Securities for Lending I Flashcards
What is a Security?
How does one obtain security?
The bank takes a security as insurance/protection against situations in which the cash flows needed to repay the loan do not materialise and the customer is unable to meet their obligations.
To obtain security, a lender looks for the creation of a charge.
However, one shouldn’t rely on securities alone. The customer’s ability to repay should be carefully assessed.
What are attributes of a good security?
- Simplicity of title - easy to legally transfer the asset from borrower to lender - the legality of charging it as secuirty is easy
- Stability of value
- Realisability - liquid asset
What is a charge?
A general term meaning that someone other than the owner of an asset has an interest in it, whilst not transferring ownership.
All securities recognised by English law are charges.
There can be more than one charge on an asset, and their ranking (the order in which they are paid out if an asset is liquidated) is based on which was registered first e.g. for land, the register is at HM Land Registry.
What securities are recognised by English law?
- Mortgage (legal mortgage) - enforceable by law; allows the mortgagee (bank) to enforce a sale subject to court approval
- Equitable charge (equitable mortgage) - deposit of an asset or documents of title to an asset with a lender that can be realised to repay the loan. A Memorandum of Deposit is required stating that this is the case. In a default the MoD can be used in court as evidence to force the asset holder to complete a legal mortgage.
- Pledge - the provision of an asset to a lender for a loan e.g. pawnbroker
- Contractual lien - holding an asset pending payment e.g. repaired boat may be held by the boat builder until payment.
What is a security discount factor?
Why discount a security?
The factor by which a security is discounted - undervaluing a security to create a factor of safety - i.e increase the banks margin on the security.
- The value of a security might be less than orignally when realised
- Expenses associated to realising a security
- A defaulting customer might not be able to meet interest charges on borrowing in addition to the borrowed amount
As such, security discount factors should be reviewed periodically or when there is change that’d affect security values - e.g. falling house prices.
What is a lending covenant?
- Lending convenants are formal agreements made at the time the loan is negotiated by the lender used to keep the risk of the loan at the same level during its entire length. They are established so as to force a review of the facilities if the covenants are breached. Breach of a covenant usually makes the loan repayable on demand, though in reality it normally brings about a renegotiation of the loan.
- Affirmative covenants are actions the company agrees to comply with, negotiating with the customer to abide by certain financial measures (e.g. capital adequacy ratios, gearing, interest to cover) and to provide information (e.g. management accounts).
- Negative covenants prohibit the borrower from doing something such as not allowing it to grant security to any other party, or limiting the amount of debt it can take on.
What are the advantages to the bank of taking shares as security?
- For quoted shares it’s relatively simple to estalish the current market value
- A full legal title over most types of shares can be acheived
- As a pledgee, under standard bank security clauses, it’s only necessary for the banker to demand repayment and for the customer to default, before an immediate power of sale arises
- Some shares are relatively stable to value e.g. gilts which are nearing maturity
- The formalities to complete the security are simple
- A banker can acquire a good title even if bearer bonds are taken provided they are taken in good faith and for value, even if the pledgor’s title is defective
What are the disadvantages to a bank taking shares as security?
- Shares tend to fluctuate in value - if they’re realised at an unfavorable moment, the proceeds may be far less than anticipated
- If the shares are unquoted, it is often difficult to obtain a valuation
- The shares offered may be a director’s qualification holding which could deprive the customer of their directorship
- The Articles of Association of a private limited company may specify that a corporation i.e. a bank nominee company, cannot be a registered holder of its shares
- If a bank sends a transfer to a company for registration, and the transfer contains forged signatures, it’s bound to indemnify the company even though it acted in good faith
- The bank may at times rely on too narrow a spread of shares, e.g. one debt may be secured over shares in only 2 companies
What types of shares are there?
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Registered Securities (quoted, unquoted or on the unlisted securities market (USM)) - These are most common type of share security today and include:
- ordinary shares - the equity of the company
- preference shares - rank before ordinary shares in event of company being wound-up
- debenture stock - loan to company secured on assets by floating or fixed charges.
