SECURITY FOR PERSONAL LENDING AND PERSONAL BORROWERS IN DIFFICULTIES

3.1 Bank Security

Security is a cover taken by a lender to cushion the institution from complete nonrecovery of a borrowing should the promised source of repayment fail to materialize of does not cover the full advance with interest.

When to take Security

  1. If loans are granted for the purchase of an asset, then, practicable the asset should be taken as security.
  2. Where the purpose of the advance is to acquire a specific asset, e.g., a home loan
  3. If it seems possible that repayment from an expected source is not forthcoming, and no viable alternative source of repayment can be seen, then security should be looked for.
  4. Security acts as collateral or as an additional cushion should the promised source
    of repayment fail to materialize in future.
  5. Where the risks and consequences of the expected source of repayment failing are such as to make it necessary to have a clearly defined and controlled alternative source.

3.2 Types of Security and Valuation

As tangible security for personal borrowing land and property, life policies or stocks and shares are used as security. Banks will not normally rely on 100% of the value of the security because values can fall, and accrued interest and realization costs can be high.
Bank security margins vary, but the following are typical of the maximum percentages they will lend against various form s of security.

  • Domestic land and property 80%
  • Life policies 95% of surrender
  • Investments 80% – 100%

Obviously much depends on volatility and the lender’s view of the market and in some cases the above figures would differ greatly. Common sense and a realistic view of the present economic situation are great aids in the valuation process. In many cases bankers
have been surprised at how security valuations can be eroded, particularly where a forced sale is necessary in tough market conditions. Needless to say regular revaluations of the security should be carried out, either professionally or by the bank manager (depending
on the asset and amount borrowed) at appropriate intervals.

Stocks and shares should be revalued quarterly (more often if the market shows signs of volatility), and property at least every three years. Life policies tend to increase in value each year as long as premiums are paid, so it is only necessary to obtain new surrender
values every five years or so.

If you are offered a second charge over property as security, a valuation of the property would first be carried out by the branch manager or, more likely a professional valuer. This valuation would then be reduce d by the margin stated above, and from the resulting figure the amounts outstanding on any prior mortgages would be reduce d to give the value of the security to the bank. At an early stage, you must confirm the amount owing to the first mortgage.

Why is a margin required?

  1. To cover any fall in value between the date of the advance and the sale of an asset. For a long term lending, the uncertainty of realizable value may be greater therefore a wider margin may be required.
  2. The costs of sale and other necessary costs relating to the need to keep the asset saleable, such as security, insurance and maintenance costs on a property
  3. The role up of interest since the last charging date.

3.3 Guarantees and Third Party Security

A guarantee is an agreement where one party agrees to be collaterally responsible for non payment of an advance by the borrower. The guarantor can take oath of personally meeting the repayments from personal income or by pledging personal assets. The guarantor undertakes that in the event the borrower fails to meet obligations under the contract, will be responsible for the miscarriage.
Bankers are reluctant to take guarantees as security for personal borrowing. If they do they must ensure that:

  • The guarantor fully understands the nature and extent of the liability – if an ‘all monies’ charge form is used the guarantor must be made aware of the implications of this clause.
  • The guarantor is given the opportunity to take or actually receives, independent legal advice, particularly if there is any chance of ‘undue influence’ being exerted – indeed, many banks now positively insist on independent legal advice being taken by all givers of third party security.
  • If security forms are to be signed at another branch, that the nature of the liability is fully explained.
  • Supporting tangible security is provided if you are relying on a large guarantee.
  • The wrongful trading provisions of the Insolvency Act 1986 are unlikely to apply.

Under these a director giving an unsupported guarantee for a company’s liabilities could later incur full liability for the company’ s debts to the detriment of the bank’s position if wrongly trading occurred. This would include continuing to trade knowing the company to e insolvent.

