Collateral for business loans has always been the same: generally, hard assets that are worth greater than the loan amount. But, the hard assets of yesterday … or of yester-century, do not maintain their values as they once did for the time periods they once could. Office equipment, inventory, technologies, IP- they all become outdated or obsolete so rapidly, and are easily replaceable at cheaper and cheaper prices, or better and with better and cheaper technologies, such that collateral does not hold up.
Even in the case of IP, it becomes outdated quickly by newer innovations, and, when it’s not outdated, capitalizing on IP is so expensive as competitive IP from competitive companies that are growing larger and larger, that it’s hard for a lender to know what security it really has. For example, a borrower-company may have IP for a home improvement product or service. In today’s market, if Home Depot or Lowe’s doesn’t buy the product or promote the service, or if they have their own version of it, the IP will be difficult to monetize, as less and less independent hardware stores remain in our communities, and launching a product without big box retail support is so expensive and difficult, even online.
Even office products, trucks, and computers, all, seemingly, obviously needed by businesses, can be bought online everywhere from all the small businesses failing due competition from the Internet, from foreign exporters that provide cheaper versions, and from companies moving to shared work spaces, where the office provides all the equipment. Even office space itself is less predictable in terms of obsolescence. There is so much of it that is vacant. As for trucks used by businesses, they may be about to be, somewhat, challenged by self-driving trucks, making existing models slower, and more costly, and less desired than modern versions. This won’t happen soon, perhaps, but its exemplifies how rapid technological change cause all assets to be unpredictable as loan security.
Inventory is marked down rapidly and considered to be “aged” is super-digital time. Consumers want new and fresh, and excess discounted products are everywhere- and the best of it that people want are at the largest discount retailers, like TJMaxx and Ross Stores, and can be found online at EBAY, causing UCC liquidation sales and auctions to be as outdated as brick and mortar retail, itself.
Manufacturing equipment is rendered obsolete by changes in technology as well as by policies related to taxes and trade. Capex affects present equipment, and location of manufacturing affects values.
While collateral almost always goes down in value in downturns, it’s not always a downturn that leads to a default, and a lender should be adequately secured. Regardless, hard assets have never become obsolete so rapidly in our history, as is now happening.
The best collateral is assignments of receivables. It’s the only, reasonably, determinable value in a digital and fast-changing world (of course, the obligor or counterparty on such receivables has to be a solid debtor, or else the value of that payable is also challenged).
Real estate is also a great option for collateral for a bank, but not all small businesses- or businesses, in general, own real property. Moreover, this fast-moving world has even made real estate – retail and office- obsolete. In any event, real estate, in general, is at a very high price and priced at high valuations. Any loans made now that pay a portion of present value based on a determined loan-to-value ratio may not recoup such value upon default in an economic downturn.
Another concern for banks is that because of hard money lending (or “non-traditional” lending), banks could see their security (real property or otherwise) severally damaged by that hard money unknown. Non-traditional lenders (due to low interest rates and institutional search for yield) have seen unprecedented growth in recent years and have unprecedented influence on credit markets- perhaps, ultimately, a bad influence. While banks are forced to use lending standards and guidelines, hard money is not. Hard money that has helped elevate asset values, may be skewing present values unduly upward. And how will hard money react when it has defaults? Do these lenders have the internal systems, and default management skills, security enforcement procedures, foreclosure experience, and capital reserves to withstand defaults, while continuing to operate? Or will they cut and run, and flood the market with equipment and properties, and cause prices on similar assets to crater?
So, banks and lenders have concerns- but for banks, other kinds of lenders are part of their concerns- or should be.
Banks and lenders need to be more careful and thoughtful than ever when making loans to businesses. Business and technology changes rapidly these days- and so does the value of collateral. Also, there are non-traditional lenders in the markets with lower lending standards and less experience in holding loans for the long term.
Systemic risk could be hiding, not in loans to bad borrowers, but in loans secured by bad collateral rendered obsolete by a rapidly changing world, or collateral negatively affected by bubbles and crashes due to inexperienced and under-capitalized lenders.
While all of us deal with the unknown and rapidly changing technologies that change products and industries so fast, which provides economic risk- for banks, it provides systemic risk.
