What Is Securities-Based Lending?

Securities-based lending—sometimes referred to as SBL—is the practice of making loans using securities as 澳洲幸运5官方开奖结果体彩网:collateral. Securities-based lending is a way to access capital that can be used for almost any purpose, such as buying real estate, purchasing property like jewelry or a sports car, or investing in a business. The key restrictions on this kind of lending are similar to other securities-based transactions like buying shares or repaying a 澳洲幸运5官方开奖结果体彩网:margin loan.

Understanding Securities-Based Lending

Generally offered through large financial institutions (sometimes working with third-party lenders) and 澳洲幸运5官方开奖结果体彩网:private banks, securities-based lending is mostly available to people with wealth who have valuable, liquid securities but insufficient cash on hand to meet some short-term spending goal. People tend to seek out securities-based loans if they want to make a large business 澳洲幸运5官方开奖结果体彩网:acquisition or if they want to execute large transactions like real estate purchases. Speedy access to cash is often a priority🌠. Such loans may also be used to cover tax payments, vacations, or luxury goods.&nb🦩sp;

Here's how the process works. Lenders determine the value of the loan based on the borrower's overall investment 澳洲幸运5官方开奖结果体彩网:portfolio and on the amount of credit extended. The more credit—and thus the higher the value of the securities pledged as collateral—the lower the rate charged by the financial firm. In some cases, the issuer of the loan may determine eligibility based on the 澳洲幸运5官方开奖结果体彩网:underlying asset.

It’s important to note that the lender may insist on collateral consisting of U.S. Treasury notes, whose maturities range from two to 10 years, rather than stocks. Treasurys are among the most liquid and lowest-risk fixed-income securities in the world. Once approved, the borrower's securities—the collateral—are deposited into an account. The lender becomes a lienholder on that account. If the borrower defaults, the lender can seize the securities and sell them to recoup its losses.

In most cases, borrowers can get cash within just a few days—sometimes within 24 hours. The process is also relatively cheap; the rate borrowers are charged is generally variable based on the 澳洲幸运5官方开奖结果体彩网:Secured Overnight Financing Rate, or SOFR. This rate mainly replaced the 澳洲幸运5官方开奖结果体彩网:London InterBank Offered Rate (LI🐷BOR) for SBLs in 2023. Interest rates for SBL are typically about two to three percentage points above SOFR, dependin🌳g on the amount of collateral pledged.

Also known as securities-based borrowing or nonpurpose lending, securities-based lending has been an area of strong growth for investment banks since the 澳洲幸运5官方开奖结果体彩网:global financial crisis of 2008. In fact, securities-based lending accounts and balances have surged since 2011, facilitated by the steady riಞse in equities and record-low interest rates. Such creౠdit is popular because it tends to be easier to obtain and requires far less documentation than a traditional loan.

Securities-Based Lending vs. Securities Lending

Securities-based lending is separate and distinct from 澳洲幸运5官方开奖结果体彩网:securities lending. Securities lending is the act of loaning securities to anღ investment company or bank. Examples include stocks or other derivatives. While securities-based lending involves using securities as collateral for a loan, securities lending requires collateral in the form of cash or a letter of credit in exchange for the security in question. Securities lending normally doesn't involve individual investors. Instead, it takes place between i🦩nvestment brokers and/or dealers who complete an agreement that outlines the nature of the loan—the terms, duration, fees, and collateral.

Advantages and ꦓDisadvantages of Secu💃rities-Based Lending

Advantages

Securities-based lending has a number of benefits for the borrower. It circumvents the need to sell securities to raise cash. So investors retain their securities, which enables them to continue pursuing their investment strategy. Avoiding the sale of their securities also enables them to avoid triggering a 澳洲幸运5官方开奖结果体彩网:taxable event.

As noted above, SBL offers access to cash within a couple of days and with a great deal of repayment flexibility. Also, interest rates that lenders charge are often much lower than 澳洲幸运5官方开奖结果体彩网:home equity lines of credit (HELOCs) or second mortgages. Securities-based lending also provides benefits to the lender. It offers an additional and lucrative income stream without much additional risk. The 澳洲幸运5官方开奖结果体彩网:liquidity of securities used as collateral and the existing relationships with typically 澳洲幸运5官方开奖结果体彩网:high-net-worth individuals (HWNIs) who use the SBL service also mitigate much of the credit risk asﷺsociated with trad♕itional lending.

Disadvantages and Risks

There are also risks to SBL. One is a decline in the 澳洲幸运5官方开奖结果体彩网:collateral value. That can happen if, amid market volatility, the value of a borrower’s pledged securities falls below levels stipulated by the lender. In that event, the borrower may be required to pay down their debt or put up additional eligible securities. Otherwise, the lender may be allowed to sell some or all of the borrower’s securities. Because of that market risk, SBL is safest when used for short periods. Its risks are most likely to be justified only when the borrower needs a lot of cash quickly, such as amid an emergency or for a 澳洲幸运5官方开奖结果体彩网:bridge loan.

However, securities-based lending can be a win-win for borrowers and lenders under the right circumstances. Because it is a tool for borrowing while sidestepping the highest interest rates, it is no surprise that the popularity of securities-based loans rose as U.S. interest rates climbed in recent years. The cumulative value of outstanding SBLs peaked at $174.7 billion in the third quarter of 2022, according to the Federal Reserve. U.S. interest rates peaked roughly one year later. But interest rates are now subsiding, a trend anticipated by investors and borrowers. Not surprisingly, demand for SBLs also seems to be waning; SBLs outstanding totaled just $138 billion as of the end of the first quarter of 2024.

Securities-based lending is not tracked by the 澳洲幸运5官方开奖结果体彩网:Securities and Exchange Commission (SEC) or the 澳洲幸运5官方开奖结果体彩网:Financial🐎 Industry 🔴Regulatory Authority (FINRA), though both continually warn investors of the risks involved in this market. For example, in April 2017, Morgan Stanley settled a case in which Massachusetts' top securities regulator accused the bank of encouraging brokers to push SBLs in cases where it wasn't needed and ignoring the risks involved.

Example of Securities-Based Lending

Let's say an individual wants to do a large renovation on their home, to the tune of $500,000. They first reach out to their bank for a standard loan for the full amount and the 澳洲幸运5官方开奖结果体彩网:annual percentage rate (APR) quoted is 5%. However, since this person has a stock portfolio of 澳洲幸运5官方开奖结果体彩网:blue-chip companies worth $1,000,000, they caꦅn pledge those securities 𓆉against the loan and receive a better interest rate with an APR of 3.25%.

The lender sees the pledged securities as another layer of protection and thus offers a much lower 澳洲幸运5官方开奖结果体彩网:interest rate for that protection. The borrower likes this scenario because the stock portfolio allows them to borrow at a lower rate while keeping the stocks invested. The investor also receives the loan quicker than th💞ey would have with a standard loan.