Topic 4 - Security And Lending

Question 1

Why is taking security important?

Answer 1

• taken as insurance to mitigate against unforeseen circumstances and acts as an insurance against uncertainty (cash flow form repayment donor materialise and the customer is unable to meet their obligations).

Question 2

Does taking security reduce risk and therefore borrowing costs?

Answer 2

Yes

Question 3

Reasons for taking security

Answer 3

If the borrower cannot pay then the pledge of collateral gives the lender the right to seize and sell the assets. Psychological adv over the borrower. Value of the security should be at least more than the value of the loan

Question 4

Type of collateral

Answer 4

• cash deposit- most preferred; guarantee; residential and commercial property; letter of undertaking/ irrevocable mandate; inventory; factoring; personal property; personal guarantee; accounts receivable; life assurance policy; gilts; stocks, shares and bonds.

Question 5

Two factors for taking security

Answer 5

• look at the asset and then the means by which legally the asset is made into the security (the charge).

Question 6

What does a ‘charge’ over a security confirm?

Answer 6

Someone other than the owner of the asset has an interest in it.

Question 7

4 types of security that English law recognises?

Answer 7

Mortgage - enforceable by law and allows the holder to enforce a sale but subject to court approval.
Equitable charge - deposit of an asset or documents of title to an asset with a lender with the intent that in Eod these can be realised to repay the loan.
Pledge - provision of an asset to a lender for a loan so the lender retains the asset until the loan is repaid contractual lien - someone provides a service for another and holds the asset lending payment - can only sell upon courts formal approval so works similarly to equitable mortgages to which its is closely related.

Question 8

What is a collateral

Answer 8

An asset pledged against the performance of an obligation. Doesn’t reduce the risk of the loan as this is driven by the ability of the borrower to repay the loan. Reduces bank risk but increases cost of lending and monitoring.

Question 9

Characteristics of good colleateral

Answer 9

Simplicity of title - ease at which legal title can be transferred from borrower to lender and ease at which the charge process can be completed.
Stability of value over the period of the loan - stable securities include - cash deposits, life policies, quoted shares. Difficult to value - commercial property, unquoted shares.
Realisability - turning the security into cash for repayment if things don’t go to plan. Cheap and quick to realise.

Question 10

Adv of taking shares as security

Answer 10

• quoted shares so easy to calculate market value. Also relatively stable to value.
• full legal title over most types of shares achievable
• formalities to complete 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.

Question 11

Disadv of taking shares as security

Answer 11

• open to fluctuations so if the shares are realised at an unfavourable value then proceeds may fetch far less than the bank anticipated
• unquoted shares often difficult to obtain a valuation
• articles of association may state that a bank nominee company cannot be a registered holder of shares
• bank may rely on too narrow range of shares

Question 12

Discount factors for shares which are pledged as security

Answer 12

Gilts - less risky investments (more stable) - DF 75%
AIM listed shares - 25% DF
Main market - 50% DF
Unquoted - limited marketability - bank may still use this as security - shows customers commitment. Valued at zero but there is a monetary value which could be realised in EOD by the customer. Could be difficult to sell though.

Question 13

Types of stocks and shares

Answer 13

• registered securities (quoted, unquoted, or on the unlisted securities market (USM)) - most common types (includes ordinary shares, preference shares and debenture stock)
• bearer bonds - fully negotiable instruments
• hand to hand certificates - quasi negotiable
• British gov sec - aka gilt edged securities
• unit trusts - open ended funds
• investment trusts - close ended funds

Question 14

Adv of taking life policies as security

Answer 14

• simple assignment process - once this is done then simple and quick matter to realise the security
• easy to establish the current surrender value of the life policy
• as the assured pays more premiums the surrender value of the policy increases.
• cost to the customer for taking this security is very low
• once the assured dies then policy monies are immediately payable and the procedures for obtaining them are very simple
• as further premiums are paid the banks margin improves
• secondary market endowment policies has established itself as a robust alternative to surrendering policies

Question 15

Disadv of taking life policies as securities

Answer 15

• customer may be unwilling or unable to make premiums payments
• life contracts are Uberrimae Fidei- so if there is non disclosure of any kind then the contract will be voidable
• breach of terms by the policy holder thus policy may be voidable
• if the policy was intended to benefit dependents then the bank realises it it will mean bad publicity for the bank

Question 16

Parties involved in a life policy

Answer 16

• assurer (company who issues the life policy); proposer (who is responsible for the paying the premiums); life assured (main character of contract - who the policy is against); beneficiary (who received the benefits from the assured)

Question 17

Endowment policies

Answer 17

• endowment (provides life cover and capital sum at maturity - used as repayments for int only mortgages); min term - 10 yrs - 25 yrr - 4 categories - non profit (guaranteed sum paid but no bonus / account for inflation); full cost with profits (bonus + guaranteed sum); low cost with profits (typically used to repay int only mortgages - cheaper premium); unit linked endowments.

