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When Is Securities-Based Lending Right for Clients?

It's not for everyone, which is why it's the advisor's job to determine whether SBLs are appropriate.

By Zohar Swaine

It is becoming increasingly important for financial advisors to have a clearer understanding of how securities-based lending (SBL) products fit into a holistic wealth management advice offering. Though SBL is not for everyone, demand from high-net-worth investors, along with product innovations, mean that advisors cannot afford to dismiss this as a potential wealth management tool. Investors who want to use SBLs will find access to these products, even if their advisor does not offer it.

What is securities-based lending?

SBL products have been around for at least a decade. They are loans collateralized by the underlying assets in an investor's nonretirement brokerage account. The borrowing power, or loan-to-value, varies depending on the composition of collateralized assets, but a range of 50 to 90 percent is fairly typical.

SBL is not securities lending, which is transactional service that facilitates short selling.

SBLs are typically used for short-duration or temporary loan scenarios where short-term liquidity may be necessary, for example, bridge loans for making a down payment on a house, or paying estimated taxes to cover temporary cash-flow situations. Though they share some similarities with margin lending, SBL proceeds are restricted from being used to pay off existing margin-loan balances or for purchasing additional securities, and are designated as nonpurpose.

Compared with other loan products offered by banks and broker/dealers, SBL loans are still relatively undiscovered, but this is changing. According to a Mink Hollow Advisors survey of leading SBL providers, the market size of outstanding SBL loans is approximately $200 billion and growing rapidly. Compare this with margin-lending balances, which were at $550 billion as of July 2017, according to the latest NYSE report on margin data.

Today, the largest SBL programs are found at Merrill Lynch/Bank of America, Morgan Stanley and UBS, with many other firms offering the product as an accommodation. This is changing for a number of reasons. Broker/dealers with banking arms and those with bank-revenue sharing agreements are positioned to earn greater levels of interest-income revenues from SBLs and are exploring their options. Registered representatives going independent are asking for access to SBLs and have clients already using SBLs, which is driving independent broker/dealers and RIA custodians to accommodate these needs.

Why do clients want SBL products?

With the market at all-time highs, clients may be eyeing opportunities to leverage their portfolios without triggering capital gains and SBL loans offer a way to do so. Though these products may be best suited for short-term liquidity needs, there may be clients who want to use SBLs for other uses, which may come with added risk.

Consider: at nearly $13 trillion outstanding, U.S. consumer debt is at all-time high, according to the New York Fed's Quarterly Report on Household Debt and Credit. A significant percentage of this debt is based on prime rates and not LIBOR, which is about 300 basis points lower. SBLs are based on LIBOR, which makes them potentially appealing as a vehicle for debt consolidation. In fact, Mink Hollow research shows that SBL products are currently on average 200 basis points less expensive than margin loans at the same institution.

This is why input and guidance from advisors is critical. Advisors need to carefully evaluate the risks associated with SBLs against the cost of more expensive debt.

How is the competition using SBLs?

SBLs are generally aimed at high-net-worth individuals, but innovation may soon bring them within reach of mass affluent investors. Today, minimum-loan balances range from $100,000 to $250,000, but as automation continues to drive down costs, loan minimums may also drop. Goldman Sachs’ new SBL product specifically targets mass affluent investors through partnerships with broker/dealers and custodians such as Fidelity, and others are hoping to target this demographic as well.

In some ways, offering SBL products is similar to broker/dealers, custodians and some RIAs offering basic banking services. SBL offers advisors a distinct way to differentiate services and consolidate client wallet share. These lending solutions allow client assets to stay in-house, rather than be liquidated to go elsewhere.

Some advisors are leading with SBLs in order to attract new clients. With investment-portfolio alpha hard to come by, managing debt offers real value to clients in the context of a holistic wealth management offering. In an effort to increase borrowing lines and get assets in the door, some broker/dealers have priced SBLs attractively while others support their advisors’ ability to offer significant SBL rate concessions. Advisors with at least one large broker/dealer are able to discount rates up to 75 basis points, with the potential to discount even further.

What are the risks?

To be sure, securities-based lending carries credit and call risks and should not be considered a cure-all for all clients seeking debt-management solutions. The same inherent risks in margin lending affect SBL. Without proper monitoring of the pledged assets, a decrease in total account value or an asset-allocation change could trigger the broker/dealer calling in the loan, causing unwanted capital gains for clients. This risk is exacerbated when concentrated or single-stock positions are used as collateral.

Many firms offer SBLs with light credit checks, and in some cases, none at all. Past crises have taught us the perils associated with excess availability of credit. This means that advisors should do extra due diligence when determining whether SBL is right for a particular client, to protect themselves and their client.

Depending on the rules on the pledged accounts, an advisor's ability to manage and rebalance models properly could be impacted.

Holistic wealth management means having a full understanding of the tools that are available to balance both sides of clients' balance sheets. When it comes to considering SBL loans, it is critical that advisors appreciate the risks and properly screen clients in order to know whether it is appropriate to leverage this option.


Zohar Swaine is the founder and president of Mink Hollow Advisors, a strategy consulting firm for the wealth management industry. He can be reached at [email protected].

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