While margin loans are just about the cheapest form of financing against liquid assets, they differ dramatically from a loan against illiquid assets. Brokers and banks are happy to lend at extremely low rates against diversified baskets of liquid assets such as stocks, bonds, and other securities. There are risks, however, and the most significant one is that of a margin call which can be brought on in the event of a sudden market downdraft. Recent volatility in the equity markets makes this apparent.
When stock prices decline rapidly and unexpectedly, collateral balances in margin loans may rapidly become insufficient. If one is unable to add more collateral, the underlying equities can be sold automatically to reduce the loan balance and ensure that it meets margin requirements. The results can be an unexpected tax bill as well as a dramatic change in one’s financial position.
This does not happen with a loan against illiquid assets from New York Private Finance. First off, our loans are not demand loans but have tenors of up to six years. In addition, if the value of collateral declines below an agreed collateral maintenance level, we notify the borrower and provide a reasonable period of time to post additional collateral or pay the loan down to the required maintenance level. We do not have the right to sell out collateral instantaneously, as is the case with a margin loan. In addition, because our collateral is illiquid, it is not valued in real time but only as needed and pursuant to a third-party valuation exercise. Accordingly, in times of market volatility our borrowers need not worry about day-to-day market fluctuations and may therefore sleep better at night while enjoying the privilege of more deliberate, longer-term, strategic planning.
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