Do you find yourself struggling with how much of your portfolio should remain in stocks versus alternative investments, such as real estate, small business or lending? What if you didn’t have to choose? What if there were a way to hold on to some of your stocks and still free up cash to invest in other areas?
This is exactly the idea behind a new wave of stock loan programs being developed internationally.
Investors with stock-heavy portfolios seeking diversification are good candidates for stock loans. Stock loans can allow stock holders to borrow as much as 90 percent of the value of the stock, and they offer a great deal of flexibility.
Most have no margin calls, and the money can be used for anything except purchasing more stocks.
Stock loans are non-recourse loans, so the only collateral is the stock itself; the borrower’s credit and possessions are not at stake. The loan works as a built in hedge for the borrower’s stock; if the stock drops, the borrower can simply walk away. Borrowers can use the loans to diversify into other types of investments while maintaining many of the benefits of holding the stock.
How it works
Depending on the stock and the loan type, a borrower can get anywhere from 40 to 90 percent loan to value (LTV), according to Roel Hoekstra, co-founder of Global Stock Lending.
Stability, trading volume and price are factors in determining the LTV, Kerri Sheldon, marketing/PR manager for Triangle Equities Group, said.
The exchange on which the stock is traded also plays a role; stocks trading on major exchanges generally get from 75 to 90 percent LTV, Hoekstra said.
Stock loan companies may charge fees in the form of interest and loan origination fees. Origination fees are typically from 3 to 5 percent and interest rates for stable major stocks can vary from 4 to 11 percent depending on the type of loan, Hoekstra said.
Borrowers can make interest payments monthly or allow interest to accrue to maturity, adding to the balance of the loan on a monthly basis, Hoekstra said. Most borrowers pay off the interest at the end when they pay off the balloon style loan, he said.
All Global Stock Lending loans are written with the accrual option, and borrowers can decide whether to make interest payments, Hoekstra said. “It’s a very flexible program.”
Triangle offers loans from “two to 20 years, and the borrower determines what loan term they want,” Sheldon said.
The most popular loan lengths are two, three and five years, Hoekstra said.
Depending on the loan type, loans are usually at least $50,000 or $100,000, Hoekstra said. On occasion, he will make exceptions, but it takes the same amount of “time, effort and energy” to do a smaller loan, so most companies prefer larger ones, he said.
Stock loans are “a way to get liquidity from your equities today,” Hoekstra said. Loans can be funded quickly: within 24 hours or up to a week, depending on the company.
Most loans have no margin calls, so borrowers need not be concerned that their loan will come due before it is scheduled to do so. If the stock drops, the borrower is not responsible for coming up with the difference in value.
Borrowers can walk away from the loan without any credit damage or retribution from the stock loan company.
“There is no collateral other than the stock that the lender takes. So you don’t lose your house or your car or anything like that; it’s simply the stock that’s used as the foundation,” Sheldon said.
Borrowers have the freedom to use funds for almost any purpose they wish other than purchasing stocks, “whether they want to make home improvements, whether they want to put the money back into their company, whether they want to pay off debt,” Sheldon said.
Many borrowers use the money to invest in other ways and diversify their portfolios, with “real estate being one of the really good ones to balance the volatility of stocks,” Hoekstra said. Stock loans are a way for investors to fund riskier investments for which it is difficult to find financing, such as foreign real estate.
Stock loans allow stock holders to “use that cash elsewhere and still retain the full upside capital appreciation of the stock in the future,” Hoekstra said.
Borrowers are not selling the stock, so they receive many of the same benefits that they otherwise would, Sheldon said. For example, Triangle passes any dividends produced by the stocks on to the borrower.
Unless the borrower opts for a capped loan and agrees to set a maximum yearly percentage for potential appreciation, the borrower also retains full capital appreciation.
What happens to the stock?
During the course of the loan, most stock loan companies use hedging strategies to protect the stock and its value. The hedging strategy is agreed upon in the loan terms; borrowers are aware of the strategy being used with their stocks.
In the safest loans, the company insures the stock position and has a guaranteed buyer for that amount at a specific time in the future.
“Once we’ve insured the possession, we have essentially created a fixed asset from a variable asset, and then we access our line of credit, borrow cash against the fixed asset and give it to the borrower,” Hoekstra said.
Other hedging strategies can include staying long on the stock and actively trading the stock, Hoekstra said.
Because the stock loan company generally uses a hedging strategy with the stock, many loans have fixed lengths. Depending on the hedging strategy, borrowers may not be able to pre-pay the loan. Those who are allowed to pre-pay could face penalties.
Choosing a company
The biggest risk for borrowers lies in choosing a dishonest company. In order for a stock loan company to provide a loan, the borrower must transfer the stock shares over to the stock loan company. The company then funds the loan within a short period of time.
“The risk is that you give me your shares and I don’t…give you any cash, and I sort of disappear,” Hoekstra said. The other risk is that “you come to pay off your loan and I don’t give you your shares back because I’ve disappeared,” he said.
There is no official accreditation in any state other than California, so “it doesn’t take much to…hold yourself out there as a stock loan provider,” Hoekstra said.
For this reason, choosing a company with a solid track record is crucial. Borrowers should look for a company that will explain the pros and cons of its products and that is open with its track record and references, Hoekstra said. “Always check references….I wouldn’t do business with somebody that didn’t give me references.”
Sheldon recommended looking for a company that provides a timely response on rate quotes and that has “everything spelled out” for borrowers. Borrowers should learn how the company monitors the stock activity and watch for hidden fees and closing costs, she said.