Lesson 3 of 20 · 6 min

Term three: the lender sets collateral value

Collateral value is the lender's determination, including haircuts, eligibility and concentration limits.

The third term is that the value of your collateral, for the purposes of this facility, is whatever the lender determines it to be. Market value is an input to that determination and not the determination itself.

Three separate levers sit inside this one term:

Haircuts — the percentage of market value withheld, covered in Track 1 lesson 4.
Eligibility — whether a holding counts as collateral at all. Ineligible holdings contribute zero regardless of their market value.
Concentration limits — reduced treatment for positions above a stated share of the account, from Track 1 lesson 10.

Eligibility is the lever people least expect, because it is binary. A holding can be worth a great deal and count for nothing: restricted stock, certain closed-end or leveraged products, shares of a company you are an insider of, small or thinly traded issues, holdings in an account type that cannot be pledged. Nothing about the market value of those positions is disputed. They simply do not appear in the collateral calculation.

The practical consequence is that two figures describing the same account can differ enormously and both be correct. Your brokerage screen reports market value, because that is what it is for. The lender's system reports collateral value, and it is the only figure the maintenance test uses. Reconciling the two is the reconstruction exercise from Track 1 lesson 20, and it is the single most useful thing a borrower can compute.

Key terms

Collateral value (lending value): Market value after haircuts, eligibility rules and concentration limits. A lender determination, not a market observation.
Eligibility: Whether a holding counts as collateral at all. A binary test; ineligible positions contribute zero however much they are worth.
Determination right: The lender's contractual authority to set collateral value. Usually stated as being at the lender's sole discretion.

Worked example

One account, two very different values

A $1,000,000 account: $500,000 broad equity funds, $250,000 a single mid-cap holding, $150,000 restricted stock, $100,000 a thinly traded small company.

Broad equity funds at 70%: $350,000
Single mid-cap holding at 50%: $125,000
Restricted stock: $0
Thinly traded small company: $0
Total collateral value: $475,000
Market value shown on the brokerage screen: $1,000,000

A 52.5 percent gap between the two figures, with no disagreement about any price. Illustrative rates, not any provider's schedule.

Check yourself

Your account shows a market value of $1,000,000, but the lender's collateral value is $475,000. Is one of the figures wrong?

Saved in this browser only. No account, nothing sent anywhere.

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.