Understanding Non-Recourse Loan Structures

Recently on a number of loans, I have encountered Borrowers as well as Agents who do not understand how a Non-Recourse Stock or Securities based loan differs from a Margin (Recourse) Loan.

I have written about and explained Non-Recourse Loan structures on numerous other postings about Non-Recourse Loans, but it appears that I need to do so once again.

A Non-Recourse Loan is a credit facility that is underwritten and secured solely by the collateral being provided, in the case of this discussion, it is either shares of publicly traded companies (aka stocks) or select fixed income instruments (corporate bonds) that are publicly traded.

The loan does not require the Borrower to provide personal information (beyond what is required for KYC/AML requirements) since a Non-Recourse Lender does not require any personal or corporate guarantees or lists of other assets since the Lender will not engage in any collection actions against the Borrower for the repayment of the loan balance should a default occur (uncorrected valuation decline of the collateral, missed interest payment etc.).

The only thing at risk for the Borrower is the forfeiture of the securities pledged as collateral for the loan, nothing else. Also the loan proceeds do not have to be returned to the Lender.

Unlike a Non-Recourse Loan, a Margin Loan which is a Full Recourse Loan product requires that the Borrower meet credit qualifications, provide personal or corporate guarantees and put other assets at risk in addition to the collateral in order to secure the loan. Should a default or margin call occur and the sale of the collateral is insufficient to satisfy the loan balance, the Borrower is subject to having other assets with the Bank frozen and legal action taken to seize other assets (usually by a lawsuit against the Borrower) to satisfy the unpaid balance plus additional costs incurred by the Lender.

As for the Lender, because the only recourse that they have to offset the risk of a default is to structure a hedge (usually via hypothecation) using the securities provided as collateral as a means of protecting their financial interest.

A Non-Recourse Loan with claims of not hypothecating, trading or selling the shares unless an event of default has already occurred is a Red Flag that you are dealing with a Quasi or Fake Lender. This would be like attempting to take out fire insurance on your home once it is already on fire.

What you will likely experience with a Lender making such a claim is that upon gaining control of the collateral, they will simply dump it to the market as a means of raising the cash to fund their loan offer as well as attempting to cause a valuation drop in order to trigger an immediate default of the loan.

I would also like to point out that many Borrowers we encounter have the belief that Banks do not sell, trade, short or hypothecate the collateral when in fact they do. Because many Borrowers have far too much trust in Banks, they typically do not read the Loan Agreements and accept the sales representatives word.

Hopefully this updated posting will be read by potential Borrowers as well as Agents to help them better understand how a Non-Recourse Loan differs from a traditional Margin or Recourse Loan.

If you have further questions or still need help understanding a Non-Recourse Loan structure, please feel free to contact me to discuss a time to talk.

Michael Rowe

Origin8

[email protected]

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