Securities Based Lending
Securities based lending has become a booming business on Wall Street in
recent years, but before customers enter into these lending arrangements,
they need to understand the substantial risks involved, including having
to sell all of your stocks and pay back the loan in the event of a market downturn.
Many stockbrokers sell their customers on the idea of securities based
lending as a way to borrow money by using the stocks in their account
as collateral. Customers are enticed with the low interest rates and the
ability to borrow anywhere from 50 to 90% of their portfolio stock value.
The only restriction is clients are not permitted to use the borrowed
funds to buy more stock like a margin loan.
This sounds all well and good, and many borrowers see securities based
lending as a good way to fund cash flow for small business or refinance
other debt. But the devil is in the details and unfortunately, many customers
don’t appreciate what exactly they are getting themselves into until
it is too late. Interest rates on securities-backed loans can change every
day. In addition, your brokerage firm may decide that a security that
was previously eligible as collateral is no longer available leaving you
with less money to borrow.
Importantly, securities-backed loans are demand loans, meaning that the
lender may call the loan at any time. If you can’t repay it, the
firm can move in right away and sell securities in your account to pay
the balance in full. During volatile markets, the value of your stocks
could quickly decline significantly and if you don’t have extra
cash on hand, then you might be forced to sell your stocks and pay back
the loan immediately. Wall Street likes these loans because it is another
way for them to make money off the stock that is sitting in your investment accounts.
According to the SEC, between 2012 and 2014, one large brokerage firm reported
a 70% increase in its securities based lending while another firm reported
an over 50% increase.
Before you agree to a securities based loan, make sure you’ve read
the fine print and understand exactly what you’re getting yourself into.