3.4 Problematic Accounts

The lender should take a sort of action when dealing with personal borrowers who get into difficulties. The following aspects should be considered:

  1. Identifying problem accounts
  2. Dealing with problem accounts
  3. Rescheduling a debt
  4. Recovery procedures
  5. Legal proceedings

The first step is to identify possible problem accounts.
Warning signs
Look for:

  • Account(s) are over limit or overdrawn without a limit.
  • Dishonour of cheques paid into the account (possible cross-firing)
  • Overdraft not repaid on time, or loan repayments delayed.
  • Previously dormant accounts e.g. salary credits.
  • Rising trend of overdrafts.
  • Mails returned marked ‘gone away’.

Do not jump to premature conclusions, however, or overreact where relatively small amounts are involved, but any of the above should prompt you to examine the situation more closely. If your investigations confirm that there are problems, what do you do net?
The second step is to take a sort of action

You should

  • Contact the customer to discuss the situation.
  • Return cheques and direct debits or recall standing orders (under advice to be customer, at least on the first occasion).
  • Cancel any unadvised (control) limit and replace with a low limit, so that the account will be referred earlier.
  • Ask for the return of cheque books and plastic cards and ensure they neither are nor renewed. If possible inhibit ATM withdrawals by ‘hot carding’, place on the counter reference lists.
  • Cancel any credit open arrangements.
  • Search with a Credit Reference Agency

The lender must avoid sending a steadily increasing number of threatening letters but then doing nothing. The persistent debtor will quickly become used to receiving them and will be logical for him/her to simply ignore them.

Telephone contact
Where letters are being ignored or more urgent contact with the customer is needed, contact by telephoning is the best course. General experience suggests that telephoning produces a better response than sending letters. The reason for this is obvious, on the
telephone there is the ability to have a two way contact which leads to a greater understanding of the customer’s problem and a commitment to do something about it. The telephone call should not be made in a haphazard manner. The objectives of the call
must be clear before the call is made. The objectives will usually be:

  1. To establish contact and check the customer’s address in case a previous letter has not been received and provides the basis for future action.
  2. To obtain a commitment to correct the overdraft, or rectify the position on a loan account, etc., or to establish a realistic repayment programme.
  3. If adjustment is not possible to establish why this is so
  4. To inform a customer of the consequences should he/she fail to meet the lender’s request. Great care should be taken to avoid accusations of harassment.
  5. To obtain an up to date picture of the customer’s general financial circumstances including details of employment, assets, liabilities, income and expenditure.

To achieve the above objectives good preparation is essential. A meaningful dialogue will not be possible if the facts of the customer’s situation become a matter of dispute. The lender must be in a position to answer any questions relating to the recent history of the account.

The third step is to reschedule the debt
The discussions with a customer may show that he or she will not be able to repay the borrowing as originally envisaged. The customer may request a longer period to pay and also suggest that the lender takes on other debts where creditors are pressing. If you have
to reschedule a customer’s borrowing, i.e. to increase a loan account, extend the loan period, reduce repayments, the bank’s exposure to risk is usually increased. Greater care should be taken here to:

  • Ascertain income and outgoing, future prospects and explore how the former may be increased or the latter reduced.
  • Enquire if moneys can be raised from family, friends or sale of assets in the short term.
  • Consider amalgamating bank borrowings and external liabilities in one amount over a longer term and/or at a lower rate of interest to reduce outgoings; if possible, security should be sought and the customer advised that this is a ‘last resort’ situation.
  • Take the borrowing on loan account and the current account kept in credit, even if itmeans canceling plastic cards. Carry out regular monitoring with a view to increase repayments as soon as the customer’s financial circumstances improve.
  • The forth step is to institute Recovery procedures

If all else fails and no agreement can be reached on repayments, then you must have formalized recovery procedures as legal proceedings may eventually be necessary and you do not wish to jeopardize your case by any irregular treatment of the debtor. Most
banks’ procedures are strictly laid down, with the aim being to return the initiative and obtain repayment of as much as possible at the least cost. After taking into account any mitigating circumstances actions must be instigated and carried out as threatened. For
example, the following steps must be followed before legal proceedings can be taken.

