What is Securities Based Lending?
Securities based lending (SBL) is a type of financing where borrowers use their investment portfolio as collateral to secure a loan. This allows investors to access liquidity without having to sell any assets, thus potentially avoiding capital gains taxes and maintaining their investment strategies.
For more information, please see our article: Securities Based Lending: How to be your own bank
How it works
In an SBL, the borrower pledges their eligible securities as collateral for a loan. The lender will typically offer a percentage of the portfolio’s value as a loan, usually up to a certain loan-to-value (LTV) ratio. The borrower can use the loan for many purposes, except for purchasing additional securities. Interest rates on SBLs are usually determined based on the loan amount, LTV ratio, and the creditworthiness of the borrower.
Eligible securities for SBL typically include publicly traded stocks, bonds, mutual funds, and exchange-traded funds (ETFs). However, eligibility varies depending on the lender’s requirements and risk assessment.
The loan-to-value (LTV) ratio is calculated by dividing the loan amount by the total value of the pledged securities. Lenders usually offer a certain percentage of the portfolio’s value as a loan, with LTV ratios typically ranging from 50-75%.
In most cases, you can continue to trade or sell securities within your pledged portfolio. However, you must maintain the required collateral value and LTV ratio to avoid margin calls or potential liquidation of securities.
Benefits
SBL is very commonly used to invest in real estate. If structured properly, an investor can gain both on the value of their securities and real estate property. If conditions are right, the borrower’s interest may be covered by the yield from the investment portfolio.
Another use of SBL is to access liquidity without realizing a capital gain. In this case, the investor takes a loan and spends it outright. A well-performing portfolio can gain more than the interest after tax.
SBL often provides wide flexibility and attractive interest rates. Contact us if you’re curious about using SBL for any purpose. We’re experienced with managing portfolios used as collateral.
SBL funds are generally considered non-purpose loans, meaning they can be used for most purposes. Some notable exceptions are that they cannot be used for purchasing additional securities or paying down margin debt.
Yes, SBLs can be used to finance a variety of purposes, including business expenses, real estate investments, or personal expenditures. However, it’s important to consider the risks of using investments as collateral and the potential impact on your overall financial position.
Some lenders may allow you to increase your line of credit if your portfolio value increases (subject to their credit and risk assessment policies). It’s essential to discuss your options with your lender and understand the terms and conditions associated with any increase in your credit line.
Risks
There are critical risks.
If the investments lose significant value, you could be subject to a margin call. Failure to address a margin call may result in the liquidation of your investments. If you are carrying a large unrealized capital gain, you may be liable for significant taxes after losing your investments.
Given these risks, proper planning and management is essential.
If the value of the collateral declines below the maintenance level set by the lender, you may be subject to a margin call. You’ll then be required to either deposit additional cash or securities or face the potential liquidation of some or all of your pledged securities to cover the shortfall.
A margin call occurs when the value of the collateral in an SBL falls below the required maintenance level set by the lender. If this happens, the borrower must either deposit additional cash or securities to meet the maintenance requirement or risk having some or all of their pledged securities liquidated to cover the shortfall.
The Securities Exchange Commission (SEC) has issued an investor alert with further information about potential risks.
Getting Started
Typically SBL requires a special purpose brokerage account to be set up. Terminology varies between brokers, but here are some SBL programs:
- Charles Schwab: Pledged Asset Line (PAL)
- E*TRADE: Line of Credit
- JP Morgan: Securities Based Lending
The appropriate strategy depends heavily on many factors including: your loan leverage, interest rates, stock valuations, and the economic outlook.
We have manage SBL-linked accounts for multiple clients. Contact us if you’re interested in a professionally-managed account with a tailored investment strategy.
