CAMPARI PART VII – “I” is for INSURANCE

If you just joined the series, click here to read the Introduction to the CAMPARI framework.

In this final part of the assessment process, ‘insurance’ is much wider than the question, “Is the business or individual insured?” In the assessment context, insurance covers the issue as to what the Bank can look to for repayment if the lending doesn’t work out i.e. what security is being offered.

What Security Is Available or Being Offered?

For some business owners, this can often be the hardest part of the credit process to understand. The owner’s argument is that the business should stand on its own two feet and does not need security to back it up, especially if it has been demonstrated that the business will have no problem is servicing the debt. In theory this is fine but the Banks have to admit that no matter how good their credit assessment is, there are always going to be businesses which fail.

If, after closure of the business, there is clearly no hope of getting repaid, then the Bank has to have a fall back position to cover the debt and ensure that it suffers no financial loss and this is where security comes in.

Banks will not lend solely against security as a pawnbroker does. A pawnbroker has customers coming to him, bringing an item in against which he lends an appropriate amount. He does not concern himself with serviceability of the loan and whether the owner can afford to repay, he has the security to more than cover the debt.

The Bank, as we have seen, is more concerned with serviceability; it doesn’t want to sell a business premises or someone’s home if it can help it. The security is merely a back up if all goes wrong.

The Bank will not take just anything as security; it has to satisfy 3 criteria:

  • Easy to value
  • Easy to take a legal charge or mortgage over
  • Easy to liquidate if the business fails to pay up

If security is available then this is another strength when assessing the proposal. However, it is not considered as important as demonstrating serviceability. Security is a protection or an insurance policy and not the main reason for agreeing to lend money.

What is the Bank looking for as acceptable security? There are a number of different items, which can be taken as security, some being better than others.

 

Land / Real Estate

This is one of the most common forms of security offered. In Nigeria, this is the most acceptable. The deeds can either be in the name of the business itself, the personal name of the owner or even an unconnected 3rd party. Most owners have no problem in pledging business assets but it’s a different game when having to pledge personal assets such as a home. This can be a very contentious issue.

The Bank will look upon a house being given as security as a sign of commitment. You may look at it differently – it’s the family home and should not be risked under any circumstances. If the business is very well established and has a good trading record then the Bank will usually rely on business assets to support the borrowing but for younger enterprises, where the risk of failure is higher, you may be fighting a losing battle.

To establish the value the Bank will instruct a professional valuer to review the property. They will give two values for the property:

  • An open market value which is the figure likely to be achieved if sufficient time is given to sell
  • The second is a forced sale value, which is a figure likely to be achieved if the sale has to be quick.

 

Guarantees

If you are a sole trader, or in partnership, then you are personally responsible for your debts and that of the business. However, if you operate through a Limited Company, because it is a separate legal entity it is solely responsible for its debts and no one can look to the Directors for redress unless fraud is suspected.

As you will have learned so far, one of the key areas the Bank likes to see is evidence of commitment and if the bank is lending to a Limited company, it will always ask the Directors to enter into a personal guarantee. Basically a guarantee is a written promise by a third party stating that if the company defaults he or she will personally meet the liability.

 

Life Policies

Individuals take out life policies so that, in the event of death, a lump sum is paid out to their estate or a named beneficiary. From a business’ point of view this provision can be useful if a policy is taken out with the aim of helping the business if one of the key players dies.

For example, if a business is run by 2 people, one of them dying could leave too large a gap for the remaining partner to fill. The cash a life policy would pay out could be used to pay off Bank borrowing thereby taking pressure off the remaining partner. If the Bank sees that the successful operation of the business depends upon both of the Directors or partners, then it may take any available life polices as security or insist that a new policy is taken out. By taking the policies as security, in the event of death, the proceeds will automatically go to the Bank and then be used to reduce any borrowings.

In the case of sole traders, having a life policy as security can be important. A sole trader business relies on one person to run it. If he dies then the business effectively dies as well, leaving the family to clear up any debts. The Bank would not want to be exposed in this way and so having a life policy in place can avoid any potential risk.

 

Stocks and Shares

Share certificates for publicly quoted companies can be taken as security but they are not ideal because obviously the value can fluctuate. However, if deposited, they can be taken as a sign of faith but because of the possible fluctuations in the value, only 50% to 75% of the current value will be taken into account when calculating the overall value of security available to cover the borrowing.

 

As part of the CAMPARI mnemonic, it is appropriate that security, or “Insurance”, comes at the end of the assessment process because that is how it is viewed – security is realised or sold at the very end, after all possibilities have been explored, and only as the last resort.

Banks, as I mentioned, are not pawnbrokers, they will not lend money purely against a set of house deeds; serviceability is the key, being the ability to cover overdraft interest or loan repayments. The security taken is the protection if things don’t go to plan.

In pledging assets, whether personal or business, you must understand that security can get realised or sold off to pay debts which businesses have failed to pay. Don’t think that it will never happen, it can and it does. In offering assets as security, only pledge them on the understanding that the possibility you may lose them is very real. If you do fall into trouble there’s no point pleading to the Bank not to sell up; you are unlikely to get very far. The message is that you should pledge your assets with your eyes open.

To your success!

Olanrewaju Oniyitan






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