Challenges for Businesses to Get Better LTV for LAP
Borrowing and lending are common terms used in business and have been very useful in defining the activities of the parties involved. The lender will ask the borrower to make some commitment as security for the kind of help to be offered, which in most cases is usually in monetary form. This security defines what in business terms is widely known as collateral for money given out as loan. Some people or even businesses use property as collateralwhen borrowing money hence the term Loan Against Property (LAP). With LAP comes what is called loan to-value ratio (LTV),which ideally is the risk evaluation done prior to lending by banks and other financial institutions. This ratio determines the willingness of the lender to award the loan or not. For instance, an LAP of Rs. 240,000 against a property worth Rs.300,000 will have a LTV ratio of 80 percent.
A higher LTV ratio is considered to be a higher risk and therefore would be costly to the borrower. More over, a loan that is deemed to have a high LTV ration would warrant the purchasing of a mortgage insurance in order to offset the risk to the institution issuing the loan. So, what are some of the challenges that hinder businesses from getting a better LTV for LAP? From the definitions and elaborations made above, it is pretty obvious but here is a detailed look into what actually are the challenges: -
1. The Weakness of the LAP Segment - In this type of borrowing, the property is used as collateral in the event of a default. Conventionally, loans are usually given based on cash flows of the business and not entirely on the collateral value. The lack of a strong framework and resilience in this LAP segment presents a high risk that attracts high costs of borrowing. Putting together the prices of stagnant properties particularly in large cities and squeezing on re-funding as a result of risk aversion experienced with some financial institutions is adding stress to businesses.
Technology has helped many financial institutions like Borro in UK - U.S. to give out loans of this nature to potential clients
but hasn’t been embraced by various other organizations. Usually, banks lend up to 75-80 percent of the property value. However, businesses in UK are missing out on LAP following a slow lending pace. On its part, Borrogives secured property - backed loans between Rs.415,700 - 415.7 million with in a day.
2.Uncertainty about Delinquency- a study by India Ratings & Research agency (Ind Ra) in the ecent past shows that all loans regardless of the year when they were issued have continued to experience a high level of delinquency last year, 2016. While this is a problem, there is no sufficient statistical analysis between LTV and delinquency rates hence businesses may suffer huge pay back costs following their borrowing.
3. Shrinking Yields & High Credit Costs - initially, high yields in the LAP sector and very low credit costs provided a high risk adjusted return. This attracted quite a number of in experienced players in the market. However, increasing competition has pulled away the yields while increasing the costs of credit.
4. Dwindling Risk Mitigation Practices- there has been a need to expand loan portfolio in the wake of intense competition. This has watered down the use of risk mitigation measures. Commercial and industrial properties are now being accepted as collaterals. The proportion may reach a high of 30 percent of the portfolio for some. In this scenario, the LTV is usually low. However, realizing the liquidation is also low hence making the recovering process an issue. As a result, lenders may shy away from issuing LAP to businesses or instead increase their LTV prior to issuing the loan.
5. The Valuation Process - Prior to the issuance of a loan, the process of valuation should be conducted. In this case, it is normally outsourced to property valuation companies. There are no standardized methods yet and the real estate industry doesn’t seem to have sufficient depth. Coupled with secondary sales, the industry takes into account a lot of subjectivity. From research, it has been found out that property value tends to fluctuate greatly and changes may take place suddenly. That way, tracking the prices of collaterals on a continual basis is a costly and challenging affair and the lag experienced in price movement data can create some problems.
The LAP Segment for Businesses
All these challenges cut across borrowing by all businesses but the loans are given in different categories. Each institution has its own internal LTV limit for LAP. Tabulated below is a guide of some of the already determined supervisory limits that cannot be exceeded.
It is all about the risks involved as they tend to affect borrowing as dictated by the costs that apply. The constraints due to the absence of infrastructure for direct loans sourcing have prompted the need to build scale in the LAP sector through the use of third party intermediaries. This type of loan sourcing may have moral hazard effects to businesses and could influence credit assessment.
The lender will ask the borrower to make some commitment as security for the kind of help to be offered, which in most cases is usually in monetary form. This security defines what in business terms is widely known as collateral for money given out as loan
2.Uncertainty about Delinquency- a study by India Ratings & Research agency (Ind Ra) in the ecent past shows that all loans regardless of the year when they were issued have continued to experience a high level of delinquency last year, 2016. While this is a problem, there is no sufficient statistical analysis between LTV and delinquency rates hence businesses may suffer huge pay back costs following their borrowing.
3. Shrinking Yields & High Credit Costs - initially, high yields in the LAP sector and very low credit costs provided a high risk adjusted return. This attracted quite a number of in experienced players in the market. However, increasing competition has pulled away the yields while increasing the costs of credit.
4. Dwindling Risk Mitigation Practices- there has been a need to expand loan portfolio in the wake of intense competition. This has watered down the use of risk mitigation measures. Commercial and industrial properties are now being accepted as collaterals. The proportion may reach a high of 30 percent of the portfolio for some. In this scenario, the LTV is usually low. However, realizing the liquidation is also low hence making the recovering process an issue. As a result, lenders may shy away from issuing LAP to businesses or instead increase their LTV prior to issuing the loan.
5. The Valuation Process - Prior to the issuance of a loan, the process of valuation should be conducted. In this case, it is normally outsourced to property valuation companies. There are no standardized methods yet and the real estate industry doesn’t seem to have sufficient depth. Coupled with secondary sales, the industry takes into account a lot of subjectivity. From research, it has been found out that property value tends to fluctuate greatly and changes may take place suddenly. That way, tracking the prices of collaterals on a continual basis is a costly and challenging affair and the lag experienced in price movement data can create some problems.
The LAP Segment for Businesses
All these challenges cut across borrowing by all businesses but the loans are given in different categories. Each institution has its own internal LTV limit for LAP. Tabulated below is a guide of some of the already determined supervisory limits that cannot be exceeded.
It is all about the risks involved as they tend to affect borrowing as dictated by the costs that apply. The constraints due to the absence of infrastructure for direct loans sourcing have prompted the need to build scale in the LAP sector through the use of third party intermediaries. This type of loan sourcing may have moral hazard effects to businesses and could influence credit assessment.
