The Choice: Being A Subprime Mortgage Broker Or A Defense Contractor

Today, if you were given the choice between operating a company specializing in subprime mortgages or running a private defense company you might want to seriously consider the former. In the subprime mortgage business all you have to contend with is customers who often haven’t the money for a reasonable down payment, may not earn enough to make their mortgage payment and could walk away from the property. There is also the high regard the public currently has for subprime mortgage brokers.

If you were running a defense company you would be dealing with a single customer, the Department of Defense. This is a customer who is free to change its mind and alter or cancel the deal at any time, tells you how to make the products you sell and run your business, demands access to proprietary business information and limits what you can charge. Recently, this customer has taken to demanding that you front him money to help develop the products only he will buy. At least in the mortgage business the clients don’t ask you to pay the mortgage for them.

The Pentagon can change the rules without warning. Take, for example, the issue of liability for concurrency costs. Concurrency occurs when a program authorizes production of a weapons system or piece of hardware to go forward while development and testing are still underway. Why would you do this? Because the alternative would delay production by years after development had been completed, require that the work force be hired, then fired and eventually rehired and reduce the learning curve rate which lowers production unit costs. When a design change is required, possibly due to a problem but also possibly because the Pentagon decided it now wants the item to be bigger, smaller, faster, slower or painted blue instead of green, all existing versions of that product must be upgraded to the new standard. Concurrency entails some risks but actually saves money. Many defense programs have some degree of concurrency.

Concurrency had become an issue for the F-35 Joint Strike Fighter (JSF) program. The JSF program currently is in what is called Low Rate Initial Production (LRIP) during which relatively small quantities of the aircraft are produced while development and testing continues. The Pentagon paid most of the concurrency bills for the first four LRIP contracts with Lockheed Martin picking up the rest. Suddenly when it sat down with Lockheed Martin to negotiate LRIP 5, the Pentagon demanded that the company not just share in the cost of concurrency but assume full and unlimited liability for all concurrency costs over a threshold to be negotiated. Did I mention that Lockheed Martin already accepted additional financial risks when it acquiesced to the defense department’s demand that all future production contracts be fixed price?

The Pentagon wants you to believe that Lockheed Martin is getting away with something by refusing to accept unlimited liability for all concurrency costs. However, the company has already absorbed 30 percent of overrun costs for the first three lots of aircraft while reducing costs by 40 percent. In addition, Lockheed Martin has made some $1.3 billion in capital investments in support of JSF production over the past decade.

Today, even as the Pentagon and Lockheed Martin spar over who pays concurrency bills, the company is incurring expenses. Lockheed has over $1 billion in bills for the JSF program. Typically, the government issues undefinitized contract actions (UCAs) which authorize contractors to begin or continue work before reaching a final agreement on contract terms. Because contract negotiations can take months, UCAs are the only way for a company to maintain production, order long lead items and pay suppliers. In order to maintain the work flow, Lockheed Martin has gone ahead and incurred costs before even a UCA was signed, much less a fully definitized contract for LRIP 5. Even though the Department of Defense authorized the UCAs, Lockheed Martin is liable for all costs associated with such actions until the government agrees to pay them. The Pentagon is delaying paying the current bill for UCAs on the F-35 program, creating the impression in some quarters of trying to twist Lockheed Martin’s arm on the issue of liability for concurrency costs.

One of the advantages of the subprime mortgage business is that you can raise the rate customers are charged based on the magnitude of the risk of default. Another advantage is that if the deal is bad enough you can say no. The defense department seems to want to deny defense companies both these options.