Family Office
Borrowing Against Securities - What Family Offices Should Consider
What sort of issues should wealthy families consider in raising finance against assets such as listed equities and other securities?
The following article, which comes from the law firm,
Squire
Patton Boggs, is part of its Family Office Insights series.
This article is republished with permission. The editors of this
news service are pleased to share these insights and invite
readers to respond. The usual editorial disclaimers apply to
articles from outside organisations. To comment, email tom.burroughes@wealthbriefing.com
and jackie.bennion@clearviewpublishing.com
If the assets of a family office include securities (e.g.,
publicly listed shares or bonds), it may wish to raise finance
against those assets. What kinds of issues should it watch out
for?
Securities may be used as collateral for various finance products
ranging from highly specialist margin loans to corporate style
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 any) in which such securities are held, whether the
transaction involves a portfolio of securities or securities
issued by a single issuer and the type, listing and liquidity of
the securities.
Margin loans
Margin loans are loans collateralized by listed securities, with
the available funding and the requirements relating to the
provision of collateral to the lender(s) depending, among other
things, on the value of the securities and how easy it is for the
lender to get repaid in an enforcement scenario.
In our experience acting for both borrowers and lenders, the
areas of negotiation include the extent of recourse of the
lender(s), the level of restrictions on the business, pricing
(including any yield protection provisions), collateral
maintenance requirements, mandatory prepayment triggers (in
particular, extraordinary events affecting the relevant
securities), lenders’ rights to adjust terms and the extent to
which the borrower is allowed to deal with the collateral (such
as substitute collateral or receive income). We have focused on
some of these issues below.
Recourse and restrictions on the business
Is the recourse to the borrower limited? The recourse of the
lender(s) for the loan may be (but is not always) limited to the
collateral for the loan. Apart from provisions aimed at
preserving the value of the collateral, margin style loans
usually include limited restrictions on the activities of the
borrower. This can be attractive to borrowers with investments in
securities. Often the securities are also held through single
asset-owning special purpose vehicles.
Loan to value ratio
The loan to value ratio (the LTV Ratio) measures the aggregate
amount of the outstanding loan(s) to the value of the collateral.
There are a number of typical negotiating points on how the ratio
is set, such as is the value of the securities determined on a
particular day or based on a rolling average? If the security is
listed on different exchanges, which exchange is used to
determine the price? Once the calculation of the LTV Ratio is
agreed, there is then typically a number of different levels set
for different purposes.
Firstly, there is the Initial or Maintenance LTV Ratio, which
requires the borrower to provide collateral of a prescribed
minimum value for the drawdown of loans.
Secondly, there is the Top-Up or Margin Call LTV Ratio so that if
the value of the securities subsequently falls below a pre-agreed
threshold, the lender may require the collateral to be topped up
by the borrower transferring: (i) cash directly to the lender or
to a secured account of the lender; or (ii) additional
securities.
Thirdly, if the collateral value increases above a pre-agreed
threshold, the borrower may be entitled to have a portion of the
collateral it has posted pursuant to a margin call released to
it, which may be shares or cash depending on what is agreed.
Fourthly, there may be a further level of the LTV Ratio at which
collateral to support the initial loan may be returned to the
borrower.
The levels at which such triggers are set and the flexibility to
provide/release both securities and cash are important to the
borrower. It may also be important to the borrower to be able to
voluntarily post additional collateral, e.g., to avoid sudden
margin calls.
Mandatory prepayment, deleveraging events and adjustment
events
Certain negative events that relate to the securities will often
be included as mandatory prepayment events. There can be
significant negotiation around these, often depending on the
nature of the security. Where the security is volatile, e.g., if
it is in the emerging markets, the lender may want to have
prepayment events triggered by significant sudden price falls.
Similarly, the lender may wish to be prepaid if the relevant
exchange is disrupted or if the volume of trading falls
significantly. The borrower may wish to avoid certain events
resulting in an immediate right to prepayment by arguing that the
relevant event should instead be a deleveraging event or an
adjustment event.
In the case of a deleveraging event, instead of a right to be
prepaid, the LTV Ratio levels may be reset in a manner that is
more in favor of the lender on the understanding that they will
revert to their original levels if the original deleveraging
event is reversed sufficiently. In the case of an adjustment
event, the relevant event, such as a tender offer, or a merger
event affecting the relevant issuer of the security may only be a
prepayment event if amendments cannot be made to the loan
agreement in order to preserve the original commercial positions
of the parties.
Other borrower flexibility
The borrower may also want the right to dispose of the relevant
securities or substitute alternative securities, e.g., in a
portfolio deal. Also, on the assumption that the relevant LTV
Ratio is satisfied, it will want to be able to receive income
from the security such as dividends. There is typically
negotiation around the above provisions.
Corporate style loans
In our experience, there is a wide spectrum of loans secured over
securities ranging from margin loans through hybrid products to
more corporate style loans. At one end of the spectrum, there
could just be an initial LTV Ratio test with no margining
requirements. In this context, the lenders will typically have
full recourse to the borrower, a more extensive covenant package
aimed at preserving the value of the borrower’s assets and may
also benefit from other credit support (such as guarantees and/or
security over other assets).
Sometimes a loan may be secured over a mixture of liquid publicly
listed securities and illiquid private securities. Different
considerations will come into play where the securities are
illiquid and the loan terms will begin to resemble much more a
corporate style loan. The key, as always, is to deliver an
effective security package to the lender so that any haircut on
the value of the securities is limited and the maximum amount of
finance may be raised. Where the privately owned securities are
(sometimes significant) minority interests in a joint venture
vehicle, the negotiations tend to be more complex, as both the
lenders and the joint venture partner focus on what would happen
upon the enforcement of the security. Therefore, where possible,
it is helpful to build in flexibility to secure the shares when
negotiating the joint venture terms.