Equity-collateralised loans show return potential
Equity-collateralised loans, otherwise known as share pledge financing, allow shareholders to access the value of their holdings without foregoing the potential for value accretion. They can often be a powerful and flexible solution for long-term investors who have short- and medium-term capital needs.
However, a traditional perception exists that share pledge financing transactions can have a negative impact on the price of the share collateral, said Gordon Crosbie-Walsh, Asia CEO at EquitiesFirst.
“This is not necessarily the case and empirical analysis shows the facts. Results indicate that shares in these kinds of financings often outperform on an absolute basis and relative to the Hong Kong Hang Seng Index”, Crosbie-Walsh said.
The EquitiesFirst research team reviewed all disclosures on the Hong Kong Stock Exchange (HKEX) of share pledge financings in the market. In total, there were at least 29 publicly disclosed share pledging transactions on the HKEX from January 1, 2020 to September 13, 2021, representing 20 unique listings. Most of the companies were from the consumer (cyclical) sector, followed by consumer (non-cyclical) and communication sectors.
EquitiesFirst analysed price performance of the shares after their pledging disclosures on HKEX through April 2021. According to data, share price increased on average by +0.50% one day after disclosure, +3.00% one week after and +9.60% one month after.
The total price change to-date is +41.90% on average, representing a technical outperformance of 47.90% compared to the Hang Seng Index.
BORROWER CONFIDENCE
The consistent outperformance of shares employed in pledge financings contradicts the perception among shareholders that such transactions may impact stock price. One potential factor underlying the outperformance is the nature of borrowers using their shares as collateral for loans.
“Borrowers with strong conviction, deep understanding and long history with the stock would consider pledging it for financing and accepting a 60-70% loan-to-value ratio, rather than selling outright,” said Crosbie-Walsh.
The reality is share pledge financings have a long history and are well understood in Hong Kong. As a result, the market frequently does not react negatively or impulsively upon disclosure, he said.
In cases where the new capital will be used to improve the underlying company’s financial position, sourcing capital in this way is highly efficient as it can lower costs and improve the sustainability of the business.
It also demonstrates the long-term commitment of established and significant stakeholders such as the original founders and management.
The results of research findings for Hong Kong stocks are consistent with academic literature surrounding share pledge financing, making it relevant and worthy of consideration by investors and asset owners looking at strategies to access capital.
The 2018 research paper “Insider Pledging: Information Content and Forced Sale”[1] , while focused on companies listed in the United States, reached conclusions very similar to that of EquitiesFirst.
“When we examine the long-run return, there is significantly positive one-year abnormal stock returns after the disclosure date of insider pledging. The abnormal returns still exist even after allowing for many asset pricing factors and firm-specific risks,” according to the research paper.
PIONEERING IN THE MARKET
For close to two decades, EquitiesFirst has been a pioneer in providing loan capital against equity collateral. As a global specialist in this type of lending, EquitiesFirst has worked with major shareholders, investors, founders and family offices to structure bespoke financings and provide capital that can be vital and transformative. This has given EquitiesFirst a unique perspective into this market, including the implications for investors and their assets.
Investors who consider equity-collateralised loans share a conviction that the shares they hold will appreciate in value over the medium- to long-term. They are particularly watchful for any potential risk to their value and market perceptions. On that basis, EquitiesFirst conducted an analysis of the entire population of share pledge transactions disclosed in the Hong Kong market. This analysis provides context and insight for equity investors considering accessing capital in this way.
“By structuring our lending transactions as a sale and repurchase agreement, EquitiesFirst effectively takes a long position alongside the asset owner which has placed equity collateral in our custody. This creates a natural alignment of interests to the long-term benefit of both parties,” said Crosbie-Walsh.
It is important to note that findings about share pledge financings reflect specific statistical analysis at a specific time and may not hold true under all circumstances. Past performance is no guarantee of future return and investors should conduct their own due diligence and analysis before making investment decisions.
Furthermore, not all share pledge financing transactions are ‘created equal’. There are important distinctions within the space which must be addressed and considered. Regarding the EquitiesFirst model, the core of the investment strategy is to generate returns over time by managing the portfolio with discipline and prudence.
[1] Hung-Kun Chen, SY Hu. “Insider Pledging: Its Information Content and Forced Sale”. 2018 Financial Management Association Annual Meeting.
Disclaimer:
Equities First Holdings Hong Kong Limited holds a Hong Kong Securities and Futures Commission Type 1 License and licensed in Hong Kong under the Money Lenders Ordinance (Money Lender’s Licence No. 1839/2020). EquitiesFirst (“EquitiesFirst” refers to Equities First Holdings LLC, and all subsidiaries of such company in all countries where they are engaged in business activities of any nature). This document is prepared by EquitiesFirst. It is not intended as an offer to sell securities or a solicitation to buy any product managed or provided by Equities First. It aims to provide general information on the EFH loan facility which is not authorised for retail use in Hong Kong and is only available for Professional Investors. This document is not directed to individuals or organizations for whom such offers or invitations would be unlawful or prohibited. Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. The information contained herein may be incomplete or incomprehensive. Accordingly, the information is qualified in its entirety by the terms applicable to the facility as set out in its constitutive documents (Loan Documents) and should be read together with such Loan Documents. This presentation has been prepared without consideration of the investment objectives, financial situation, or particular needs of any individual investor. You should consider your own investment objectives, financial situation, and particular needs before taking any action with respect to a financial product referred to in this presentation. In preparing this presentation, EFH is assuming your organization is capable of evaluating the merits and risks of any financial transaction described herein and its suitability for your organization’s purposes and its legal, taxation, accounting, and financial implications and that in making this evaluation you are not reliant on any recommendation or statements made by EFH. Before entering into any transaction EFH strongly encourages you to independently assess these things and fully understand the transaction in its entirety. EFH does not act as an adviser in any capacity and strongly recommends all borrowers seek independent advisement when assessing the transaction and its suitability. To the extent it is permitted by applicable law, Equities First, its affiliates, and any officer or employee of Equities First or its affiliates do not accept any liability whatsoever for any direct or consequential loss arising from the use of this presentation or its contents, including for negligence. Trading in equities, futures, options, commodities, currencies, or derivatives can have risks and is not appropriate for all persons. Under some market conditions, it may be impossible to liquidate a position. Copyright protections exist in this presentation. The contents of this presentation are strictly confidential and may not be disclosed, reproduced, distributed, or published by any person for any purpose without the expressed written consent of EFH, LLC. EFH makes no guarantee, representation, or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Equities First only and are subject to changes without notice. Further information is available upon request.