Question 18

4 types of policies

Answer 18

1) endowment - provides life assurance and capital sum used as repayments for int only mortgages
2) whole life - can be taken with or without profits - only pays out on the death of the assuredly after a certain age so set up for the family typically to assist them for funeral expenses etc.
3) term assurance - most common and cheap policy - benefits paid if the beneficary dies after a specific age. Beyond that, if survived then no payout. Usually short term in nature. Premiums depends on various factors incl gender, type of policy
4) unit linked - increasingly popular - used to provide life assurance with the remainder invested in unit trusts.

Question 19

Key things to consider when taking policies as security

Answer 19

1) is the policy assignable - usually a statement on the policy states this.
2) uberrimae fidei - if the proposer doesn’t disclose a material fact at the time of application - false information given which leads to the contract being void
3) insurable interest - the proposer must have a monterary int in the life assured for a policy to be issued to avoid any speculation
4) premiums - should be paid upto date
5) conditions which might affect security value - free of any conditions that might detract from value as security - provisions against suicide
6) age admission - either age admitted or age not admitted
7) prior assignment - if assigned previously then the relative assignation makes up part of the chain of title
8) valuing the policy - this is the immediate value of the bank security. More important than the sum assured of a policy
9) sum assured
10) surrender value - most acquire a surrender value 2 yrs after they have been issued.

Question 20

Why do banks normally take 100% of cash deposits as security

Answer 20

Stable in value and expected to increase as interest on these deposits will be added to it

Question 21

Adv of taking guarantees as security

Answer 21

• easy to take -no form of registration necessary
• far reaching clauses within a bank guarantee gives the bank max possible protection and powers
• max liability fixed to the amount quoted on the guarantee form
• with exception of a specific guarantee, all principal debtors liabilities are secured now and in the future
• stable value provided the guarantor remains financially sound
• alongside additional supporting guarantee, then a very strong security
• as guarantees are considered third party, ignored when claiming against principal debtor for recovery

Question 22

Disadv of a guarantor

Answer 22

• if not suported by security which has a stable value the worth of the guarantee is entirely dependant on the financial standing of the guarantor - which can be quite risky!
• despite far reaching clauses, a guarantor may still be able to avoid liability on a technicality
• considered by the guarantor as a formality and the liability not considered real so should understand the full implications
• if guarantor doesn’t pay up then legal action can be taken - time consuming and expensive

Question 23

Key features of a guarantee

Answer 23

• valued at 100% depending on whether the guarantee is suppprted and nature of supporting security (if supported by cash deposits then really good!)
• a promise by a third party to repay the lender of the borrower fails to do so - involves 3 parties (lender, guarantor, borrower).
• third vs direct party - third party security considered better - should be held in support of a guarantee rather than held directly for borrowers obligations - strengthens the banks position

Question 24

Steps involved in completing the security

Answer 24

1) establish the financial standing of the guarantor - esp if joint and several guarantee an enquiry for the full amount is made on all the guarantees
2) review the general conditions
3) use the standard bank guarantee form - any deviation should be referred to the banks legal team
4) place where the guarantee should be signed -where independent legal advice is not obtained, preferable to have all guarantees signed at the branch in the lending officers presence
5) joint and several guarantees - more than one guarantor then all should sign
6) correct specification of principal debtor
7) copy guarantee to guarantor
8) annual status enquiry on each guarantor

Question 25

Charge

Answer 25

Legal or equitable interest in an asset given by the owner of a property to secure money borrowed e.g. mortgage
First ranking over an asset; second charge follows; priority of liquidation depends on date of registration with the register (in the land registry)

Question 26

Steps of taking a legal first mortgage in England and Wales

Answer 26

1) obtain title information document
2) have it updated by sending to the land registry after obtaining the owners consent
3) search using form 94A and on receipt note when protection period for searching expires
4) value the property
5) search the local land charges registry for an encumbrances (road proposals, compulsory purchases, which might reduce the value)
6) check on overriding interests by asking the owner to complete a questionnaire and if any interests emerge insist of independent legal advice and they must postpone their interest
7) execute document of charge
8) register at the land registry
9) give notice to the property insurance company
10) receive title information document from the land registry

Question 27

How is an equitable charge taken?

Answer 27

By taking the certificate of title to the property along with a signed memorandum of Deposit

Question 28

Adv of taking property as security

Answer 28

• provided no problems with title to the property, completion of this title is simple although involved solicitors so can be time consuming and expensive
• value of land and house very stable over a period of time (in times of recession this can fall)!

