Pledged asset definition
/What is a Pledged Asset?
A pledged asset is an asset that is being used as collateral on a loan. A pledged asset reduces the risk of the lender, since it can take possession of and sell the asset if the borrower defaults on loan payments. Since the presence of a pledged asset reduces the risk of the lender, the borrower may be able to negotiate for a reduction in the interest rate charged.
Depending on the situation, the lender may require the borrower to deposit cash or securities (the pledged asset) in an account that the lender controls. By doing so, there is no question that the lender can access the asset in the event of a loan default, though the borrower continues to receive all dividend and interest payments from the security issuers during this period. The exact amount and type of assets to be pledged is decided upon during negotiations between the lender and borrower.
Once the borrower pays off a loan, the lender is legally obligated to transfer all associated pledged assets back to the borrower.
Characteristics of a Pledged Asset
The key characteristics of a pledged asset are as follows:
Collateral function. The primary characteristic of a pledged asset is its role as collateral, reducing the lender’s risk by providing a tangible or financial guarantee. If the borrower defaults on the loan, the lender can seize or sell the pledged asset to recover the owed amount.
Ownership retention. The borrower typically retains ownership of the pledged asset and can continue to use it, but the lender holds a lien or security interest until the debt is fully repaid. This arrangement means the asset cannot be sold or transferred without the lender’s consent.
Valuable and liquid nature. Pledged assets are usually valuable and, ideally, liquid (easily converted to cash). Common examples include real estate, vehicles, stocks and bonds, savings accounts, and business equipment. The higher the value and liquidity of the asset, the more security it provides to the lender.
Reduction in borrowing costs. Offering a pledged asset can help borrowers obtain better loan terms, such as lower interest rates, higher borrowing limits, or extended repayment periods, because the collateral reduces the lender’s risk.
Legal and contractual agreement. The pledge of an asset is documented in a legal agreement, detailing the asset being pledged, the terms of the pledge, and the conditions under which the lender can take possession of the asset.
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Example of a Pledged Asset
Grissom Granaries operates grain barges and tugboats on the Mississippi River. It is experiencing high volume, as more farmers want it to transport their grain. To accommodate demand, Grissom wants to purchase additional barges and tugboats, at a cost of $30 million. However, the company can only afford to pay $5 million for these assets, and so enters into a loan arrangement with a local bank to finance the remainder of the purchase. To reduce its lending risk, the bank mandates that the new barges and tugboats be designated as pledged assets under the lending arrangement. That way, if Grissom does not pay back the loan, the bank can take possession of these assets and sell them off in order to pay down the loan.