CFI CBCA Loan Security Exam Questions With Complete Solutions.

Loan Security Learning Objectives - 01. Compare different types of security and assets used as security 02. Determine the security value of different assets based on MAST principles 03. Discuss the role of legal counsel and the importance of legal representation Security is a form of - insurance that is provided by the borrower. • No loan should be granted if the lender expects security will have to be enforced or realized. • Security is taken as a final safeguard in case of default. Manage the risk of a borrower defaulting on the loan: - -Assess sources of loan repayment -Assess security Types of security - Direct • Real estate • Machinery and equipment • Inventory Indirect • Personal guarantees • Corporate guarantees • Letters of comfort Direct security relates to - collateral that can be used to secure a loan. Two ways for a financial institution to secure its financing position using assets: -Fixed Charge: (Land, Buildings, Machinery) • Attaches to a specific item of the company's property.• The lender has legal right to the asset. • The charge fixes to the asset. Floating Charge: (Inventory, A/R, Marketable securities) • Attaches to a general class of assets. • Borrower can trade its assets during the ordinary course of business. • The charge would fix if there's an insolvency or a loan default. Two common ways to protect the lender with direct security: - Specific Collateral • Specific asset(s) • In the case of default, the lender takes ownership of the asset(s) General Security Agreement • All assets as a whole • In the case of default, the lender seizes the borrower's assets the most common form of indirect security. - A guarantee Here is a brief overview of three types of guarantees. - Limited guarantees Unlimited guarantees Personal • The guarantor is an individual. • The individual is personally responsible if the borrower is unable to repay the debt. • The lender has the right to pursue the guarantor's personal assets. Corporate • The guarantor is a company. • The company is responsible if the borrower is unable to repay the debt. • The companies are related through ownership.Joint & Several • There are multiple guarantors. • Any and all guarantors may be required to fulfill a borrower's debt obligation. • The lender may pursue any one of the guarantors for the full amount of the guarantee. Letter of Comfort: - It is a letter given by a third party (often the parent company) to help secure lending facilities for the borrower. It is a weaker form of reassurance because it is nonbinding and there is typically no recourse against the letter of comfort provider. Example wording: "The parent company will manage the business of the subsidiary (the borrower) in such a way as to meet its liabilities under the loan agreement." Assets Used as Security - Real Property Land • Immovable • Simple to establish and transfer legal title • Generally retains its value Buildings • Office buildings • Shopping centers • Hotels • Warehouses and factories Personal Property Personal property is any property other than real property. -Goods - -Inventory and equipment -Cash Instruments --Cash and money market securities -Chattel Paper - -Conditional sales contracts -Securities - -Bonds and equities -Intangibles - -Licenses and patents Evaluating Security It is important to evaluate the quality of assets to be used as security. Consider the following 4-point checklist when assessing potential collateral: - Marketable Ascertainable Stable Transferable Marketable Is there an active secondary market to sell the asset if needed? Ascertainable Is it easy to value the asset? Does the asset have a readily ascertainable price? Stable Does the asset's value change frequently or is it relatively stable? Transferrable Can the asset be easily transferred to a new owner? Evaluating the Quality of Accounts Receivable - -Customer base -Bad debt experience -Aging -Credit policies• Aged receivable list