Securities Based Financing – The Missing Piece in Most Financial Planning

Securities-based Financing – Education Corner

The Missing Piece in Most Financial Planning

Whether you’re a buyer, a broker, or a seller, “the close” is always the most important part of a successful transaction. This is the part where the thing is bought, the act is done, and (hopefully) everyone goes home with a big smile on their face.

That would be perfect. In reality, it usually takes a lot of blood, sweat, and yes, even tears to get to that point. That’s because financing big business, franchise, or commercial real estate investments has become a lot more complicated and time-consuming, despite what some bank ads may tell you.

We can blame the mortgage meltdown and the resulting financial crisis, as well as the mountains of new rules that now cover the whole financial industry and don’t seem likely to go away any time soon. But a few people with a lot of initiative have stepped up to fill the funding gap left when lending takes too long or isn’t enough. Securities-based financing, which are basically loans against stocks, bonds, mutual funds, or other fungible, marketable securities, are now a very useful tool in this area. I’ll explain why in a minute.

. In reality, getting to that point more often than not requires a lot of good old blood, sweat and yes, even tears. That’s because financing major business, franchise, or commercial real estate investments has become not simpler (despite what some bank advertisements may be telling you) but a good bit more complex and time-consuming.

We can thank the mortgage meltdown and the ensuing financial crisis for that and the reams of new regulations hovering over the entire financial industry — with little promise of slackening anywhere in sight. But into this void a few enterprising souls have ventured to fill the financing gap left when lending takes too long or is not enough. Securities-based financing – essentially loans against one’s stocks, bonds, mutual funds, or other fungible, marketable securities – are now a very viable tool in this regard. I’ll tell you why in a moment.

First, A Retail Stock Loan History Lesson

Companies like mine, A. B. Nicholas, have made it common for people to get good, solid, licensed loans using their stocks or bonds as collateral. But it wasn’t always like this, not even close.

Back in the late 1990s, the “nonrecourse stock loan” was created. In these loans, the client gave full ownership to the lender, who was usually private and not a FINRA member, but often had academic credentials. The lender then gave the client a loan for up to 90% of the value and charged interest on the remaining principal. They were called “nonrecourse” stock loans because the client could quit the loan at any time and use the portfolio to pay off the debt. Everyone thought it was great. The idea was loved by brokers. Sales went up.

But the “nonrecourse” stock loan turned out to be little more than a sale of securities, as tax courts ruled in 2010. That’s because the lenders would sell the securities in the portfolio once they got full title and ownership of it. This way, they could keep the difference between the loan money they gave the client and the loan-to-value. So, a 90% stock loan would end up giving the lender a 10% return. On top of that, interest would be paid, and if the stock price went down in the meantime, clients were likely (and encouraged by the lender so they wouldn’t have to return the shares) to walk away, using their “nonrecourse” rights and locking in the lender’s profit at 10% or more with no further obligation to return anything to the client.

At the very least, it’s a risky business.

If the client insisted on paying off the loan instead of leaving, that was fine with the lender as long as the portfolio was worth the same or less when the loan was paid off. If the amount paid back was more than what it cost to buy the stocks back on the market, the lender would get a second windfall by keeping the difference between how much it cost to buy the stocks (at a lower price) to give them back to the client and how much the client had paid to get his shares back. This did not happen very often, though. Most clients used their right to leave.

The Floor Falls Out

When many clients’ collateral stocks went up in value, like when oil prices and related stocks went up right before the 2008 recession, these companies lost their floor. When clients saw this, they wanted the more valuable stocks back and gladly paid back their loans in full.

But the amount the client had to pay back was not enough to cover what it would have cost the nonrecourse stock loan lender to buy the shares back from the market, since the price would have gone up.

So, the amount the client paid to pay back the loan wasn’t enough to cover the cost for the lender to buy them back from the market. Now, these lenders had to pay for the difference between what the client had paid and how much it cost to buy back all the shares the lender had already sold to pay for the “loan” (actually a sale, said the IRS tax court, since the stocks were sold to generate the funds for the “loans”).

