Frequently Asked Questions...

How is the lender able to offer such low interest rates?

Low interest rates are made possible because over the life of the loan, the lender will be using and trading the shares securing the loan.

Is there any limit as to loan size?

There is NO UPPER LIMIT on loan size as long as there is sufficient value in the portfolio to collateralize it.  The lender can easily lend into the hundreds of millions. The minimum loan size, however, is $100,000.

Who owns my stock during the loan? Or, who has title to my stock during the loan?

The stock is transferred to the lender, via a qualifying stock lending agreement, giving it full title.  However, because it is not considered a constructive sale, it does not trigger a taxable event per IRS Code Section 1058.  The borrower retains all beneficial interests in the securities. The borrower will receive any dividends, interest, appreciation, and any other benefits that flow from the stock during the term of the loan.

If the stock has a dividend during the loan will I get it?

Yes. The borrower receives a credit against the loan's interest payment of all amounts equal to dividends, interest, or other distribution on the stock during the term of the loan. This is done quarterly.

Yes. Because this is a loan against, and not a sale of the shares, any dividends generated by the securities are still taxable as they normally would be.  The borrower will receive a 1099 misc form from the lender at the end of each calendar year.

If the shares appreciate in value, will I get that appreciation?

Yes. The borrower realizes full appreciation of the shares.  At the end of the loan period, the borrower will receive back from the lender the same number of shares originally pledged as collateral, which automatically includes any appreciation as well.

The loan proceeds can be used for virtually any purpose the borrower wants, including to buy more marginable stocks.  However, those stocks purchased with loan proceeds cannot be used as collateral for a margin loan.  By the same token, the borrower may not use the loan proceeds to extend credit to others who intend to purchase marginable stocks for the purpose of obtaining a margin loan against them. 

If I default on this loan am I personally liable and will it ruin my credit?

The answer to both questions is no. This is a non-recourse, non-recorded loan and the lender cannot come after you personally nor report you to the credit bureaus.  If you default, you get to keep the money, and the lender gets to keep the stock as the sole remedy.

What if the value of the stock falls significantly? Or, what does this default provision in the loan mean?

Every loan has a default trigger or "call". The loan sets the default trigger at 80 percent of the loan amount – not 80 percent of the securities’ value. If the value of the stock, based on a running three day average, falls below the default floor, the borrower has two options: a) the borrower can walk away keeping the loan proceeds and the lender keeps the pledged securities, or b) the borrower can buy down the default floor to the current market value and keep the loan current.

For example, assume the stock had a full market value of $100,000 when the loan was made. Also, assume the loan terms established a 70 percent LTV, so the loan was for 70 percent of $100,000 or $70,000. If the value of the stock falls below 80 percent of the loan amount, that is, $56,000 ($70,000 x 80%), for three consecutive days, then the borrower has two options – walking away and keeping the loan proceeds, or buying down the floor to the current market value.

If the borrower does walk away, he or she always has at least 25 percent more in cash that the current market value of the securities ($70,000 vs. $56,000 market value, or less). Also, remember that the loan is non-recourse and the lender doesn’t report to the credit bureaus, so the default does not affect the borrower’s credit rating. With option b) the borrower may contribute additional cash or shares to keep the loan viable. The decision to tender additional cash or securities is solely in the borrower’s hands. The borrower could choose not to risk more capital and terminate the loan or the borrower could choose to keep the loan in good standing by curing the default caused by the loss in value of the collateral.

The additional cash or shares tendered to cure the default do not become part of the collateral for the loan and are not subject to repayment or refund at any time. At origination, the borrower and the lender agreed to a minimum fair market value for the collateral of the loan. The payment of the additional cash or securities establishes a new lower minimum fair market value and higher risk threshold for the lender and borrower alike. Those funds sent in “buy down’ the price of the securities to set a new floor for the stock and thus maintain the minimum value ratio between the amount of money loaned and the minimum value of the security for which the lender is willing to be at risk.

