Scotsman Guide - November 2008 Commercial Edition

Securing Funding with Securities
Stock loans and similar funding sources deliver brokers another lending vehicle
By Adrian Skiles, owner, Artice Funding

In your work as a commercial mortgage broker, you may have heard the terms “stock loan,” “stock-secured financing” and “securities-based lending.” These phrases all refer to lending programs in which borrowers pledge their securities — stocks, bonds, mutual funds or options — as loan collateral.

For mortgage brokers, these programs offer an alternative form of funding for clients. Brokers can earn income from the origination of these products either by collecting a referral fee from the lender or by collecting a fee from the borrower.

Typically, a broker or loan-origina-tor license is not required — these are, after all, not mortgages. Brokers should, however, check with their local authorities to ensure that they are in compliance with all requirements before offering these products.

When brokers begin to work with securities-based lending programs, there is plenty to know and learn.

to repay the principal at the end of the loan term, the lender’s only option is to keep the securities. Should a loan default occur, the loan is canceled, the borrower keeps the money received from the loan, and the lender keeps all interest in the securities. The loan default is not reported to any credit bureau or placed on public record.

The basics

To start, these loans are nonpurpose. The securities alone stand as collateral for the debt, and loan proceeds may be used for any purpose other than purchasing or carrying securities.

Interest rates for these programs usually fall between 3 percent and 5 percent. Also, loan-to-value ratios may be as much as 80 percent of the securities’ value. The liquidity of the securities on the open market determines the interest rate and the loan amount. Although there is no minimum or maximum loan amount, lenders typically like loans to be greater than $50,000.

Loan terms typically are between three years and 10 years with a fixed interest rate and interest-only payments due to the lender. The loans do not have closing costs, broker fees or transaction fees. Moreover, credit reports, income verification and employment verification are not required.

Application process

The loan application process is quite simple, and funding often occurs in just a few days.

To start, the borrowers supply the name and number of shares that they wish to pledge, along with the desired loan amount and term. The lender then conducts a preliminary examination of the request. Based on an assessment of risks, the lender will determine the loan-to-value ratio along with a proposed interest rate.

Once the borrower and lender agree on terms, the loan documents are drawn up and arrangements are made for the securities to be transferred to a holding company. The securities’ average closing price for three consecutive market days determines the final value assigned for loan purposes. This is called the “strike price.”

The borrower then transfers the ownership of the securities to the lender. The borrower retains all beneficial interests in the securities and will receive any dividends or interest that accrues.

At the end of the loan term, the loan may be renewed, refinanced or paid off. If the loan is appropriately paid in full, the pledged shares are returned to the borrower. It is, however, important to note that lockout provisions prohibit borrowers from making principal-reduction payments or paying off the loan early.

“These programs offer an alternative form of funding for
clients. Brokers can earn income from the origination of these
products either by collecting a referral fee from the
lender or by collecting a fee from the borrower.”
All securities not OK

Not all types of securities may be used as collateral. The securities must be able to be freely traded without restrictions, and borrowers must prove that they are not directors or executive officers and do not have more than a 10-percent stake in the company that issued the securities. Also, retirement funds such as 401(k)s and pension plans cannot be used.

Beyond that, these loans are non-recourse. If the borrower doesn’t make the interest payments when due or fails

■■ What is the company’s track record,
and can it offer client references?
The value effect

If the securities’ value falls below an agreed-upon minimum fair-market value (usually 70 percent to 80 percent of the loan amount) during the loan term, the loan is considered in default.

Adrian Skiles began his career in the mortgage business more than 20 years ago and is the author of the book Secrets of Mortgage Lending. Since 1997, he has owned his own mortgage firm, now called Artice Funding, in Atlanta, where he offers residential and commercial services. He is a long-time member of the National Association of Professional Mortgage Women and the National Association of Mortgage Brokers. Contact Skiles at (770) 888-8063, adrian@articefunding. com or www.articefunding.com.

In such cases, the loan contract may require borrowers to contribute additional shares or cash. The decision to move forward is solely up to the borrower. Remember, this type of lending is nonrecourse. Borrowers may simply stop making payments and walk away from the loan, thus forfeiting the collateral without additional punishment.

When evaluating securities-based lenders, mortgage brokers should help their clients answer the following questions:

■■ How long has the company been in
business?
■■ What are the company principals’
backgrounds?
■■ What assurances can the company
give that the full collateral will be re-
turned upon successful completion of
the loan term?

■■■■■

Borrowers with securities that qualify for this type of lending should be well-informed of the benefits and drawbacks. As with any major financial transaction, borrowers should consult with their tax adviser before entering any agreement that may have tax consequences.

Commercial mortgage brokers who work with these loans will soon realize that their clients can use funds for downpayments or the outright purchase of property. In that way, securities-based lending can lead brokers to additional avenues of income.