119. Collateral Loans

A collateral loan is one which is secured by property having marketable value, deposited with the lender. Collaterals fall under three grand divisions: (1) Stocks and bonds; (2) Real estate and (3) Miscellaneous collateral. New York City banks and especially those located in the financial district, loan large sums of money on stocks and bonds. This security is of the very highest grade, because its market value is known absolutely from the time the loan is made until it is paid. There is always a market for the security. These Wall Street loans are made on time, demand or call.

Wall Street call loans are loans made to brokers on good security and are so named because the bank reserves and exercises the right to request the payment of the loan at its own pleasure. The broker reserves and exercises the right to pay the loan at his pleasure.

A loan on mixed collateral is more desirable than a loan on one kind of stock or bond, for if the bank is compelled to sell the securities it will receive better returns on the collateral if it can sell small lots of several securities than a large block of one security. In the same way a loan of $45,000 on one thousand shares of United States Steel Common at 55, having an approximate value of $55,000 would be a better loan than a loan of a like amount on eighty-two shares of Standard Oil at 670 having a market value of approximately the same amount. If the market should suffer a reversion and Steel dropped to 54, the loan would still be margined by 20 per cent and the whole of the security could be sold, if necessary, for more than enough to pay the loan. In the same time that Steel dropped one point, Standard Oil would have fallen ten points or more and the security worth as much as the Steel, when the loan was made, would be worth but $54,120, a margin of only 18 per cent. If an attempt were made to sell the stock, it would probably decline still further and might result in a loss.

Quoting from Kirkbride and Sterrett's book on "The Modern Trust Company" p. 81:

The amount of margin which is required varies with the sort of collateral. Thus, it is perfectly safe to loan very nearly the full market value of government bonds, and of most state and municipal securities. First mortgage railroad bonds can also be taken at a higher valuation than stock and other securities readily marketable, perhaps, but of less certain value. If the collateral is composed entirely of speculative stocks, a sudden break in the market may in a few hours - and before there is an opportunity to sell - turn a comfortable margin into an actual loss. In figuring margins it is important to bear in mind that in times of contraction in values, when securities are selling at a low level, a margin may be safe which in times of inflation and prosperity, when high records are being made, would be entirely insufficient to assure safety. In the former case, prices will probably stay within a moderately narrow range, while in the latter a sudden large shrinkage may occur.

In New York two tests are applied to a collateral loan, the first requiring that the value of the securities must have a margin equal to 20 per cent above the amount of the loan, and the second, that the loan must have ten points margin, that is, that the amount loaned must be $10 per share less than the market price of the stock. This is reckoned by dividing the number of shares of stock (or if bonds, $10,000 are equivalent to one hundred shares of stock) into the margin. For example, if there were 2,000 shares of mixed stocks in a loan of $100,000 divide this number of shares into $20,000 (the 20 per cent margin), and the result shows an average margin of ten points on each share held. If the ten point rule is strictly adhered to, it has the effect of discriminating against low-priced, non-dividend-paying stocks, while the 20 per cent clause requires an ample margin on high-priced stocks. There are few institutions in New York which require nearly fifteen points with the 20 per cent margin, and some which do not adhere strictly to the ten point requirement. Outside of New York, the ten point test is not often applied, the usual requirements being simply 20 per cent margin on good mixed collaterals.