Securities Based Lending - An Alternative Source of Funding

You may have heard the term "stock loan", "stock-secured financing" or "securities based lending". All of these refer to the type of lending program where the borrower's securities (stocks, bonds, mutual funds or t-notes) are pledged as collateral for a loan. These are "non-purpose" loans and no lien is placed upon any asset such as real estate or personal property. The securities alone stand as collateral for the debt. Proceeds of the loan may be used for any purpose except to purchase or carry other securities.

Interest rates for these programs are usually between 2.5% and 4.5% and the loan-to-value ratios offered may be as high as 80% of the securities value. The factors that determine the rate of interest and the amount of the loan are how actively traded and liquid the securities are on the open market. The loan term is typically between 3 and 10 years with a fixed interest rate and "interest-only" payments due to the lender. Funding can take place in just a matter of days. A credit report is not required nor is any income or employment verification done.

Not all types of securities may be used as collateral. The securities must be able to be "free traded" without any restrictions. Retirement funds (401k's, pensions, etc), do not qualify for this type of program. (There are other lenders, who can lend against, nano, pink sheet, bulletin board, restricted and big board stock, Treasuries, ETFs).

These are also "non-recourse" loans so if the borrower does not make the interest payments when due or fails to repay the principal at the end of the loan term, the lenders only option is to keep the securities that were pledged as collateral. Should a loan default occur the loan is canceled and the borrower keeps the money received from the loan and the lender keeps all interest in the securities. The loan default is not reported to any credit bureau or placed in public record.

The loan application process is quite simple and should take just a few days to complete the loan process and receive the funds. To start, the borrower supplies the name and number of shares that they wish to pledge along with the loan amount and term desired. The lender will then do a preliminary examination of the loan request and based upon an assessment of risks they will determine the loan-to-value ratio along with a proposed interest rate.

The terms are offered to the borrower and upon agreement by both parties the loan documents are drawn up and arrangements are made for the securities to be transferred to a holding company. A final value is then given to the securities based on an average of the closing price of the collateral for three consecutive market days. This is called the "strike price". The borrower then transfers the ownership of the securities to the lender. The borrower still retains all beneficial interests in the securities and will receive any dividends or interest that accrues from the securities during the term of the loan.

At the end of the loan term the loan may be renewed, refinanced or paid off. If the loan is paid in full at the agreed upon term the exact number of shares or collateral initially pledged is returned to the borrower. One important point is there is a "lock-out" for the term of the loan which means the borrower may not make any principal reduction payments or pay off the loan entirely until the end of the agreed upon loan term.

If during the term of the loan the value of the securities falls below the agreed upon minimum fair market value (usually 80% of the loan amount) then the loan would be considered in default. (There are other lenders who will care even if the stock value goes down to zero) The contract may require the borrower to contribute additional cash or shares as more collateral to keep the loan out of default. The decision to move forward is solely up to the borrower. Remember, that this type of lending is non-recourse, so should this type of shortfall occur the borrower may stop making the payments and simply walk away from the loan and forfeit his collateral with no penalty or recourse from the lender.

When choosing a lender here are a few items the borrower may want to consider prior to entering into this type of arrangement:

oHow long has the company been in business?

oWhat are the backgrounds of the principals in the company?

o What assurances can the company give that the full amount of collateral will be returned to the borrower upon completion of the loan term?

oWhat is their track record of returning the pledged collateral to the borrower at completion of the loan term?

oDoes the lender have past client references that the borrower can speak with?

So if a borrower has securities that would qualify for collateral and would like to borrow funds at a low fixed interest rate then this may be a viable option with these benefits and drawbacks:

Benefits

oLow fixed interest rate

oInterest-only payments

oNo liens on any other asset

oQuick funding

oNon-taxable event

oNo credit check

oLoan is not reported to the credit bureaus

oNo verification of income or employment

oNo closing costs, broker or transaction fees

oNon-recourse loan

oBorrower receives dividends or interest that may accrue from the securities during the term of the loan

oAt the end of the loan term the exact number of shares or collateral initially pledged is returned to the borrower

Drawbacks

o Lock Outs - no early loan pay off is allowed (There is another provider has no lock out clause, however the rates are variable)

These loans are a "qualifying stock lending agreement" and therefore a non-taxable event with respect to any gain or loss at the time of the transfer of the securities. But as in any major financial transaction the borrower should consult with their tax adviser prior to entering into any agreement that may have a tax consequence.

The typical minimum loan amount is $100,000 and there are no maximum loan limits. In today's tightening credit markets Securities Based Lending offers a funding option that may be worth exploring.

There are lenders who will accept these forms of collateral.

-US Treasury Notes/Bills

-US Treasury Bonds/Strips

- Fannie Mae & Ginnie Mae CMO's

- Federal Home Loan CMO's

- Free-trading U.S. Stocks

- US Government Agency Bonds

- Municipal Bonds

- Corporate/Non-convertible Bonds

- Foreign Sovereign Debt

- Convertible Bonds

- Exchange Traded Funds

- Unit Investment Trusts

- Variable Rate Demand Obligation

- Warrants

For Information only. "Not an offer to buy or sell securities. No tax, insurance, or financial advice of any kind is provided. Please consult with a licensed professional for guidance on any of these matters. All loan program information is understood to be true and accurate at the time of this publication."

Karna Hoskote MBGM Capital Inc

About the Author Karna has been in the lending business for over 3 years. Focusing in alternative finance solutions. He may be contacted at MBGM Capital Inc, 312-628-7366 or Khoskote@commercialfinances.net. The website is http://www.commercialfinances.net.