“We were dramatically pushed to put these on all of our client accounts.”– Steven Dudash, former Wall Street broker.
Traditionally reserved for high net worth investors, securities based loans (SBLs) have become a popular offering for banks and brokerage firms. Given the right circumstance, SBLs can help satisfy the need for short term cash (bridge loan). SBL’s are not subject to painful underwriting scrutiny of traditional loans, rather the pledged collateral is stocks, bonds, ETFs, and mutual funds within an investment account. However, regulators are becoming increasingly concerned investors do not understand the risks of SBLs and are keeping a close eye on banks & brokerages that push these complex products (see FINRA & SEC issue warnings on securities based loans)
Securities Based Loans (SBL)– using one’s investments as collateral to secure a loan. SBLs have become big business for broker dealers and banks as share prices have climbed to all-time highs and interest rates have remained low.
Has record low volatility given borrowers a false sense of security?
Good Uses of SBL’s
Short-term loan– business owners with a future expected cash inflow might use a SBL to meet current obligations
Capitalize on time sensitive opportunities– SBL’s can be approved and funded without underwriting headaches of traditional loans (mortgage, HELOC)
Emergencies– see above
Poor Uses of SBL’s
Speculation – SBLs are “non-purpose” loans, meaning you can use the proceeds for almost anything (except buying stocks with borrowed funds). This is great for flexibility, but the borrower needs to be mindful of taking speculative risks.
Funding a lavish lifestyle– the rapid growth of SBLs has been compared to the home equity line of credit borrowing boom that contributed to the financial crisis. Borrowers are more likely to tap lines of credit if they believe the underlying asset will continue to go up in value.
Using it because it’s available– many advisors are paid handsomely to push these products without fully explaining the risks. Appreciating equity markets and lack of volatility can numb the borrower into a sense of false security (Wall St. advisors push SBLs).
Questions to ask before you borrow against your assets:
What are my interest payments based on (LIBOR + spread)?
When would my interest payment reset higher?
How volatile are the underlying assets that provide collateral?
What happens if my investment portfolio goes down in value and triggers a liquidation?
Do my dividend and interest payments automatically pay the SBL interest?
How does my broker/advisor get compensated for recommending an SBL?
Can I move to a new firm with an outstanding SBL?
Equity market appreciation, low interest rates, and lack of volatility have made securities based loans more marketable. Investors should understand the risks and range of outcomes before borrowing against their investable assets. In our opinion, selling securities outright to access capital is superior to borrowing against one’s portfolio.