Pledged Collateral - The Strategic CFO®

Pledged Collateral

Tags: collateral, margin, pledged collateral
By: Dan
July 24, 2013

Pledged Collateral Definition

Pledged collateral refers to assets that are used to secure a loan. The borrower pledges assets or property to the lender to guarantee or secure the loan. Pledging assets, also referred to as hypothecation, does not transfer ownership of the property to the creditor, but gives the creditor a non-possessory interest in the property. This means that the borrower still retains the ownership of the property, but the lender has a claim against it.
In the event of default, the collateral for a loan may be liquidated and sold off by the creditor in order to pay for the unsettled debt. In this case, the borrower loses possession of the collateral properties. All proceeds from the sale of these collateral properties go to pay off the debtors obligations.

Collateral Items

In business, a company may pledge various types of property as collateral. A borrower may pledge physical assets, such as equipment, machinery, real estate, buildings, or inventory, or it may pledge trade receivables, such as the value of the company’s accounts receivable, which represents money owed to the company.

Margin Collateral

For investments, a dealer or broker may require an investor to pledge a certain amount of capital as collateral for the investments made with money borrowed from the broker or dealer. The margin collateral must equal a specified proportion of the value of the investments. This occurs when an investor wants to short a stock, which typically involves borrowing. Often, the margin collateral must be at least 50% of the value of the investments, although it could also be a different percentage, depending on the circumstances.
If the value of the investments decreases so much that the value of the margin collateral becomes less than 50% (or some other specified percentage) of the value of the borrowed investments, the investor may receive a margin call from the dealer or broker. A margin call is when the dealer or broker calls the investor to tell him that the margin collateral has fallen below the minimum threshold, and that the investor must post more margin collateral to regain the required threshold.

Hypothecation

Hypothecation is another term for pledging collateral to secure or guarantee a loan or other debt obligation. The borrower, or hypothecator, pledges, or hypothecates, property to the lender. The creditor then has a non-possessory claim against the hypothecated assets. In the event of default, the creditor would take control of the hypothecated assets. Then, they would liquidate them to repay the borrowers debt.