What kinds of issues should wealthy families consider when raising funds for assets like listed stocks and other securities?
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If a family office’s assets include securities (for example, publicly traded stocks or bonds), it may wish to raise funds on those assets. What kinds of problems should he watch out for?
Securities can be used as collateral for a variety of financial products ranging from highly specialized margin loans to business type loans. The terms offered by lenders will depend on factors such as the jurisdiction of the issuer of the security and / or the account (if applicable) in which those securities are held, whether the transaction involves a portfolio of securities or securities issued by a single transmitter. and the type, listing and liquidity of the securities.
Margin loans are loans secured by listed securities, the funding available and the requirements for providing collateral to the lender (s) dependent on, among other things, the value of the securities and the facility with which the lender repaid in an execution scenario.
In our experience for both borrowers and lenders, areas of negotiation include the scope of recourse of the lender (s), level of restrictions on the business, pricing (including performance protection provisions ), collateral maintenance requirements, mandatory prepayment triggers (in particular, extraordinary events affecting the relevant securities), the rights of lenders to adjust terms and the extent to which the borrower is allowed to process the loan. guarantee (such as a guarantee of substitution or to receive an income). We have focused on some of these issues below.
Company remedies and restrictions
Is the borrower’s recourse limited? The recourse of the lender (s) for the loan may be (but not always) limited to the collateral for the loan. In addition to provisions to preserve the value of collateral, margin loans generally have limited restrictions on the borrower’s activities. This may be of interest to borrowers who have invested in securities. Often, securities are also held through special purpose entities holding unique assets.
Loan to value ratio
The loan-to-value ratio (the LTV ratio) measures the total amount of the loan (s) outstanding against the value of the collateral. There are a number of typical trading points about how the ratio is set, such as the value of securities determined on a particular day or based on a moving average? If the security is listed on different exchanges, which exchange is used to determine the price? Once the LTV ratio calculation is agreed, then there are usually a number of different levels set for different purposes.
First, there is the initial or maintenance LTV ratio, which requires the borrower to provide collateral of a minimum prescribed value for the loan drawdown.
Second, there is the LTV Reload or Margin Call Ratio so that if the value of the securities subsequently falls below a pre-agreed threshold, the lender may require the collateral to be completed by the borrower. transferring: (i) cash directly to the lender or to a secured account of the lender; or (ii) additional titles.
Third, if the value of the collateral exceeds a pre-agreed threshold, the borrower may be entitled to part of the collateral he has posted under a margin call, which may be in stock or in cash depending on that. which is agreed.
Fourth, there may be an additional level of the LTV ratio at which the collateral to support the original loan can be returned to the borrower.
The levels at which these triggers are set and the flexibility to provide / release both securities and cash are important to the borrower. It may also be important for the borrower to be able to voluntarily deposit additional collateral, for example to avoid sudden margin calls.
Mandatory prepayment, deleveraging events and adjustment events
Certain negative securities-related events will often be included as mandatory prepayment events. There can be significant negotiations around these, often depending on the nature of the security. When the security is volatile, for example if it is in emerging markets, the lender may want prepayment events to be triggered by sudden and large price drops. Likewise, the lender may wish to be prepaid if the relevant exchange is disrupted or if the volume of transactions decreases significantly. The borrower may wish to avoid certain events giving rise to an immediate right to prepayment by arguing that the relevant event should instead be a deleveraging event or an adjustment event.
In the event of a deleveraging event, instead of a right to be prepaid, the LTV ratio levels can be reset in a manner more favorable to the lender with the understanding that they will return to their original levels. whether the original deleveraging event is sufficiently reversed. In the case of an adjustment event, the relevant event, such as a takeover bid, or a merger event affecting the issuer of the relevant security can only be an early redemption event if changes cannot be made to the loan contract in order to preserve the original commercial positions of the parties.
Other borrower flexibility
The borrower may also wish to have the right to dispose of the securities concerned or to replace alternative securities, for example in the context of a portfolio transaction. Additionally, assuming the relevant LTV ratio is satisfied, it will want to be able to receive income from the security, such as dividends. There are usually negotiations around the above provisions.
Corporate style loans
In our experience, there is a wide variety of securities backed loans, ranging from margin loans to hybrid products to more corporate style loans. At one end of the spectrum, there might just be an initial LTV ratio test with no margin requirement. In this context, lenders will generally have full recourse to the borrower, a set of more extensive covenants aimed at preserving the value of the borrower’s assets and may also benefit from other credit supports (such as guarantees and / or collateral on other assets).
Sometimes a loan can be secured by a mix of liquid listed securities and illiquid private securities. Different considerations will come into play when the securities are illiquid and the loan terms start to look much more like a business type loan. The key, as always, is to provide an effective security package to the lender so that any discount on the value of the securities is limited and the maximum amount of funding can be raised. When private equity is a (sometimes large) minority interest in a joint venture vehicle, negotiations tend to be more complex, as the lenders and the joint venture partner focus on what would happen during the execution of the transaction. guarantee. Therefore, where possible, it is useful to allow for some flexibility to secure the shares when negotiating the terms of the joint venture.