Securities-Backed Lines of Credit: Low Interest Rates with Big Risks
Securities-backed lines of credit (SBLOCs) allow investors to borrow money using their investment portfolios as collateral. Investors borrow money either from the firm or an affiliated bank. Firms market SBLOCs as a way for investors to get liquidity out of their investments without selling any securities.
In 2015, the SEC issued an investor alert on Securities-Backed Lines of Credit. Securities firms had begun offering increased numbers of SBLOCs to investors, with some firms reporting increases in securities-based lines of credit as large as 50% to 70%. That trend has continued, and Bank of America reported issuing approximately $62.4 billion in securities-backed loans in 2021. This makes SBLOCs more popular than home-equity lines of credit.
How Does an SBLOC Work?
- The securities in the account serve as the collateral for the loan.
- SBLOC contracts specify the total amount you may borrow. This amount depends on the value of the securities in your account. Typical SBLOC loans range from $100,000 to $5 million.
- The interest on an SBLOC can fluctuate and is calculated daily, although some firms offer fixed rates.
- SBLOCs are revolving lines of credit. You can borrow the entire amount, or borrow money as needed, up to the amount of the limit.
- Firms usually have investors pay monthly interest.
- Investors can still buy and trade securities in their accounts as usual.
- The firm provides checks so investors can withdraw from their SBLOC accounts. Borrowers may also use electronic funds transfers, ACH payments, and electronic funds transfers.
Securities-Backed Loans of Credit Pose Substantial Risk
Brokers should carefully review these risks associated with securities-backed lines of credit. Investors should know that securities-backed lines of credit only work in their favor when the market is producing strong returns. When the market experiences volatile price changes, investors risk amplifying their losses with SBLOCs.
Broker Misconduct and Securities-Blocked Lines of Credit
Brokers often receive commissions for selling SBLOCs. This increases the likelihood that a broker may recommend SBLOCs that are not in their investor’s best interest. If you become embroiled in a dispute with your broker and the brokerage firm, your securities-backed lines of credit make it more difficult to switch to another firm. You cannot simply switch your SBLOC from one firm to another without the possibility of incurring significant losses or exposing yourself to potential liability.
Securities in your portfolio may decline in value to the point they can no longer serve as collateral. At that point, your brokerage firm may call you to let you know you must post additional collateral or repay the loan, typically within a very short timeframe of two to three days. If you do not make the required collateral payment, the firm can liquidate your securities to satisfy the maintenance call.
To make matters more uncertain, your firm can decide which securities in your portfolio can be used as collateral. If the firm decides one of your securities is no longer viable collateral, they may change your credit limit. You could also be required to deposit more collateral into your account.
- When that happens, you may end up paying more in interest for your SBLOC than you are earning on your portfolio, resulting in a net loss.
- If your investments lose value, your lender might use your securities to get their interest payment.
- Do you have investments that pay dividends? Make sure you know if the SBLOC will keep your dividends as repayment on your loan.
- If you have a money market account in your portfolio, the interest charge might come out of your redemptions.
Tax Consequences of SBLOCs
One of the main risks presented by securities-backed lines of credit are the unintended tax consequences. If your SBLOC liquidates securities to make interest payments. Those liquidations might lead to capital gains tax.
Interest Rates Can Rise
Interest rates for SBLOCs usually depend on the London-Backed Offered Rate (LIBOR). If those rates go up, your SBLOC rates will be affected.
Why Do Investors Like Securities-Backed Lines of Credit?
Securities-backed lines of credit may seem attractive as they often offer lower interest rates than regular personal loans from a bank. They also offer flexible payment terms. In a bull market, securities-backed loans could seem like the best deal on the market for a loan. SBLOC lenders are not always required to run a credit check—the amount of the loan often only depends on the value of the securities in your account.
- Investors who get SBLOCs expect their investments to appreciate at a rate that will outpace the interest rate.
- Investors are free to pay the outstanding balance whenever they want to — either the entire outstanding balance or part of the balance.
- Debt from a securities-backed line of credit generally does not show up as debt on a credit report.
A Wall Street Journal article entitled “Buy, Borrow, Die” highlights the role that SBLOCs play in many billionaires’ wealth strategies. Heirs do not have to pay capital gains tax on an inherited portfolio of stocks until they sell a security. If they inherit a portfolio and use it for low-interest loans, they can use it as a source of liquidity without selling the securities, thus avoiding any capital gains and allowing the securities to continue to appreciate.
Make Sure You Understand the Terms of Your Loan
Investors may feel tempted to borrow huge amounts with their SBLOC. Banks will often allow investors to borrow as much as 50% of the total value of their portfolios. This can result in huge interest payments when the portfolio’s value declines.
Who is the Lender?
Firms often offer securities-backed lines of credit through a third-party lending institution. Your brokerage firm might not know the complete details of of your loan. Make sure you get information from the actual lender.
Investor Lawyers for SBLOC Claims
Brokers may not make the terms of your loan clear. Investors should do research independently, but brokers may purposefully omit important information or misrepresent investors. If you believe your broker recommended you an SBLOC that led to losses, contact an investment attorney to review the potential merits of your claim.