  • Check that security (if held) is complete and can be realized.
  • Make every effort to contact the customer, trying his/her last known place of work as well as his home address.
  • Try to visit him/her at home or work (if feasible) – to avoid allegations of ‘duress’, take a witness with you from the bank.
  • Make a formal demand by letter, or as specified in the Consumer Credit Act 1974 if the borrowing is regulated.
  • In appropriate cases, pass the matter to a tracing or debt collecting agency for a percentage of the amount collected, say 27% they will visit regularly and collect payment on behalf of the banks.

In view of the cost of the above, most banks will write off small bad debts without further ado. Each bank has its own internal instructions which you should refer to and follow closely.

Legal proceedings
If there is no response from the borrower to the action taken so far, then the following legal steps can be taken. Customers often respond at this stage, but beware of those who make repayment promises which they have no intention of keeping in order to delay
proceedings.

Solicitor’s letter
A solicitor writes on behalf of the bank giving two weeks to respond to avoid legal action. These can be expensive unless you have your own in house solicitor. Even so, they are cheaper than litigation and can be effective in focusing customers’ minds. Sworn statement of affairs A statement from the debtor under oath giving details of his financial affairs must be taken in the presence of a solicitor or commissioner for oaths. How ever this does not necessary mean that the debtor is telling the truth.

Mareva injunction
This is a court order freezing the debtor’s assets (if any), preventing their removal from the court’s jurisdiction, until judgment on the debt can be obtained.

Judgment
Your solicitor issues a default summons if the debtor does not respond to a letter of demand. The country court or High Court (as appropriate) will then issue judgment against the debtor for not responding to a formal demand for repayment. Judgments are
registered against the debtor with credit reference agencies, acting as a warning to future prospective lenders.

Installment order
A debtor can apply to court to repay a judgment debt by installments. The court will usually accept offers of very small amounts if the debtor is highly committed and on low pay, and the lender must accept whatever is offered.

Oral examination
This is a questioning by the court after judgment about the debtor’s financial circumstances. It can be useful in revealing the debtor’s previously unknown assets. Often the threat of this can persuade the debtor to offer repayments before the court hearing.

Enforcing the judgment
When judgment has been made in the bank’s favour, the bank can use various methods to recover the debt, depending on individual circumstances.

Attachment of earnings order.
This is a county court order to the debtor’s employer to deduct regular repayments from his wages or salary to be paid into court. This is only possible if the debtor continues in full time employment and his earnings exceed a minimum figure laid down by the court.

Charging order
This enables the bank to obtain an equitable charge over land or stock exchange investments held by the debtor. The bank cannot sell the asset, but if the debtor sells it, the bank will receive the proceeds, subject to any prior charges.
Receiver by way of equitable execution Similar to a charging order, but it covers assets a charging order cannot touch, for example, a life policy.

Garnishee order
This can attach funds owed by a third party to the debtor, and have them paid into court for the bank’s benefit. This is useful when the debtor is known to have savings elsewhere, which can be located and identified.

Levying execution
This is a court warrant enabling the bailiff or sheriff to seize the debtor’s good s and sell them to repay the debt. This is only useful where you are sure the goods are in the debtor’s name and not for example, bought on hire purchase.

Bankruptcy
This is a final step, but a dangerous course of action. It means that whatever assets can be realized go to benefit all creditors, unless the bank had taken security, which gives the bank priority over other creditors, or has taken steps to attach any identifiable assets
beforehand.

Insolvency proceedings are costly and bank tend to resort to them only in exceptional circumstances e.g. where they suspect a customer of dishonest or they consider there is a real risk that assets may be dissipated.

Voluntary arrangements
Under the Insolvency Act 1986, proposals for the partial settlement of debts, or payment over time, can be put to the creditors. Three quarters by value of the creditors must agree for such proposals to be sanctioned.

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