, similar parameters apply such as, mortgagees earning higher income and increased property values.
Conversely, the worst situation for lenders, and the ones to always avoid, are those wherein borrowers have a dire need for additional funds yet presently have no viable expectation of how they’ll pay their obligation back. And in most of the cases like that, lending isn’t really a sound business at all, but more like taking the funds and going out to the track to wager on I’ll Have Another who we all know was scratched.
And that’s why, from my own experience, I’d question what’s happening in Europe right now and take a very hard look at the real probability of Spain’s ability to pay back $125 billion euros. Because from all the data I’ve seen about it's recovery chances, I think I’ll Have Another was a better bet.
That’s it for today folks.
Adios
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