After the Great Recession of 2008, large brokerage firms that were searching for ways to rejuvenate their revenues expanded their service offerings to include securities-backed lines of credit (SBLOCs). As a recovery took hold at that time, many investors began to realize solid returns and growing portfolios. Brokerage firms correctly estimated that these factors would increase investor comfort in the leveraging of their portfolio assets. Those firms fine-tuned their SBLOC offerings to enable investors to access the cash liquidity in their portfolios without having to sell any portfolio assets.

 

Unlike stock loans that pay the net principal balance of a loan to a borrower, SBLOCs are typically structured as revolving lines of credit with specified borrowing limits. The borrower can continue to buy and sell securities in an account that holds pledged collateral. In most cases, the borrower is only required to make monthly interest payments against the total borrowed amount. The borrower can also pay down the outstanding loan balance and borrow additional funds at a later date as long as the SBLOC remains open. In this sense, SBLOCs offer investors more flexibility than a stock loan that has a specific term and a defined maturity date.

 

SBLOCs also share several features with margin loans that investors use to finance their stock purchases. SBLOC funds have no use-of-funds restrictions other than limitations on purchases of additional securities.

 

 

The securities-backed lending industry has expanded to include banks, financial advisory firms, and other third parties as SBLOC lenders. In each case, the borrower and lender execute an agreement that specifies the maximum amount that may be borrowed and the investment assets that will secure the credit. Depending on the blend of assets in an investor's portfolio, an SBLOC lender will set borrowing limits from 50% to 95% of the then-current aggregate value of those assets. Most lenders will not establish SBLOCs for a borrower whose portfolio is valued at less than US$100,000. Because SBLOCs are essentially complex transactions that involve publicly-traded securities, quality lenders will only offer them to individuals, corporations, and foundations that can qualify as accredited investors.

The investor's primary risk with an SBLOC is a significant reduction in the value of the collateral that secures the loan or a jump in prevailing interest rates. Either of these can require the borrower to deposit additional collateral to secure the SBLOC. If the borrower is unable to make that deposit, the SBLOC agreement gives the lender the right to liquidate a portion of the borrower's portfolio, in which event the borrower will likely face capital gains tax consequences.  Borrowers should always consult with their individual tax, legal, and accounting advisors before they execute an SBLOC agreement to understand the full implication of the risks that they are accepting.

 

SBLOCs and other forms of securities-backed lending are valuable tools that investors can use to draw liquidity out of otherwise static portfolio holdings. No tool is effective, however, unless the investor has the knowledge and expertise to use the tool properly and to its maximum advantage. Further, securities-backed lending will be most appropriate when it is used as part of a broader wealth management strategy that is specific to each investor and his or her unique financial goals and strategies.