Banks are cautious even with such liquid loans as Wall Street call loans. The reason for this wariness will be clear when it is shown in a later chapter how call loans have so often proved uncollectible in panicky times, and how the fear of a general call for payment has often precipitated trouble in the Street and even in the whole country. The chief points that are watched are the kind of security, the bank's title to the security and the margin of value of the security over the loan.
5. Kind of security.—Borrowers on call are always anxious to use as many industrial stocks for collateral as the bank will allow. Bankers usually require, however, that at least 60 per cent of the securities be railroad issues, because they are less speculative. Loans should not be made on the stock of a company which has not demonstrated its ability to make money, or on stocks which have no market.
A loan on mixed collateral is more desirable than a loan on one kind of stock or bond, for if the bank is compelled to sell the securities it will receive better returns on small lots of several securities than on a large block of one security. In the same way a loan on a low priced active stock is better than one on a high priced inactive stock.
6. Bank's title.—The question of the bank's title to the securities involves many important points, and it is of as much interest to banks in the outlying districts as to those in Wall Street.
In the first place, the bank must be in a position to obtain legal title to the security in its possession, in case of default.
This necessitates the indorsement of the securities in blank, and this must be done in proper order. In the case of Wall Street call loans, the banks require that the securities be a good delivery under the rules of the New York Stock Exchange. These rules in clude technical points in which the country banker or the business man is not particularly interested.
In the second place, a man cannot hypothecate something he does not own. If he produces a certifi cate of stock, drawn to the order of some other per son, and requests the bank to make a loan upon this stock, the stock is of no value to the bank even tho it is apparently correctly indorsed in blank, unless the borrower files with it a certificate or agreement signed by the person in whose name the stock is drawn giving the borrower the right to hypothecate the stock. This certificate, or agreement, is known as an hypotheca tion certificate.
7. The business man should not go to the bank and expect to get a loan to the full extent of his security, even if he presents government or first class railroad bonds. In most states, banks are re
quired by law to have a margin over and above the amount of the loan. This margin must be maintained at all times. In addition to this, when the bank ex aminer calls he may instruct the bank to reduce the loan by a charge to profit and loss in order that the security may be worth more than the loan by the re quired margin. Of course, the market value and not the face value is taken into consideration for this pur pose.
The margin ordinarily required is 20 per cent. That is, the loan may not exceed 80 per 'cent of the market value of the collateral deposited. A second test which is applied in New York is that the loan must have a ten point margin, that is, that it must be $10 a share less than the market value of the collateral. The ten point test falls heavily upon any security that is selling at less than $50 per share. Under the 20 per cent rule, the loan on a stock selling at $40 could be as high as $32; under the ten point rule, it could not exceed $30. The latter rule is not often applied outside of New York.
8. Investment William Law, vice president of the Central National Bank of Philadel phia, in an unpublished address, divides borrowers into four classes: investment, industrial, capital and mort gage borrowers.
Investment borrowers are those who borrow to in vest the proceeds in certain securities or property which they wish to carry with a view to resell at a profit, to hold until funds can be accumulated to pay for the purchase, to enable the holder to gain cer tain control of influence, or otherwise to accomplish some object external to the transaction. These are loans ordinarily granted to brokers, investment bankers and market operators. These loans are usu ally secured by the deposit of collateral and can read ily be realized upon in proportion to the convertibility or salability of the securities deposited. Under nor mal conditions, such a borrower will pay his loan at one bank from the proceeds of the transaction, by sell ing the securities pledged there or by borrowing from another bank. If loans of this character are the obli gations of active and capable men, they are an excel lent investment for a portion of the funds of a This is especially so if they are payable on demand and secured by well-distributed and properly mar gined collaterals possessing a broad market. How ever, when money is abundant, such loans yield a comparatively low rate of interest and they are often open to the dangers of call loans, which will be dis cussed in a later chapter.