A Lesson in Liquidity

hedge fund maze

A Lesson in Liquidity

Liquidity Enables Longevity

Liquidity Enables Longevity

        I had an interesting call yesterday that I’d like to share.  A hedge fund asked if I would be interested in purchasing a note for approximately 3 million.  The first question of course is what is the value of the collateral asset securing the loan? The answer was 10 million. Follow-up question, what is the current rate of interest? At this point, the note was carrying a 29.5% default interest rate.

What does that tell us?

        In layman’s terms, the equity of the property is your monthly compensation.  You have to ask yourself, given the amount of return and the asset securing the return, why would you move to push this asset off your books? The answer is simple, while you’re showing a phenomenal rate of return on your income statement as well as an increase in your equity on your balance sheet, you’re also carrying a non-performing asset.

        So, the next logical question is what is the cost of holding the asset?  In this particular case, it was 10% (i.e. the investors were guaranteed a rate of return of 10% a month whether the asset performed or not). This to me, sounds like a manageable and highly profitable event provided your portfolio of notes by in large are performing. I’m in the business of lending liquidity, and in order to do that, I have to have liquidity. Phenomenal returns and increase value are great provided you have the liquidity to see the investment through. Trading liquidity for high return non-performing assets can cause a reversal in your high profits and book values as you look to liquidate holdings in order to regain proper liquidity.

My feelings on the subject,

Nathaniel S. Fulford

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