MGT601 SME MANAGEMENT

Lesson 23 Types of Collaterals/Guarantees / Assets and Pledge Techniques for Security

Chapter Learning Objectives This lecture deals with the types of collaterals /guarantees/assets and pledge techniques for security.

Collateral  In lending agreements, Collateral is a borrower's pledge of specific property to a lender, to secure repayment of a loan.  The collateral serves as protection for a lender against a borrower's default.

Collateral…. If a borrower does default on a loan (due to insolvency or other event), that borrower forfeits (gives up) the property pledged as collateral - and the lender then becomes the owner of the collateral.

Concept of Collateral  Collateral, especially within banking, may traditionally refer to secured lending (also known as asset-based lending).  In many developing countries, the use of collateral is the main way to secure bank financing.  The ease of acquiring a loan depends on the ability to use assets such as real estate as collateral.

Guarantee  Guaranty, in finance, is a promise by one party (the guarantor) to assume responsibility for the debt obligation of a borrower if that borrower defaults.  The person or company that provides this promise, is also known as a surety or guarantor.

Collateral/Surety/Guarantee  The terms collateral and surety really mean the same thing.  They are guarantees you give to lenders by pledging assets, which they can seize and sell off, if you do not payback the loan.  There are other forms of guarantees that can secure a loan, such as an insurance policy to the benefit of the lender, or an understanding by a third party to repay the loan, should default.

Typical Collateral  Land and buildings: first, second mortgages, debentures on property;  Other fixed assets: charges, debentures on machinery, equipment, vehicles;  Share certificates in the borrowing company;  Guarantees from banks, other institutions, export credit guarantee and insurance schemes, third parties;

Continued….  Cash; Receivables: invoices, bills, promissory notes;  Stocks or inventories of finished goods, commodities, warehouse receipts;  Raw materials;  Investments, marketable securities.

Negotiating for Short Term Credit  Negotiating with a lender (who should be ready in principle to grant you a short- term facility) relies more on how well you are prepared than on any particular bargaining skill.  A good knowledge of your business and a sound grasp of all the facts and figures on your results, current situation and prospects are the most convincing arguments you can put forward.

Continued…..  Lenders aim to get a good rate of interest on their money at a little risk.  They will probably prefer the types of facilities and payment methods that their staffs are most familiar with, and which do not present too much back office effort or time.  As their time is precious, lenders will try to obtain fees for services rendered

Continued…..  Negotiations should benefit both the parties and each must come away feeling satisfied with the outcome.  The relationship will perhaps develop into a long-term one, with the bank growing to appreciate and trust you as transactions develop and your business expands.  Bankers are also keen to keep good customers.

Continued…  In foreign trading, it is virtually impossible to avoid the banking system if you are an exporter or an importer.  Most payment methods require a third party to hold money or documents in trust until an obligation is satisfied.

Continued…  Seek the bank’s advice on the different methods of payments and credit facilities available.  Don’t stop at the list given in the bank’s brochure or leaflet.  Explore all the possibilities, but remember that your banker will be more knowledgeable than you are about the risks, advantages and drawbacks of each system

Checklist for Commission Fees and Charges  Appraisal Fee (Or Front-End Fee): Percentage of total facility paid up front, often as a deduction from principal disbursed. Amount varies from one institution to another.  Commitment Fee, Interest Rate Per annum on Un-Disbursed Portion of Facility. This is often waived. Rate usually varies from ½% and 1%.

Continued…  Interest on Outstanding Principal, Overdrafts Expressed as a Per Annum Rate. Rate may reflect lender’s assessment of risk. Low rates may be available through incentive schemes for exporters or for development components considered for special economic benefit to the country.

Continued  Legal Costs and Charges Expenses incurred in preparing the legal documentation and drawing up charges, debentures. Mortgage fee 1% of the mortgage value, 1 % of the sum ensured, stamp 1% of the value, registration fee 2% of the mortgage value.

Continued…  Revenue Office Fee: Disbursement fees. Amount charged by the lender as a flat fee at each disbursement if there is more than one.  Charges for Payment Facilities, Services: Fees and commission charged for opening and confirming L/Cs, collection and other sundry services rendered by the banks.  Discount Rates: Percentage taken by the bank for discounting receivables

Improving Your Negotiating Position  “Be a good player” is the first and foremost rule.  Build up your reputation as someone who always pays on the dot. Be particularly careful to honor interest payments on time.  Interest payments are the bank’s revenue and affect its operating results.

Conclusion  Finally, always keep in mind the purpose of borrowing. To survive in the business, you have to be competitive, which means in minimizing costs and overheads. If you borrow, it must always be the better alternative to not borrowing, and this can only be so if the terms and conditions are right.

Thanks you Happy Learning, Keep Learning