The Decline in Collateral Value Will Further Complicate Corporate Financing

Although the first association with monetary tightening is more expensive financing, the increase in interest rates brings several other unwanted consequences. One of them is the decline in the value of collateral for loans. Namely, as interest rates rise, the value of long-term assets such as real estate and securities decreases because future cash flows are discounted at higher rates. The end result is even fewer opportunities for refinancing credit obligations. When the already tightened conditions of banks for approving loans are added to the equation in a situation of impending recession, the outcome is far from bright for companies that need to refinance old loans or take out new ones.

– In Croatia, loans are mostly secured by real estate. With the decrease in the value of these collaterals, companies may find themselves in trouble when taking out new loans, and depending on the agreements they have signed, also with existing ones. Banks, for example, may assess that the degree of collateral coverage is insufficient and condition the extension of credit lines on the request for additional collateral. If a company cannot offer new collateral, it may face a reduction or even cancellation of the available credit line.

This can be quite a blow to its liquidity. Some banks have introduced clauses allowing them to request additional collateral at any time, and although this is not a common occurrence, some contracts state that banks can even demand the return of the entire loan if the client cannot provide the necessary additional collateral – explained credit analyst Mario Kurtović, adding that the decline in collateral value is most evident in commercial real estate, such as factory facilities or hotels.

Contracts for loans in Croatia contain standard clauses under which the bank can, in the event of a decline in the value of collateral or if it loses legal prerequisites, request additional or substitute collateral, and in some cases even terminate the loan agreement, i.e., request its return, as confirmed to us by Erste Bank. However, they clarified that this happens extremely rarely in practice and only in extraordinary circumstances.

Tightened Standards

– In most cases, when such a situation occurs, the bank, in a partnership relationship and adequate communication with clients, finds a solution that satisfies both contractual parties – state Erste Bank.

For existing loans and credit lines, banks revise collaterals in accordance with regulatory requirements, usually on an annual basis, and besides the regular process and dynamics, valuation can also be conducted in situations when available information indicates that the value of collateral has decreased due to significant market changes.

– For credit institutions, the obligation to assess the value of real estate pledged to secure loan repayment is regulated by several regulations and guidelines. Thus, the Decision on the Classification of Placements and Off-Balance Sheet Obligations of Credit Institutions prescribes the obligation to assess the real estate that serves to secure loans if it is used for the purpose of calculating impairment of individual exposures. These provisions stipulate that during the contractual relationship, the credit institution is obliged to continuously monitor the value of the properties that serve as collateral for its exposures, and for commercial real estate at least once a year, and for residential real estate once every three years. The credit institution is obliged to monitor the value of the properties more frequently if market conditions are subject to significant changes – they said at the HNB.

Although banks do not explicitly state this, the standards for loan approvals have been significantly tightened due to increased uncertainty last year, and this trend has continued during the first half of this year.

– In the observed period, the tightening of standards was most influenced by the perception of risk, i.e., the deterioration of expectations regarding general economic trends, as well as the prospects of the industry or individual companies. Banks also pointed out the cost of funding sources and balance sheet constraints, as well as a lower risk tolerance level, especially at the beginning of this year, as factors contributing to the tightening of credit standards in this sector. For the third quarter of this year, banks expect the continuation of tightening credit approval standards at the same intensity as in the previous quarter – emphasized the HNB.

Such expectations clearly show that banks are already standardly trying to mitigate their risks in uncertain times, and pulling back and making loan approvals more difficult is a tool they resort to in such situations.

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