Many commercial loans are made to trusts. How well do you really understand trusts? Investopedia defines a trust as follows: A fiduciary relationship in which one party, known as a trustor, gives another party, the trustee, the right to hold title to property or assets for the benefit of a third party, the beneficiary. [Yawn] I am falling aslseep here! C'mon, George, how about a jazzier explanation?
Suppose I am a filthy rich robber baron. A robber baron is a popular finance expression to describe an unscrupulous American capitalist who acquired his fortune and power by ruthless means. Famous examples of robber barons include J.P. Morgan (banking), Andrew Carnegie (steel), Andrew W. Mellon (banking), and John D. Rockefeller (oil). These are the guys who broke the heads of union strikers with bats and who used insider information and dirty deals to build their fortunes.
"Behind every great fortune lies a great crime." -- Honore de Balzac
As a filthy rich robber baron, I win the affections of a beautiful wife. My wife is 25 years younger than me. She is gorgeous and loving; and she bears me three wonderful young children. I adore her. Unfortunately my sweet trophy wife is as dumb as a rock, and I worry about what will happen to her and our young kids when I die. (I am not talking about my own beautiful wife, Cisca, who was once our company's Controller and who is far-far-FAR quicker than me. I am talking about our imaginary robber baron with the daffy wife.)
Therefore, I, the filthy rich robber baron, go to Ron, my trusted friend of 45 years, and ask him if he will please manage my family's money after I die for the benefit my wife and kids. He agrees. In my will I set up a testamentary trust into which I transfer all of my bank accounts, stock accounts, real estate, and ownership of my companies.
In this story, the rich robber baron is the trustor or settlor (same thing) of the trust. I set up the trust. Hence the name, "settlor". My trusted friend, Ron, is the the trustee. The trustee follows my instructions contained in the trust agreement. He does this to provide a comfortable living for my lovely widow (who is now dating our handsome chauffeur) and a college education for my kids (the last of whom looks an awful lot like the chauffeur). My wife and kids are the beneficiaries of the trust.
Per the trust agreement, Ron invests all of my great wealth into a diversified portfolio of investment grade bonds. An investment grade bond is defined as a bond rated BBB or better by Standard & Poors. By the way, a great many (tons and tons of) trust agreements only allow the trustee to invest in investment grade bonds. This is why a BBB bond rating is so coveted. These bonds will provide the income for my hapless wife and our three minor children.
In my story, you will recall that I created this trust in my will. Such a trust is called a testamentary trust, as in "Last Will and Testament". Now such a trust is obviously irrevocable because - helloooo? - I am dead. A trust that cannot be changed is known as an irrevocable trust.
But a settlor or trustor (same thing) does NOT have to be dead to create an irrevocable trust. A huge benefit of an irrevocable trust is that it provides substantial protection from creditors. Once assets are transferred to the trust, they no longer belong to the settlor; rather, they become the legal property of the trustee to hold for the beneficiaries.
For example:
Let's talk about me, George III (the old man). I own a commercial hard money mortgage company, and I assemble syndicates of wealthy private investors to make subprime, commercial first mortgage loans. Back in 2005 I saw the crazy loans that my industry was making, and I greatly feared that a deflationary depression was coming. I had been warning my investors for a decade that real estate values were poised to take an enormous dive, but the exact timing was unknown. I even wrote a book about it. My biggest fear was that my investors would blame me for the Great Recession and sue me.
Now if I had enjoyed great wealth at the time (I didn't), I would have created an irrevocable trust (I didn't) for the benefit of my three wonderful kids that would have been beyond the reach of creditors. They would have had money for college and a small downpayment on a house. By the way, my frank and dire warnings, along with my alarming book, probably saved my company. Blessedly I wasn't blamed. Almost all of my hard money competitors were sued out of existence.
Now let's have some fun. Suppose I - I'm back to being the rich robber baron - had woken up in the middle of the night, and I had wanted to grab one of my cigars hidden in the garage. To my horror, I find my young trophy wife doing the wild thing with my chauffeur in the back seat of my big, black Mercedes. (Remember, this is just a story. In real life I drive an immaculate, ten-year-old, white Infiniti.)
Furious, I divorce my wife and change my will. At the advice of my attorney, this time I create a living trust. A living trust, which is also known as intervivos trust, is a trust that can be modified during the lifetime of the settler (trustor). The beneficiary of this living trust is my curvaceous secretary, with whom I have been having an affair for ten years. The nice thing about a living trust is that if I ever catch her "kissing" the UPS guy, I can easily change my trust again.
A great many wealthy couples today hold title to their assets in the name of a living trust. This has the advantage of avoiding probate. For underwriting purposes, lenders simply ignore the existence of the living trust. A lender is not going to ask for a copy of a financial statement on the living trust because, in most cases, its the exact same thing as the borrower's personal financial statement. When the loan is approved, a commercial lender will ask for a copy of the living trust, or an abstract of the living trust, just so he can verify who has the authority to sign on behalf of the trust. An abstract is just a one-page or two-page summary of the important terms.
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