Unit 3: Security

Question 1

Why do lenders want security?

Answer 1

All lending has a risk because lending involves the future and the future is uncertain.

Question 2

What is the ultimate risk the lender must guard against?

Answer 2

The borrower’s bankruptcy

Question 3

When is security required?

Answer 3

When repayment capability is unproven, or outside unsecured borrowing policies

Question 4

How does taking security actually work?

Answer 4

• Lender asks borrower to provide an asset as a protection against loan not being repaid.
• Lender obtains the right, where there is a default against the loan terms, to sell the asset to repay the borrowing.
• If a security asset needs to be sold, it must be done quickly (holding high quality security will assist with this).

Question 5

What 3 essential qualities does a lender look for in a security?

Answer 5

1. Simplicity of Title (Ownership)
2. Stability of Value
3. Saleability or Realisation

Question 6

Why is Simplicity of Title/Ownership important?

Answer 6

Ideally, a lender must ensure the security is free of all liabilities or encumbrances of any nature which might prevent any future action they may want to take regarding the security.

Example: Borrower offers security over their property, which already had an outstanding mortgage against it. They then default on their loan. Now the lender needs approval from the first security holders to now sell the property.

Question 7

What two aspects must be considered for stability of value?

Answer 7

1. Margin (difference between loan amount and value of security should be sufficient enough to allow for any volatility)
2. Holding value (asset value should not fall below amount of the borrowing - take care with things like managed funds and shares)

Question 8

What are 3 of the the easiest security options a banker can select from?

Answer 8

1. Cash lodgements or term deposits
2. Residential property (with exceptions)
3. Listed shares (volatility must be considered)

Question 9

What are 5 of the the most difficult security options a banker can select from?

Answer 9

1. Specialised or commercial property
2. Furniture, fixtures and fittings
3. Unlisted shares
4. Unique items (like jewellery and artwork)
5. Managed investment funds (due to pricing fluctuations and taking a formal charge over this type of asset)

Question 10

What are 4 unacceptable residential securities?

Answer 10

1. Time-share properties
2. Purchase of Crown Land (other than ACT)
3. Purchase of large rural properties (generally greater than 40 hectares)
4. Uninhabitable house (some lenders won’t accept)

Question 11

Can security turn an unsuitable loan application into a suitable one?

Answer 11

No - no amount of security can turn an unsuitable loan application into a suitable one.

You should always look to the viability of the application for repayment, not the security for the loan.

Question 12

What are 2 reasons we say that no amount of security can turn an unsuitable loan application into a suitable one?

Answer 12

1. Security should only be a secondary strategy to guard against any unforeseen events that may occur during the life of the loan.
2. Could be reputational damage if a bank is seen evicting defaulting borrowers from their homes due to having a security-led loan assessment framework.