One by one, these nonrecourse stock loan firms went out of business because they had to manipulate and lie to the brokers who sent them new clients (“everything’s fine,” “we’ve hedged all the stocks, no worries,” “bring ’em on,” etc.) to keep getting enough new clients and stocks to make enough money to return stocks to clients who had already paid off their loans and expected to get them back quickly. More clients meant more sales, but the lenders made less or no money because they used the money from one sale to buy back shares to give to people who had paid off their loans and were waiting. A bad thing about to happen.

Before long, many innocent people got caught up in what amounted to a Ponzi scheme, where new loan clients had to pay off the ones who had already paid off their loans. Due to the sale of their securities, which they had reported as loans based on the lender’s promises, many of these unfortunate clients got new tax bills.

The Institutional Stock Loan Was Alive But Limited 

Today, thankfully, almost all “nonrecourse stock loan” lenders are long gone, and many of their former owners are in jail for a wide range of crimes, most of which involved telling brokers and clients outright lies about selling and hedging their clients’ securities. By not being honest with both the client and the broker, these lenders denied both parties the full information they needed to make an informed decision about whether or not to move forward with this kind of financing for their clients. Because of this, they were doomed to fail.

Major brokerages have always had some kind of credit line program for their best clients with a lot of money. For example, a typical “margin loan” was a loan of credit to buy more of the same stock and put more buying power to work. But it came with a lot of risks, didn’t give a lot of loan value, was very expensive, and wasn’t meant to be used for business or real estate investments, but to buy more stocks. Still, it was done through licensed institutions and there was no sale to fund. All of these institutions were also members of the SIPC and FINRA, which are two of the most important organizations that make sure institutions are honest.

A Client-Informed Idea Takes Root

Something fresh was needed as loan windows closed even for high-credit borrowers. In the wake of the financial crisis, I considered starting from scratch and targeting the franchise and commercial real estate markets, which were hurting. The objective was to open our eyes to whatever it took to help these key markets get through the financial cyclone and potentially develop a new financial connection with a major licensed institution that could be beneficial afterwards. Many ideas were investigated. Most had no upside for our target clients—until we explored the old securities loan idea in depth by starting with its most fundamental qualities and rebuilding from there.

How might we make a stock loan that was the opposite of “nonrecourse” stock loans? How would this financing program work? How could a stock loan product meet these niche markets’ needs for a competitive, low-cost, low-doc financing solution while also being legally compliant?

Safety first. A large SIPC-member bank and its FDIC-member banking division would oversee the product. There would be full credit line responsibility. Lender advising and management could only be done by those having perfect FINRA records and all necessary licensing (e.g., Registered Investment Advisers, Certified Financial Planners, etc.)

The clients’ stocks could only be held in an account owned by the client alone—no joint ownership, third-party ownership, or “beneficial” ownership—like any major U.S. online brokerage account at Charles Schwab or TD Ameritrade. Same. The lender’s only recourse would be a lien on the account. No securities sale could ever finance the line of credit.

The safety and security needs were vital. If the product wasn’t competitive and market-specific, none of that would matter.

Our Assembled “Wish List” for Securities Based Financing:

  • Our franchise and commercial real estate clients wanted reports, data, and status for their accounts any time, day or night online.
  • They insisted on rates below the best mortgages and loan-to-value better than anything available retail. Cost and cash-on-hand were two huge factors for our clients.
  • They wanted full freedom to trade in the account in while the portfolio secured their financing, as long as the collateral value remained sufficient to cover the outstanding principal.
  • Interest-only repayment was a must, in a revolving stock loan credit line with no term maturity date, much like a home equity line, to put maximum control in the hands of the client, not the bank/brokerage. If they wanted to defer interest payments and place it back on the loan so they’d have no payments to make for a while while preserving their new businesses’ cash flow, that would be important.
  • They wanted a partnership with the lending organization, in essence an opportunity to develop a financial relationship through this “back door” method that would also put the client potentially at the front of the line later for preferred conventional business financing if they began with their credit line.
  • They said no to mandatory lender account management fees: after all, they said, “We’re looking first and foremost for financing here, not brokerage advisory services.” So account management fees would need to be waived.

And much more. 

A. B. Nicholas struggled for a year to meet that lofty aim. Hundreds of brokers and advisors at big and minor licensed institutions interviewed for the job insisted on charging fees, reducing loan value, or raising rates. We were often told we were unreasonable. We even considered abandoning our “wish list” at one point.

