Securities as Collateral

By Kratz, Lisa | The Journal of Bank Cost & Management Accounting, January 1, 1995 | Go to article overview

Securities as Collateral

Kratz, Lisa, The Journal of Bank Cost & Management Accounting

Securities, as collateral, are one of the many types of collateral that require a financial institution to perfect its interest. In addition, securities are also one of the easiest types of collateral to take, due to the following:

1) easy to value,

2) ease of liquidation,

3) generally perfection accomplished by possession.

However, there are factors of which a financial institution has to be aware in order to maintain its security position.

One of the key risks with securities as collateral is ownership status. A financial institution needs to verify with the Securities and Exchange Commission the status of ownership for each security taken as collateral. The perfection and foreclosures procedures a financial institution should take to secure its interest in pledged securities is another issue that has to be resolved. There are many types of securities, and the steps in perfection and foreclosure vary as to the type, as well as to the procedures of inquiry.

With securities as collateral, a financial institution should verify or inquire first, the ownership or previous history on pledges; second, the type of securities and the requirements associated with that type; and third, the steps that need to be taken in order to perfect and the procedures involved in foreclosure.


The following chart, in "Two Sides of Collateral: Security and Danger" from The Journal of Commercial Lending, June 1994, refers to the components of secured lending: (chart omitted)

To make a secured transaction truly secure, the loan officers should focus on four areas:

1) The borrower,

2) Seniority position,

3) Protection,

4) Control.

Collateral leads bankers to a fake sense of security. Collateral used as a basis for credit should be time tested and verified as to appropriateness to current conditions. Seniority refers to "the financial institution having top priority on the 'assets' of the borrower over other creditors due to legally enforceable claims."(1) Methods associated with the seniority vary according to the type of collateral taken.

Protection refers to the realizable value of the collateral upon liquidation."(2) The focus points are value, margin vulnerability, marketability, and insurance of the collateral. Value is the determinable market price associated with the type of collateral used to secure the loan. Margin generally represents the "working capital cushion built into a financing agreement."(3) Vulnerability represents the risk associated with the volatility of the loan and unplanned events (i.e., government uproars, etc.).

Marketability helps in the liquidation process by determining where, for how much and when the collateral can be liquidated. Insurance is required to protect the financial institution's estimate of value. Control "is the time value of collateral, the value and the care of the asset, and the associated documentation for the purpose of ensuring the proper coverage of the exposure and the claim of the...."(4) financial institution.


In 1977, the SEC established the Securities Information Center (SIC) to help monitor missing, lost, counterfeit, or stolen securities. The SIC is the clearinghouse for all reports and inquiries concerning the ownership of securities. The Uniform Commercial Code (UCC), Article 8 and Article 9, covers the issues associated with securities as collateral and the foreclosure on those securities. Article 8 covers the transfer and perfection of security interest in non-government securities, and Article 9 refers to the foreclosure on stock.

Foreclosure of stock can create unusual problems for the creditor. The problems come primarily from the conflicting policies of the UCC and the federal securities law, Securities Act of 1933. In the initial phase of default proceedings, they are similar to personal property foreclosure. …

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