Is the transfer of the stock for the loan considered a "constructive sale" and is it considered a taxable event?

No. The transfer is not considered a constructive sale and it is not considered a taxable transfer according to Internal Revenue Code 1058.  IRC 1058 states that taxpayers who enter into a qualifying stock lending agreement receive non-recognition treatment with respect to any gain or loss at the time of the transfer of the securities.  This section provides an exception to the general income recognition priciples of Section 1001 of the IRC.  This is a common transaction in financial markets, and again, one of the many great benefits of Securities Based Loans.

What does the lender do with the stock during the loan period? Or, how do I know they will have the stock to return to me at the end of the loan?

These are good questions in today’s turbulent marketplace but we can answer them. The following examples explain how the lender protects its investment and the borrower’s interests over the course of the loan, through a sophisticated hedging strategy and model which it follows.

Options and Futures
The lender sometimes utilizes the option and the futures markets to position itself to return stock at the end of the loan period. The lender will buy an option contract which allows it to purchase a security at a set price at a future date. An option contract is an instrument that is guaranteed by The Options Clearing Corporation to deliver the shares on the future execution date. This strategy and model locks in the share delivery consistent with the loan maturity date. This provides a simple method to ensure the return of the securities at the due date but to also hedge against fluctuations in the value of the shares over the term of the loan.

Evolving Long Position
The lender sometimes utilizes an “evolving long position” approach which can be simply described as buying back a static number of shares per day over the term of the loan. For example, if the loan term is three years there are typically 756 market trading days in that time period. Depending on the nature of the security and its history, current performance, and analysis of approximately 100 technical indicators, the lender may choose to reduce its risk of market fluctuation by selling some or all of that stock position. If the lender sold 50 percent of 200,000 shares pledged for a loan, the evolving long position could be as simple as repurchasing 132 shares per day over the course of the loan. That strategy takes advantage of short-term variations in the market price to allow the lender to return the shares on a known and agreed-upon maturity date while at the same time reducing the risk of wide fluctuations in any one stock’s price.

Trading Spreads
Another method of hedging the risk of price fluctuations used by the lender involves trading the shares over the course of the loan term in a manner that is neutral to the share price in the market. The lender never trades in a manner to influence the price of any security. Small blocks of shares may be traded over short time intervals to take advantage of known and constant oscillation in all share prices. This relies on a proprietary algorithm model and system. The details of this trading platform and strategy are beyond the scope of this summary but it essentially follows the stock market’s natural oscillations and allows the lender to hedge its risk, protect its capital, and profit off of the movements.

Interest Payments
Interest payments generate a stream of income which also serves to hedge against risks associated with holding any particular stock. That revenue allows the lender to buy shares of option contracts to position itself for the return of the shares.

Liquidity
Because the value of securities such as stocks and bonds typically changes on a day-to-day basis (and in fact second-by-second in the real-time marketplace), the lender protects its loan and the borrower’s position by selling a portion or all of the securities to protect against the risk of the securities falling in value. Such a decline would diminish the security for the cash loaned to the borrower. A portion of the sale proceeds can be used to enter into hedge positions to further protect against any extreme price movements.

By converting some or all of the securities to a cash position, the lender has “hedged” itself against the erratic price movements in the security. For example, in the event of a downward price movement, the lender is protected against some of the risk associated with the loan of its cash. Likewise, in the event of upward price movement, the lender repurchases shares at favorable prices over the course of the loan period.

Defaulted Loans
From a macroeconomic level, each loan is part of a larger portfolio and when considered in light of modern portfolio theory, some shares increase in value and other decrease in value. As a result of that market activity, some borrowers elect to walk away from their non-recourse loan because they have more money than the stock is worth at some given time. The margin between the amount loaned and the retained value plays a role in hedging against the other positions. Recognizing these realities allows the lender to focus on developing a gradual long position on holdings that have a high probability of the borrower wanting the stock back at the end of the loan term.