A New Financing Option

However, persistence pays. We “got it” in a big licensed U.S. brokerage and banking institution. We found the right person who  recognized market needs. LeverageLine by A. B. Nicholas was created.

Thus, we began offering this new securities finance program to our clients. Though it was initially difficult to break through the “never heard of it” and “not invented here” barriers, our unique, wholesale securities-based financing option became a mainstay not only for those seeking to fund their projects outright but also for those simply needing additional cash to supplement their resources without having to sell their securities.

Our modern, secure, regulated, no-title-transfer stock loan has proven its worth: net loan value has climbed at least 10% per year and is becoming known as a business-friendly securities lending program. We now have four key institutional partners offering our clients the LeverageLine securities-based financing solution.

A Solution Nobody Knew Was There

With these traits, it’s clear that securities financing is a way to solve immediate problems—lots of them, every week, for a wide range of business and real estate investors.

Over the years, we’ve built a great reputation for solving difficult problems quickly and cheaply for first-time franchise, business-buying, and commercial real estate clients. This has earned us praise from the industry as a whole and from many individual clients as well. We are very happy and proud to see their businesses grow and succeed, knowing that LeverageLine was a part of that.

Today’s Securities Based Financing Can Fill the Gap Well

Take a recent client who needed to refinance her two commercial real estate properties but didn’t want to sell her stocks and bonds. If she did, she would have to pay a big capital gains tax and miss out on any future growth in her assets in a well-chosen portfolio with good long-term growth potential. On top of that, she kept her portfolio because it was something that her father had given to her.

Even though she had a perfect credit history, the bank wouldn’t lend her anything close to what she needed to finish the refinancing. This was because she already had two real estate loans out for other properties, and the recession had made it harder for everyone to get loans. But she needed the financing quickly. Waiting 45–90 days for SBA or bank financing approval, along with the huge amount of paperwork, detailed asset review, and tax returns, and with no guarantee of financing in the end, would leave her with another huge high-interest payment on her property, even if she got the financing in the end. But by that time, the property was probably long gone anyway. She needs the money right away. On top of all this, she needed more money for overhead costs, which would have used up most of her remaining cash if she didn’t have more.

Our securities lending network came to the rescue right away. Within a week, she got out of her expensive 7.9% loans and into our friendly, clear, and easy 2.24% APR interest-only credit line. She can pay back the principal whenever she wants, since there is no set date for it to be paid off and no penalties for paying it off early. Also, because her portfolio was big, this is a very big way for her to save money. The loan is not reported to credit bureaus either, since it is a private asset-based loan between the institution and the client. This means that it has no effect on her credit rating. Later, she wants to build credit for the business by putting the loan in the name of the business and setting up a Dun & Bradstreet credit file for it with the help of her LeverageLine brokerage. This is a normal and standard service for a lending institution with expert advisors we’ve chosen for their experience with our target markets.

Even though she took money out of her portfolio and put it into her growing business, it is still making her money today. She has more money, her costs are lower, and she started a relationship with a big institution “through the back door” (via ABN), which often sends its clients to that lending institution, so she got better service right away. On top of that, she found out from her licensed accountant that she would get some tax breaks because she was using the money from her credit line to make direct investments in her business and hadn’t sold any stocks in the process. (Note to readers: Always talk to a licensed tax professional ahead of time about whether you can deduct loan interest in your particular case.)

This focused, modern version of securities based financing is flexible, safe, licensed, and managed by and through one of four brokerage and banking institutions with “household names.” It is simple, easy, and quick, and A. B. Nicholas has built in a number of extra benefits just for our clients.


Is securities-based financing something that could help you? It’s true that sometimes other programs may be better. There are also some rules about who can be eligible. For example, you would need securities that are not part of an IRA, trade for more than $5 per share, were worth at least $80,000 at the start, and were not restricted. In other words, the asset must have value as unencumbered collateral. Pre-existing margin loans can be easily paid off by your lender ahead of time, but the assets themselves must qualify.

This iteration of financing using one’s securities can be a lifesaving option that prospective business buyers would be hard-pressed to ignore.

-Dan Stafford, Founding Partner

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