What Your Bank Holds as Security

A credit desk lends against cash flow. The first way out of any loan is the business paying it back from what it earns, and no amount of security makes a loan whose first way out is doubtful into a good one. Security is the second way out: the answer to the third of the Three Questions, what happens if the first answer is wrong. It also decides how much capital the bank must hold against you and therefore what it can charge, which is why a well-secured facility is cheaper than the same facility unsecured. And it changes behaviour, which is the part of the reasoning banks say least often: a borrower whose house is behind the guarantee runs the business differently from one who can hand back the keys.

A trading business usually gives the first and the fourth, adds the second if it owns its premises, and the third for each asset the bank financed separately. The term loan and equipment finance files show the specific charge at work; the development loan file shows a mortgage carrying almost the whole second way out; the bank guarantee file shows cash cover, the dearest security there is, measured in the working capital it locks up.

Security over anything other than land is made public by registering it. In New Zealand and Australia the register is the Personal Property Securities Register; other countries keep the equivalent under another name. Registration is what gives the bank priority: whoever registers first over an asset ranks first on it, which is why a bank registers before it lends and why the letter asks you not to give security to anyone else. It cuts both ways. A supplier who sells to you on credit and registers its own interest in the goods it delivered can rank ahead of the bank on those goods, and an equipment financier who registered over the machine it financed ranks ahead of the general security agreement on that machine. The desk reads the register before it lends and at each review, and so should you: what is on it against your company is a list of who is ahead of whom.

Much less than the balance sheet shows, and the gap is the whole of the desk's thinking. Security is valued at what it would realise in the circumstances in which it would be realised — a failed business, a receiver, a forced sale — not at what it is worth to a going concern. Receivables are collected at a discount, because customers of a failed supplier find reasons not to pay. Stock sells for a fraction, and some of it does not sell at all. Plant goes to auction. Land is the most reliable, and even land is discounted for a forced sale. LVR, Security and Collateral works the arithmetic on a manufacturer's balance sheet and shows how far the realisable value falls below book. That gap is why the bank asks for the guarantee as well: the general security agreement is the second way out, and the guarantee is the third.

All obligations. Almost every security document secures everything you owe the bank, now and later, under any facility — not only the loan it was signed for. Repaying the term loan does not release the security if the overdraft is still there. Cross-collateralisation. In a group, security given by one company stands behind the borrowing of another, and a guarantee from a sister company puts its assets behind yours. A profitable subsidiary can be pulled into the failure of a weak one this way, and a buyer of the subsidiary will find the bank in the way. Negative pledge. You agree not to give security to anyone else, which means the equipment lease and the supplier's credit terms that come with a registration are each a consent to ask for first. The guarantee as security. An unlimited guarantee reaches everything the guarantor owns, and Personal Guarantees sets out why a cap, a scope and a release path are the three things to negotiate before signing it rather than after.

Security is released when the obligations it secures are gone — all of them, given the all-obligations clause — and the release is a document from the bank and a discharge on the register or the title. Partial release, to sell an asset the bank holds a charge over, needs the bank's consent, and the consent is a credit decision: where do the proceeds go, and what cover remains? On a facility that financed the asset, the proceeds repay it. On a general charge, the desk will look at the whole file before it lets cover go. Substitution — releasing one asset as another comes in — is usually easier than release alone. Guarantees are the hardest to recover, because a release is a one-way door for the bank and it will want to see the business standing on its own for some time first. Ask in writing, with the numbers, at the annual review when the file is open anyway, and ask for a path rather than an event: what would the bank need to see, by when, for the guarantee to come off?

Five questions. Which assets, exactly — and would a specific charge over the financed asset do instead of a general one, where the facility is small against the business? Which entities — does the group structure need every company in, or only the borrower and the one holding the property? Is the guarantee capped, and to what? What does the all-obligations clause pick up that you have not thought of — a credit card, a trade line, a lease with the bank's finance arm? And what is the release path — not whether, but what the bank would need to see? The desk has answers to all five, and it would rather give them at the facility letter than at the sale of the business, when they are harder to change and cost more.