Banks Eye Intangible Assets as Collateral

Whatever it takes.

Faced with the imposition of stricter capital controls thanks to the excesses exposed by the financial crisis, banks are searching for ways to extend the asset base against which they will be measured.

The banking institutions are approaching this challenge with the same intelligence and creativity that they brought to the development of innovative financial products prior to the collapse. Which makes regulators, government officials and investors justifiably nervous. It was the introduction of increasingly complicated securities whose goal was to expand the leverage available in a capital constrained environment - and whose impact and implications were imperfectly understood - that triggered the crisis.

Intangibles, the business assets like brand, innovation and customer loyalty that drive business value but which have hitherto been largely ignored by financiers have long been ripe for more focused mainstream adoption. The unfortunate aspect of this latest development is that while it provides the respect these factors deserve, it does so as a means for evading controls imposed to stifle excessive risk taking. Should this undermining of the Basel III accords lead to another crisis, intangibles will be blamed and their adaptation further delayed.

That said, there is value in bringing this long overdue recognition to the field. We can only hope that the application to solving this particular problem will not unduly color further consideration of their value. JL

Brooke Masters reports in the Financial Times (hat tip Ken Jarboe):

Several US banks want to tap the value of the intellectual property holdings of their borrowers as a way of trimming their capital requirements, which are to be made tougher under Basel III rules.

Under the terms of many loans, banks have the right to seize a borrower’s patents and trademarks as part of a foreclosure proceeding. But these intangible assets cannot generally be counted towards the loan’s security for regulatory capital assets because they are considered too difficult to value.

Now some banks – faced with tougher safety rules that begin to take effect in January – are exploring whether they can use the assets to reduce their estimates of expected losses in case of a default, in turn reducing the risk weight of the loan and overall capital requirements.

The banks seek deals in which an insurer agrees to buy a borrower’s intellectual property – anything from a mobile phone patent to a logo or recipe – for a fixed price in case of default. That price could then be counted against the expected losses, in the same way the expected proceeds from a credit default swap can be used today.

The structure was given a boost by last year’s Nortel bankruptcy, where sale of the group’s wireless patents generated more than $4.5bn, five times the price originally offered by Google.

“There is now awareness that these types of assets are fungible and transferable,” said Adam Tepper, global head of corporate development at M.Cam, a US finance company that is working on a couple of proposed structures involving intellectual property.

“We’re giving the insurance companies a pathway to provide new capital to banks,” he said.

The discussions have got bogged down over the price banks would pay the insurers for the contract. The banks argue the price should be lower than for a CDS because there is an asset that changes hands.

But Mr Tepper said one US deal was close to being ready for submission to the US Federal Reserve for regulatory approval. The Fed declined to comment. Regulators in two other countries have not seen such deals, but they said approval might depend on whether the contracts qualify as tangible assets for accounting purposes.

If the structures fly, they could make it cheaper for banks to lend to tech and biotech groups and other start-ups that are valued for ideas more than physical assets. The model for using the value of intellectual property as collateral started as a way of making it easier for small businesses to get loans.

But Barbara Ridpath, chief executive of the International Centre for Financial Regulation, warned that such structures could prove problematic. “While this innovation appears to actually pledge something of real value, as in most innovation, it is not the first use that is worrisome, but rather the likelihood of lenders bounding into the product in such volumes that they distort the original value proposition of the product.”