Lake Wobegon Syndrome

As I’ve probably mentioned lately, I’ve recently worked with several clients on debt-raise projects.  Based on that experience, as well as others over the years, I’ve begun to identify a malaise among credit providers which I’ll refer to as Lake Wobegon Syndrome.

By now, probably most people are familiar with Garrison Keillor’s Lake Wobegon.  For those among us who aren’t aware of it, he describes it as a town where “all the women are strong, all the men are good-looking, and all the children are above average”.  There’s a recognized Lake Wobegon effect, otherwise known as Illusory Superiority (Wikipedia link: Illusory_superiority) which “causes people to overestimate their positive qualities and abilities and to underestimate their negative qualities”.  That’s interesting, and we all know sufferers and victims, but it’s NOT today’s subject.  Instead, the phenomenon I’ve identified is that all lenders tend to seek borrowers which are “strong, good-looking, and above average.”  [Interjection of personal observation ... Well, DUH!]

There’s a very obvious and compelling reason for this among bank and other regulated lenders: having identified the parameters which tend to suggest success or failure in an industry (in our restaurant world, this might include unit-level sales volumes, cash-flow margin, leverage, and other telltale markers), our friendly lenders are compelled by their credit or risk managers to only book loans for borrowers on the successful side of the line.  Reason?  These credit and risk managers must answer to regulators, who are generally not experts on the various industries.  For job preservation reasons alone, it’s easy to understand why these multiple layers of explicit or implicit approval lead to a narrow view of acceptable risk.  While I’ve described some restaurant-specific parameters, this syndrome seems to be occurring in various industries.

So, because nature abhors a vacuum, as the regulated lenders have narrowed their focus, a group of alternative lenders has arisen.  Understanding that the banks will seldom compete with them for the borrowers which are perceived as below average, they tend to structure higher-cost debt facilities aimed at compensating themselves for the higher risk.  (Feel free to insert the word “perceived” at appropriate points throughout.)  All this is fine and good -- it’s how markets work, right?  If a provider fails to serve a pool of customers, someone else will, and will price their services appropriately.  Here’s the interesting wrinkle: many of these non-regulated lenders have apparently concluded, rightly or wrongly, that the banks won’t compete for all the “above average” business; as a consequence, many of these lenders are now searching for the “above average” borrowers themselves, and backing away from the “below average” borrowers who would have been expected to pay their higher fees and interest rates.  I haven’t yet been able to determine whether these lenders have gotten burned, and are therefore backing away from risk, or if they just believe there’s an opportunity to charge above average rates for borrowers which (one would think) should qualify for better terms.  I welcome any experiences or observations.  Meanwhile, some of those “below average” operators and borrowers, including more than a few whose results and profiles really are NOT below average, are now stuck with few or no lenders willing to support them at any cost as standards tighten among the non-regulated lenders.  It’s an interesting, but perhaps hazardous, phenomenon, a situation which will likely force yet more closures and distressed sales across several industries in coming months and years.  The economy continues limping, at least in part for lack of liquidity.