Why Property is Poor SecurityWhy is this? My own view is that we’re in the realms of psychology: houses and other buildings are literally tangible, and give a feeling of solidity and security. But buildings are also illiquid in all senses of the word. The weaknesses of property as a banking asset are that it is long term; and produces little cash flow (i.e. relies on a sale or refinancing). My proposal is that lending against cashflow assets rather than property is more solid, and more likely to be “fit for purpose” in the current environment.
Let’s assume two banks lending to an SME. Bank A has a term loan secured on the company’s buildings. Bank B provides money via factoring/trade receivables financing or similar, in other words against the SME’s trade debtors. Which is preferable?
Experience has shown that firms, in this case the SME’s debtors, will pay their suppliers first, otherwise they might be out of business fairly quickly. After this, if the SME is having trouble paying the bank loan, the directors would approach the bank with a re-scheduling proposal. Any sensible bank (although some would say that that is an oxymoron these days!) does not want to crystallise a loss, plus the hassle of enforcement, sale of a property into a falling market and bankruptcy of the SME if it thinks that it can get paid over time.
Lending backed by property is superficially seductive, but lending backed by shorter-term assets such as trade debtors is more solid. This is illustrated to some extent in the world of securitisation: as far as I have been able to ascertain, no trade receivables bond has ever been downgraded except due to counterparty risk, such as downgrade of a swap provider. The same cannot, unfortunately, be said for property-backed bonds.
The conclusion is that we need to monetise shorter-term assets such as trade receivables and trade finance receivables. This will get money to firms which desperately need it; and give investors a high-quality and stable asset.
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