Question 29

Disadv of taking property as security

Answer 29

• may be difficult to sell either through deterioration in the property upkeep or lack of demand in the markets
• costs involved in upkeeping
• in realising the property the bank may have to vacate the tenants - reputational risk
• bank may need to enter into possession of tenanted property and have to take responsibilities of landlord
• legal expenses to be met by the customer - as solicitors employed to act for grantor of security
• valuation can be difficult and expensive

Question 30

Tangible and intangible assets in Scotland called??

Answer 30

Tangible - Corpeal

Intangible - incorpeal

Question 31

Real vs personal property

Answer 31

Real - land, building or both

Personal - anything else such as shares

Question 32

Key features of a debenture

Answer 32

• provides both a charge by way of a mortgage and a floating charge (equitable mortgage) over its current assets (crystallises as a fixed charge during EOD).
• in Scotland, a bond and floating charge - allows the owners to deal with the assets as and how they wish but during eod when floating becomes fixed then borrower cannot deal with the assets (not available to the borrower).
• however hard to value a floating charge due to fluactiation in trading cycle
• a floating charge still allows the bank the ability to appoint an administrator

Question 33

Freehold vs leasehold

Answer 33

Freehold - ownership (perpetual) until the owner dies
Leasehold - ownership subject to agreement with freeholder for a period of time (at lease end the property returns to the owner)

Question 34

Produce as a form of security

Answer 34

The goods title made over to the bank by way of endorsement and delivery to the bank by a warehouse warrant or by means of a delivery order granted by the owner in favour of the bank and intimated by the storekeeper.

The value of the commodity may fall or there may be loss through deterioration or damage to the goods whilst in storage

Question 35

Features of a ship as a security

Answer 35

As prescribed by the merchant shipping act 1993 all uk vessels should be registered in Cardiff to allow banks to obtain an effective security

Question 36

Assignation of contract monies and deeds as security

Answer 36

The right to payments of sums due or to become due under a contract can be assigned unless there is a explicit clause against the stating that debt cannot be assigned

Question 37

Using letters of undertaking / irrevocable mandates as securities

Answer 37

Most seen in property transactions and where bridging finance is being provided against sale proceeds of the property

Question 38

Postponement of loan as a security

Answer 38

Letter of postponement for example in case of adirector loan would confirm no repayment without banks consent

Question 39

Cash lodgement as a security

Answer 39

Usually provided by a third party either direction or in support of a guarantee

Question 40

Cont liabilities

Answer 40

Arises when a bank undertakes an obligation to a third party on behalf of a customer so the. Bank may ask the customer to sign an undertaking to reimburse the bank for any payments which it has to make in discharging this obligation (counterindemnity)

Question 41

Constituents of a standard security

Answer 41

Personal obligation; description of property; standard conditions; warrandice

Question 42

In Scotland is security over land and property take by means of a legal mortgage?

Answer 42

No - it is by way of standard security

Question 43

Adv of securities from ltd companies

Answer 43

• charge can be taken over assets which is otherwise difficult to charge
• straightforward procedure
• lender can appoint an administrator following a petition to the court to grant an administration order

Question 44

Disadv of securities from ltd companies

Answer 44

• valuation can be difficult
• upon realisation certain assets may have disappeared or fallen sign in value
• creditors will see the crystalisation of a floating charge as a sign of financial difficulty
• for realisation, an administrator needs to be appointed whose costs will reduce the value of the assets being sold or disposed of
• floating charge could be invalid if the business is insolvent when the security was granted

Question 45

Where should the charge granted by companies be registered

Answer 45

Companies house or in Edinburgh (for Scottish companies)

Question 46

Securities which are not required to be registered — SNIP

Answer 46

Shares
Negotiable instruments
Insurance policies
Produce

Question 47

Types of contingent obligation

Answer 47

Direct credit substitutes (bank called upon to meet customer’s obligations ; transaction related (when banks risk is dependant on likelihood of something happening); short term trade related (movement of goods over which a bank has certain rights); other - e.g bank asked to endorse a bill of exchange on behalf of an customer

Question 48

Seven ways loans can be made

Answer 48

1) banks solicit loans (sales, cross selling etc)
2) buying loans (participating with other banks - shares national credit when there is a syndicate of >3 banks for $20 m
3) loan commitments
4) customers requests
5) loan brokers
6) overdrafts
7) refinancing of loans due to lower rates

Question 49

What is customer profitability analysis

Answer 49

Considers all aspects of the relationship with the customer when pricing a loan (RAROE)

Net before tax rate of return to the lender from the relationship = revenue from loans and other products provided by the customer - expenses from providing loans and other services to the customer / net loanable funds used in excess of this customer’s deposits

Positive then approved because lender will earn a premium over all expenses incurred

Negative then may be denied or pricing improved to continue the relationship on a profitable basis