Earlier in the century, weak borrowers and over priced assets caused risks to banks- ones that materialized. The secret risks for banks and lenders today is: (a) rapid change that is occurring with historically unprecedented speed that makes collateral outdated and obsolete, in combination with (b) inexperienced and un-seasoned excess, hard liquidity bidding-up asset prices. And the national nature of our financial system, just like last time, makes these risks- risks to us all.
Banks, due to Dodd Frank, have good liquidity. But, rising interest rates, and even a steeper yield curve, while good for banks, are not good for hard money lenders, which borrow low and loan high, because the “high” will become too high to make any sense for most borrowers. At low rates, a hard money loan can make sense, especially as the lower rates cause higher asset values, because hard money can make an acceptable spread with acceptable risk. While hard money is often financed by loans they take from banks, another way that hard money lenders get capitalized is with investor equity. But equity investors will seek fairly balanced risk-rewards, and as rates rise, can find it in sovereign (mostly, U.S.) treasury bonds, or even in cash equivalents. They may reject the risks that come with hard money loans. Plus, rising interest rates can, simply, make this equity less available. What this means for the rest of us is that less capital for businesses and real estate will be available- at reasonable rates, at least. Markets could be surprisingly affected by significantly less liquidity from non-traditional lenders as rates rise. The fact is, no one really knows what assets are funded by traditional vs. non-tradition capital.
Neil S. Siskind, Esq., President
The Siskind Law Firm
Neil Siskind is the Founder & Chairman of The Fatherhood Assignment
Learn more at: http://www.neil-siskind-the-fatherhood-assignment.org/
Neil Siskind is the Conservator of the Neil S. Siskind Nature Preserve
The Neil S. Siskind Nature Preserve is over 7 acres of environmentally-pristine waterfront land in a magnificent setting along New York’s majestic Hudson River. The Preserve includes a variety of species of animal and plant life, and is a precious example of the thoughtful maintenance of New York’s priceless open spaces. The land’s uses are limited to outdoor recreation such as hiking and climbing, and the study of ecology, nature and land use. The Neil S. Siskind Nature Preserve allows for the intelligent contemplation of our valuable natural resources and the most effective ways to maximize them and keep them protected.
Neil Siskind, Founder, “National Fatherhood Day” – March 29th
To encourage recognition of the needs of boys and girls who are living without fathers or father-figures in their lives.
Read about the non-profits and charities whose missions Neil Siskind supports and promotes: www.neilsiskindsupports.com
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Neil Siskind’s Volunteer Work:
– Memorial Sloan Kettering Cancer Center, Volunteer
– Memorial Sloan Kettering Cancer Center, My Fundraiser- Help Neil Siskindhelp children with cancer to be more comfortable: http://mskcc.convio.net/site/TR?px=3182108&fr_id=2632&pg=personal
– Make-A Wish Foundation- Help Neil Siskind make sick children’s wishes come true by creating your own fundraiser: Neil-Siskind/Help-Make-A-Child-Smile.htm
– DonorsChoose.org- Donate to one of my needy public classrooms: http://www.donorschoose.org/NeilSiskindGiving
– Champion Children– We seek to inspire people through stories of children who have overcome challenges: http://siskindlawfirm.com/neil-siskind-champion-children/
Neil Siskind’s Pro Bono Work:
– Saving Senior Citizens- Protecting New York’s senior citizens from fraud and financial abuse www.savingseniorcitizens.com
– Senior FreeStart Business– Pro Bono: We seek to help put senior citizens in the right direction so that they can face the challenges of the modern economy: http://siskindlawfirm.com/free-start-business/
– Veteran FreeStart Business– Pro Bono: We seek to help put Iraq and Afghanistan war veterans in the right direction so that they can face the challenges of the modern economy: http://siskindlawfirm.com/free-start-business/
– In development: The Neil S. Siskind School of Hope: A free school to teach inner-city youths the skills of entrepreneurship and importance of economic self-sufficiency.
Neil Siskind’s Government Work:
– Suffolk County District Attorney’s Office, Boston, MA, 1994, Intern
– Office of Senator Christopher J. Dodd, Newington, CT, 1992, Intern
– Hartford County Department of Probation, Hartford, CT, 1991, Intern
Neil Siskind’s Community Assistance:
Financed & operated a legal clinic providing low-cost legal services to struggling Long Islanders during the recession to help clients resolve debt, organize finances, and launch new businesses.
Neil Siskind’s Professional Curriculum Vitae: http://neilsiskind.com/
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