What Is Loan Stock?
Loan stock refers to shares of common or preferred stock that are used as collateral to secure a loan from another party. The loan earns a fixed interest rate, much like a standard loan, and can be secured or unsecured. A secured loan stock may also be called a convertible loan stock if the loan stock can be directly converted to common shares under specified conditions and with a predetermined conversion rate, as with an irredeemable convertible unsecured loan stock (ICULS).
Understanding Loan Stock
When loan stock is being used as collateral, the lender will find the highest value in shares of a business that are publicly traded and unrestricted; these shares are easier to sell if the borrower is unable to repay the loan. Lenders may maintain physical control of the shares until the borrower pays off the loan. At that time, the shares would be returned to the borrower, as they are no longer needed as collateral. This type of financing is also known as portfolio loan stock financing.
Risks to Lenders
Since the price of a share can fluctuate with market demand, the value of the stock used to secure a loan is not guaranteed over the long term. In situations where a stock loses value, the collateral associated with a loan may become insufficient to cover the outstanding amount. If the borrower defaults at that time, the lender may experience losses in the amount that is not covered by the current value of the shares being held.
Issuing Business Concerns Over Loan Stock
The issuing business of a stock used to secure a loan may have concerns regarding the outcome of the agreement. If the borrower defaults on the loan, the financial institution that issued the loan becomes the owner of the collateralized shares. By becoming a shareholder, the financial institution may obtain voting rights in regards to company affairs and becomes a partial owner of the business whose shares it possesses.
Loan Stock Businesses
There are full-fledged businesses that function solely by providing options for loan-stock transactions, allowing a portfolio holder to obtain financing based on the value of his securities, as well as other factors such as the implied volatility of their holdings and creditworthiness. A loan-to-value (LTV) ratio is established based on the portfolio, similar to how a home's value is assessed when securing a home mortgage, and the funds are backed by the security holdings in the borrower's portfolio.