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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So wrote Mark Twain when a prematurely published obituary was brought to his attention.
I attended a briefing on the economy and markets last week. Some of the content was good if gloomy (maybe realistic!).
However, one speaker blithely said that "the originate to distribute model is dead". I had to take him to task about this-the word I used was "superficial". No doubt one of his ancestors in the early 1720s was going around telling anyone who would listen that "the joint-stock company model is dead", in the aftermath of the South Sea Bubble.
The plain fact is that both the joint-stock company and securitisation are useful techniques which have advantages for many parties. The abuse of something does not negate the value of the thing itself. 3,000 people die in road accidents in the UK every year. So if we go back to 19th century transport and banking, we'll all be much better off. Won't we?
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It's not often I speak up in defence of big banks-what's the mission of Robin Hood Finance after all?-but the attitude of the government and the press to rate cuts is not, shall we say politely, very intelligent or considered. "Banks Fail to Pass On Rate Cuts" thunder the papers, and not only the red-tops.
The reality is that banks don't fund at base rate, but at deposit or wholesale rates. A quick look at The Times' best buy easy access accounts today shows rates from 4.5 to 6%. 3-month Sterling Libor, the commonest benchmark, closed last week at 3.38%. And that's if banks can get funding in this maturity. They would be delighted to have unlimited funding at 2%.
The real problem is not interest rates, but the availability to banks' customers of funding at any price. Banks are constricting lending where they can, which is individually rational, but collectively disastrous.
Small businesses are not concerned whether Base Rate is 3%, 2% or lower, but are very concerned about having enough funding to ensure their survival.
RHF is currently working on a project to help smaller/medium sized businesses by raising funds against their trade finance receivables. This looks like a virtuous circle of profitability and helping businesses and the economy. It is this sort of basic approach which is needed now.
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I worked for this bank with the strange name in the 1980s. Of course, it didn't manufacture anything, and wasn't based in Hanover. What brings it to mind is that fact that it was brought low over 20 years ago because of exposure to bad assets. ("Bad" has somehow become "toxic" over time). The bad assets in question were mainly South American sovereign debt. "Countries don't go bust" was the slogan at the time. True in a way-but if they don't pay their bills, the effect is the same.
So there were many billions of unloved, illiquid bonds weighing down banks' balance sheets. Sound familiar? One solution which proved successful was the Brady bond, named after the eponymous US Treasury Secretary. These came in many forms, but often had their principal guaranteed via zero-coupon government bonds.
Sir James Crosby's government-commissioned report, published yesterday, recommends that mortgage-backed securities should be covered by government guarantees. Would not the proven Brady structure, where risk is shared, be a better bet?
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I have received a headhunter's email. They are looking for a Head of Research for Commercial Mortgage Backed Securities. Amongst the requirements are a PhD and 15 years of research experience, plus a load of stuff about publishing, publishing...
This would be understandable if the headhunter were trying to fill an academic post. But this is a commercial organisation. Why not ask applicants to submit their research in this area over the last five years, and compare it to what actually happened?
Even after all we’ve seen in the markets, people are still going down the “more of the same” path. It’s a bit like those Englishmen abroad who think they just have to shout louder if the foreigner doesn’t understand.
PhD? LTCM did much better than that-they were brought down by the work of two Nobel laureates they had on the Board.
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