Collateralized stock loans give investors another mechanism to realize near-immediate liquidity from the unrestricted, publicly-traded stocks that are in their portfolios. In a typical stock loan, the investor will borrow a sum of cash that is a percentage of the value of the collateral stock that the investor will pledge to secure the loan. Most stock lenders will lend from 20% to 70% of the value of the stock. The final loan-to-value that a lender will offer will be a function of the fundamental financial strength of the issuer of the stock and the average daily trading volume of that stock.
Other than in very unique circumstances, a collateralized stock loan will generally be non-recourse in nature. If the borrower fails to repay the principal balance of the loan, the lender’s only remedy is to assume full ownership of the legal and equitable title to the stock that the borrower pledged as collateral. Per the terms of the loan agreement, the lender has no right or opportunity to pursue any of the borrower’s other assets to make up the difference between the value of the collateral as of the date of the borrower’s default and the principal balance of the loan. Thus, the lender takes substantial risks in making a collateralized stock loan, and the final loan-to-value ratio that the lender sets for the loan transaction is a reflection of the lender’s assessment of that risk.
Collateralized stock loans are preferred liquidity solutions that enable investors to retain an ownership interest in their stock without selling that stock in the open market. Higher-quality lenders will require investors to transfer collateral shares to a third-party custodian that will hold and manage the shares while the loan principal balance is due and outstanding. When the lender has received verification that the collateral shares are in a custodial account, it will then fund the principal balance of the loan.
Investors that hold substantial portions of an issuer's shares might prefer a collateralized stock loan over selling the shares because the sale of a large block of stock can depress share prices, particularly if the shares are thinly-traded. In addition, if the issuer declares a dividend while a loan is outstanding, the custodian will retain that dividend and deliver it to the borrower upon repayment of the principal balance. Thus the borrower can derive all benefits of owning the stock while enjoying the use of a portion of the stock's cash value.
Most collateralized stock loans are for terms of between one and five years. The borrower pays simple interest during the loan term and repays the loan principal balance on the loan maturity date. Alternately, the borrower can elect to retain the full principal balance, in which event the lender assumes full possession and ownership of the collateral stock and the transaction terminates with no further liability on the part of either party.
As with all transactions involving publicly-traded stock, a borrower should always consult his or her financial, legal, tax, and accounting advisors to understand the full implications of a stock loan and a potential default before engaging in a collateralized stock loan transaction. A stock loan lender will facilitate a transaction but will not make or provide any warranties or representations on how the transaction will affect the borrower’s financial profile.