It is easier to understand collateral value when your collateral is something like real estate. You receive an appraisal and calculate your loan-to-value.
When your loan is secured by business assets, this becomes a little more complicated. Accounts receivable, inventory, and equipment can fluctuate in value. This makes it harder to determine whether or not your loan is fully secured.
You should perform detailed collateral analysis as your borrowers’ request new loans, renew their lines of credit, or begin to fall behind on payments. Knowing the strength of your collateral is key to understanding your risk of loss.
Loan Policy on Collateral Values
Your financial institution should have a clear policy around collateral and loan-to-value (LTV) limits. For example, your policy may dictate that you can lend 75% of the value of commercial real estate.
With other assets, you may have filed a blanket lien covering all accounts, equipment, inventory, receivables, etc. In this case, your policy might dictate that you calculate the policy limit in one of two ways:
- A blanket limit when secured by “business assets” (say, 60% of the total value)
- Individual limits on each asset type
When calculating LTV under the second option, you will need to review each asset’s value that has been pledged as collateral. In this case, you’ll look at the accounts receivable and apply the appropriate percentage, the equipment and apply the appropriate percentage, and so forth.
The Borrower’s Balance Sheet
Your loan policy or the purpose of the loan may need you to value individual assets. For this, you will usually turn to the borrower’s balance sheet. Part of your loan agreement with the customer should require that you receive updated financial statements on a regular basis. This could be anything from annually to monthly.
After receiving the updated financial statements, you will input the data into a spreading software. Then you will analyze the borrower’s financial position. This analysis should include reviewing the balance sheet and any assets that have been pledged as collateral.
This is particularly important if you are renewing any loans for the borrower. If the assets of the borrower have lost a lot of value since the prior financial statement, you may be faced with one of the following:
- You cannot get a loan approved for renewal
- You will need to renew the loan at a lower amount.
- You will need to add additional collateral.
Depending on how you have secured your loans, you will either compare the collateral value to a single loan or compare the collateral value to multiple loans. You may also do a global analysis where you calculate LTV based on all loans secured by all collateral.
When determining if there is a collateral shortfall, it is important to look at the big picture. If your collateral has decreased in value, you may turn to other collateral securing that loan. What was once an abundance of caution that now provides actual loan support.
Make sure that you understand the relationships between your collateral and your loans. This is based not only on the security agreements but also on any language on the loan documents regarding cross-collateralization.
The Right Tools for Collateral Analysis
Having effective tools for evaluating collateral is critical for completing collateral analysis. For example, you can use tools that integrate the assets of your borrower’s financial statement into the overall collateral analysis. This will save you time in determining the value of your collateral.