Lesson 4 of 20 · 6 min

Term four: advance rates are assigned and can be revised

Advance rates are policy, not contract terms, and they can be changed at the lender's discretion.

The fourth term is that advance rates are assigned by asset type and can be revised. Not renegotiated — revised, by one party, under authority the agreement already grants.

This is the term that most surprises borrowers who read the numbers at origination as fixed. The 70 percent advance rate quoted on a broad equity fund is a current policy figure. It usually appears in a schedule or an appendix rather than in the body of the agreement, which is itself informative: material that can change is typically kept out of the operative terms.

A revision has the same arithmetic effect as a fall in market value, and it can arrive on a day when nothing happened in the market. Reduce a 70 percent advance rate to 55 percent on a $600,000 collateral base and collateral value falls from $420,000 to $330,000 — a 21 percent reduction, comparable to a serious market decline, delivered by a policy change.

The compounding case is worse and is the one the corporate research emphasises: a haircut increase and a price decline can arrive together, because the same conditions that cause prices to fall cause lenders to reassess how much of that value they are willing to lend against. The two effects are not independent, and modelling them as independent understates the joint outcome substantially.

Key terms

Advance rate: The percentage of an asset's market value counted as collateral. Assigned by the lender and revisable at its discretion.
Schedule: An appendix to the agreement containing figures that can change. Material held in a schedule is usually material the lender may revise.
Joint stress: A haircut increase and a price decline occurring together. Correlated by their shared cause, so they cannot be treated as independent events.

Worked example

A policy change and a market decline, separately and together

Collateral $600,000 at a 70% blended advance rate, balance $290,000, threshold 70% of collateral value.

Starting collateral value, LTV: $420,000, 69.0%
Advance rate cut to 55%, no market move: $330,000, LTV 87.9%
20% market decline, advance rate unchanged: $336,000, LTV 86.3%
Both together: $264,000, LTV 109.8%
Shortfall in the joint case: $105,200
Required sale at 3.33×: $350,667

Either event alone breaches the threshold. Together the shortfall cannot be cured by selling collateral at all, which is what joint stress means arithmetically.

Check yourself

Your advance rate is cut from 70% to 55% on an unchanged $600,000 portfolio. What happened to your collateral value, and how does it compare to a market decline?

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.