To transfer the shares into the name of the bank’s nominees company a stock transfer form must be completed and signed by the registered owner of the shares and sent with the share certificate (if one’s been issued) to the company registrar
- Bearer Bonds - are financial securities that are not registered under the name of any particular shareholder but where pocession of the bond serves as proof of ownership. Theyare fully negotiable and as such it’s normal to get the transferor to sign a memorandum of deposit or letter of pledge to confirm and outline the bank’s rights
- Hand-to-hand Certificates - quasi-negotiable and an org will have procedures for taking this type of security
- British Government Securities - issued by the govn as a means of borrowing money - gilt edged securities (gilts). The procedures are exactly the same as those for registered securities and the transfer form and certificate must be sent to the BoE as registrar
- Unit Trusts - ‘open-ended funds;’ pools the resources of many people and from this open ended pool the trustees place the funds in a wide range of investments. Depending on the level of contribution, the investor will be given a registered certificate which shows that they purchased a stated number of units in the trust. Unit trust schemes operate under a deed of trust by which a trustee, such as a bank, will be appointed to oversee the operation of the scheme. If an impledgement is being taken, the certificate should be deposited with the bank and the renunciation form on the reverse of the certificate should be made in favor of the bank’s nominee company. The certificate should then be submitted to the trustees, who will issue a fresh one, showing the nominee company as the registered holder
- Investment Trusts - not actually trusts at all, but a limited company with a fixed share capital and is quoted on the LSE. Investments trusts don’t make or sell products but invest in shares. Security over investment trust company shares is completed in the same way as for registered shares
Give examples of typical discounted values?
- Cash - not discounted 100%
- Guarantee - variable if supported, nil if unsupported
- Residential property - ~80%
- Letter of undertaking/Assignation of security - 100% if closed bridging, ~77% if open bridging
- Life Assurance - 75%
- Alternative investment market shares - generally around 25% of the value
- FTSE shares - generally 50% of the value
- Unquoted shares - generally no value due to their limited marketability
- Gilts - generally 75% of the value
If taking shares as security, what is it necessary to do?
It is important to have a share value monitoring system in place to value the security on a regular basis and to check this against the bank’s real/potential exposure to ensure that an adequate margin is being maintained.
The shares are normally transferred to the bank’s nominee company and a memorandum of deposit (letter of pledge in Scotland) taken.
What are the advantages of taking a life policy as security?
- The method of completing an assignment is simple
- It’s easy to establish the current surrender value of the life policy
- If an assignation has been taken, it is a simple and quick matter to realise the security
- As the assured pays more premiums, so the surrender value of the policy increases and so the bank’s margin improves
- The cost to the customer of taking this type of security is low
- If the assured dies, then the policy monies are immediately payable and the procedures for obtaining them are very simple
- The secondary market in endowment policies has established itself as a robust alternative to surrendering policies
What are the disadvantages of taking a life policy as security?
- A customer may be unwilling/unable to make regular premium payments
- Contracts of life assurance are uberrimae fidei therefore if there’s been any non-disclosure of a material fact, the contract will be voidable
- Slight risk that the person who acts as proposer of the policy does not have an insurable interest in the assured
- There may be a breach of the terms by the policy holder, thus making the policy voidable
- If the policy was intended to benefit dependants upon the assured’s death, and the policy is realised by the bank, bad publicity may result
What parties are involved in a life policy?
- The Assurer- the company which issues the policy in return for premiums accepts the risk
- The Proposer - the person who completes the proposal form and is responsible for the premiums being paid
- The Life Assured
- The Beneficiary - the one who recieves the money if the life assured dies
How do banks take security over a life policy?
- In England and Wales, banks use a Memorandum of Deposit
- In Scotland, security over a life policy is taken by way of an assignation, granted by the person to whom the policy belongs, in favour of the bank and its assignees. The form of assignation which banks use is known as an assignation in security.
