Lesson 15 of 25 · 6 min

An eligibility floor that zeroes a row

A price test does not haircut Oakridge. It deletes the product, which is a different operation.

An eligibility floor is a test a holding must pass before it is allowed onto the schedule at all. Common forms are a minimum unit price, a minimum issued size, a listing requirement, or a requirement that a preferred dividend is current. Fail the test and the advance rate is not reduced. It is replaced by zero.

Put a $75 price floor on pledged equities and preferreds. Oakridge Utility preferred prints at $62.40. The floor fails. Oakridge's $511,680 of market value remains in the pool — the shares are still pledged — and its lending value goes from $281,424 to $0. The pool's lending value falls from $3,277,251.25 to $2,995,827.25. The blend falls to 2,995,827.25 ÷ 6,032,795 = 0.49659, which is 49.66 percent.

Stated capacity is again unchanged. $2,995,827.25 is still above $2,400,000, so the minimum is still the limit. The surplus shrinks from $877,251.25 to $595,827.25. Same shape as Calder's reclassification, smaller hole, different cause. Calder failed a category test. Oakridge failed a price test. Both tests write zero into the third term of the product.

The floor is discontinuous, which is the property that distinguishes it from a haircut. A 55 percent advance rate on Oakridge at $62.40 would have been $281,424 at $74.99 as well, scaled only by the price move. The floor does not scale. At $75.00 the product exists; at $74.99 it does not. A one-cent print through the threshold removes the whole of the row's collateral at once.

A haircut is a slope. An eligibility floor is a cliff. Oakridge's $281,424 lives or dies on which of those the rule is.

Key terms

Eligibility floor: A minimum test — price, size, listing, dividend status — that a holding must pass before any advance rate applies.
Cliff: A rule that takes a quantity to zero at a threshold, rather than reducing it in proportion.
Preferred dividend test: An eligibility rule that preferred stock is countable only while the issuer is current on the preferred dividend.

Worked example

Oakridge against a $75 price floor

March book. Illustrative rule: any equity or preferred with a unit price below $75 is ineligible. Oakridge prints at $62.40.

Oakridge unit price versus the floor: $62.40 against $75
Oakridge lending value after the fail: $0
New pool lending value: $2,995,827.25
New blended advance rate: 49.66%
Stated capacity: $2,400,000

The floor did not take 55 percent of a smaller number. It took the whole product, on a one-cent logic.

Check yourself

An illustrative $75 price floor makes Oakridge ineligible at $62.40. What happens to Oakridge's lending value, to the pool's lending value, and to stated capacity on the March book?

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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.