CandleFocus

Loan Stock

Candlefocus Editor
Loan stock is a form of equity security, typically a share in a publicly traded company, which is used as collateral to secure a loan. This practice enables the lender to protect their investment by obtaining a large portion of the issuer’s assets if the loan is not paid back. There are risks, however, associated with utilizing loan stock as collateral.

If the share price of the issuing company falls, so too does the value of the loan stock pledged as collateral. This could result in the lender not recovering full repayment of the loan, decreasing their return on the investment.

For the issuing company, having a loan stock exercised as collateral can become a problem if the loan defaults, or goes into default. This could result in the lender becoming a major stockholder of the issuing company, as by exercising the loan stock, the lender would become the owner of a large block of the company’s shares.

The Federal Reserve’s Primary Dealer Credit Facility (PDCF) enables major financial players to obtain overnight loans through the pledging of loan stock and other types of collateral. Just as with other lenders, the PDCF faces the same challenges and risks associated with loan stock as collateral.

Ultimately, the decision to use loan stock as collateral for a loan rests on the lenders’ willingness to accept the associated risks. Due diligence is key, as stock prices can increase or decrease quickly and unexpectedly, turning what appeared to be a good investment into a bad one.

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