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Non-Bank Banks

09/12/2013 6:30 am EST

Focus: ETFs

Neil George

Editor, Profitable Investing

Neil George, editor of By George, discusses non-bank banks and the Small Business Investment Incentive Act and suggests a way to aid your investments in the tech sector.

NANCY:  Hi, my guest today is Neil George.  Hi Neil, and thank you so much for dropping by.

NEIL:  Nancy, it’s always a pleasure.

NANCY:  That’s wonderful.  Let’s talk about non-bank banks.  When I think about non-bank banks, I think about the way they used to be back in the 1970’s and the 1980’s, and that’s not what the terminology means today.

NEIL:  Well Nancy, there’s another phenomena in the marketplace that stems from a period of time in which the US was in a real pickle.  You and I both remember the 1970’s.  We both might have been little tykes back then…

NANCY:  Yes, we were.

NEIL:  But at least we remember our history.  Inflation was really out of control.  Interest rates were to the moon.  Many people were having difficulty getting mortgages; a lot of people had one or two mortgages on their homes.

NANCY:  And negative amortization mortgages.

NEIL:  Even worse, and the idea – it wasn’t because people had bad credit, it was because banks really were kind of constrained and they knew with inflation in the double digits, if they made a mortgage loan, they were getting paid back in effectively less valuable dollars in the future, and what made it even worse and made the economy really go into that stagflation mode was that businesses couldn’t get loans, because again, banks were afraid to make loans and they were very fearful of the impact of inflation.  Jimmy Carter, the president back then, and congress…

NANCY:  The peanut guy.

NEIL:  Yeah, the fellow from Georgia – no, and the naval officer.

NANCY:  Right, a physicist.

NEIL:  And a physicist, nuclear physicist, so a guy with a propeller head, but regardless of how people judge him and his presidency, one of the bit of legislations that he basically signed off on was the Small Business Investment Incentive Act of 1980, and what this bit of legislation did, it basically examined small and mid-sized businesses and what they needed.  Needed to have access to capital, needed to have access to loans, and therefore, what this did was it enabled companies to be setup much like investment companies that were setup under the Investment Company Act of 1940.  In other words, like funds.

NANCY:  Right.

NEIL:  Companies could set themselves up as a company and be able to make loans to businesses, particularly small to mid-sized firms, and they would not be taxed as a corporation, so they don’t have to pay any corporate income tax.

NANCY:  Interesting.

NEIL:  But, at the same time, the money that they would earn would be passed through to their investors.  This provides two nice incentives.  One is that the investor in these sorts of companies that would be funding it would be able to get a fairly good dividend, and back then it was pretty high, and today, there were a handful of these sorts of companies that are quite well and we’ll talk about a few in a moment, if you would like.

NANCY:  Is there a percentage that they’re required to give back to the investors?

NEIL:  No, there isn’t.

NANCY:  Okay, so not like a REIT.

NEIL:  It’s not like a REIT, but there is a general incentive for them to pass through, so the idea the investor gets a lot of cash flow back, but also, they get all the depreciation and all the other expenses passed through, so that part of their dividend is going to be shielded from current tax liability, so the benefit is you get a lot of interest in your dividend, and you’re not going to have to pay as much of your own income tax on that amount, so it’s a win-win all around.  No double taxation and you actually get part of your dividend is tax shielded, so there have been a variety of companies that have used this formula to be able to operate, and one of the ones, since we’re in San Francisco, not too far away from here is Paolo Alto, which is sort of the tech mecca of the US.

NANCY:  Exactly, Stanford University.

NEIL:  And you have a lot of guys in hoodies in their parent’s garages that are coming up with the gizmos that you and I and the rest of the world are going to want to have or got to have, and we’ll stand in line at various stores to buy these little gizmos.

NANCY:  And pay a premium for them.

NEIL:  And we’ll pay premium, or it might very well be the next wiz bang thing on the internet, or who knows that it’s going to be, but tech is one of those things that Northern California is famous for.  Well, there’s a firm that’s headquartered in Paolo Alto right in the thick, and there’s a – the guys running this company have really gotten to know all those guys in the hoodies in the garages, and they’ve been able to identify the guys that are going to make it and not, and so their process is they will basically come in, they will help examine the company, and a lot of them are everything from small to already established private companies in the technology world, but these companies need funding, and therefore, they will make loans to them.

NANCY:  But not like VC’s where they take out part of the equity.

NEIL:  No, but what they do is they do have an equity incentive, so the idea that the companies have to pay back their loans, but they also get to participate in the equity through warrants, so when the companies go public and cash out, they’ll get a piece of the action, as well as their loans repaid, and they’ve been doing this over and over.  Now, the company in Paolo Alto is a company called Hercules Growth Technology Corporations, HTGC, and it’s a company that has had a fairly good track record.  Some companies, like, you might remember Facebook.

NANCY:  Yes, I might have heard of that.

NEIL:  You might have heard of Facebook.  Well, Facebook came to the market about a year ago, and one fellow with the hoodie in the garage…

NANCY:  Right, Zuckerberg.

NEIL:  Mr. Zuckerberg, who still likes his sweatshirts.  He was able to make about $18 billion dollars out of it.  Now, investors, subsequently, they’re just getting their money back kind of.

NANCY:  Right, a year later.

NEIL:  A year later, but Hercules got their money up front, just like Mr. Zuckerberg.  Another company you might have heard of, Google.

NANCY:  Yes.

NEIL:  That one’s kind of famous now.  Well, years ago, it wasn’t so famous, and the idea that those are two examples, and there’s a myriad of other investments that this company has helped to fund with these sort of loans.  Now, one of the other great benefits, Nancy, is that, as you know, people at the Money Show are always interested in income, and income is one of those things that retirees, as well as people looking to build a portfolio really needs, and so Hercules throws off a lot of cash and the current dividend is about 8% right now.

NANCY:  Very healthy.

NEIL:  So the idea, if you like the idea of investing in technology and you like the idea of being able to cash in on what’s next and what’s going to be really big, but you also want to make sure you’re going to be paid and get a good dividend, Hercules is one I really think people ought to take a look at.

NANCY:  Fascinating.  Thank you, Neil.

NEIL:  Thanks Nancy.

NANCY:  And thanks for being with us on the Video Network.

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