Character, Capacity and Collateral - The Heart Of A Banking Relationship.
How is your banking relationship?
You may have a solid banker. But what if your banker changes? They could be promoted, fired, change careers, or about to start a family. Will your relationship with the bank prevail?
Any banking relationship relies on your “file” - your documented history. Think, how the bank views you.
Key factors that determine this view are – Character, Capacity and Collateral.
Character
Integrity
Who are you connected to
Spending habits
Willingness to pay
Upfront for information provision
Capacity
Strong servicing evident
Up to date financial information
Strong history and forecast of servicing
Collateral
Security documentation in order
Quality security with acceptable margins
Valuations current
When dealing with banks there will be a lot of compliance and form filling. These all lead to satisfying the three Cs.
Let's examine each.
Character
If there was a legal loophole that did not obligate you to repay the bank, would you exploit it?
Regardless of what your answer is, this is why banks assess capacity and take security (collateral). Banks try to assess your character, but they actually assume they get it wrong and take security to protect their investment.
This will involve forms. Lots of forms! For instance, the credit check. If you have an issue it's telling the bank that you have missed or reneged on a financial obligation in the past - to a bank this screams character issues.
Your bank asks to see your debtor / creditor report with days outstanding. Why are some of your creditor payments outstanding for 90 + days? Is this normal? Why is it taking you so long to pay people you owe money too?. Again, this analysis falls into the Character “C”.
Sometimes issues appear. Be upfront about them.
Capacity
Having been assessed as a person of “Good Character” the next step for the bank is to assess your ability to repay (servicing) the loans requested.
This is done by evidencing and assessing your income and your business or living commitments, against the proposed loan repayments. Is there enough to go around? Banks apply a stress factor to this assessment to create a margin of safety for you and them. They do this by increasing the interest rate applied, usually several whole percentage points above what you’ll actually pay to begin with.
If the capacity assessment is done right, then the bank should not end up having to rely on its last line of defence - collateral.
Collateral
So what forms the “Collateral” for the bank?
There are three basic areas;
File notes / details of conversation regarding the loan facility together with signed applications etc.
Letter of offer that details the terms and conditions of the loan / facility acknowledged by the borrower (s).
The Security, which can be one item or depending on the complexity of your structure can easily be multiple securities.
Why do banks take security? Simply, in case the bank was wrong.
Wrong about your character;
If you were committed to pay the bank back regardless of your circumstances, in an acceptable time frame, the bank would not need security, and if it had security, it would not foreclose in it.
Wrong about your capacity;
If you were no longer able to service your loans / facilities, but you were prepared to sell assets you have to satisfy the bank, in an acceptable time frame, the bank wouldn't have the need for security or to foreclose on it.
A combination of both.
The term collateral or security, is not as simple as the mortgage over a property. It is also about arranging the legalities of the security so that it is enforceable in need.
Think of security items such as “fixed and floating charges” or “deeds of subordination”. These often have very little or no value attached to them by the banks, so what’s the purpose?
They are control mechanisms that will give the bank certain powers over an array of business decisions. In effect these types of collateral are arguably more powerful than a mortgage over property. Understand the powers these documents wield before signing.