Securities Based Financing – The Missing Piece in Most Financial Planning

Securities-based Financing – Education Corner

The Missing Piece in Most Financial Planning

Whether you are a buyer, broker, or seller, the key piece of any successful transaction is always “the close” — and that means the part where the thing is purchased, the act is done, and (we all hope) everyone heads home with a huge smile on their face.

That’s the ideal. 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

Good, solid, licensed financing using one’s stocks or bonds as collateral is now customary through the efforts of companies like mine, A. B. Nicholas. But it was not always so, not by a long shot.

Back in the late 1990s we saw the birth of the “nonrecourse stock loan”. These were loans in which the client transferred actual ownership – lock, stock, and barrel – to the lender (usually a private, non-FINRA member but often with academic credentials) who then gave them a loan for up to 90% of the value and charged interest on the outstanding principal. They were “nonrecourse” stock loans because the client had the right to walk away from the financing at any time and sacrifice the portfolio as repayment of the debt. Sounded great to everyone. Brokers loved the idea. Sales took off.

But the “nonrecourse” stock loan turned out to be, as tax courts ruled in 2010, little more than a sale of securities. That’s because the lenders would sell the securities in the portfolio once it was transferred to the lender’s full title and ownership, allowing the lender to pocket the difference between the loan funds they gave to the client (as a result of the sale) and the loan-to-value. Thus, a 90% stock loan would get the lender a 10% payday in effect. On top of that, interest would be paid, and if the stock price went down in the interim, clients were likely (and encouraged by the lender so as to absolve them of further responsibility to return the shares) to walk away, exercising their “nonrecourse” rights and thereby locking in the lender’s profit at 10% or more with no further obligation to return anything to the client.

Risky business at the very least.

If the client insisted on paying off his loan rather than walking away, that was fine as far as the lender was concerned too – as long as the portfolio was worth the same or less at payoff time. If the amount repaid was more than what it cost to buy the stocks back in the market, the lender would get a second windfall, pocketing the difference between the cost of buying the stocks (at the lower price) to return to the client and the amount of repayment money the client had paid to get his shares back. This was rare, however; most clients exercised their right to walk away.

The Floor Falls Out

The floor fell out of these companies when many clients’ collateral stocks rose in value, as when oil prices and related stocks rose just prior to the 2008 recession. Seeing this, clients naturally wanted the more valuable stocks back and were happy to repay their loans in full.

But the amount the client was required to pay their loan off was insufficient to cover the nonrecourse stock loan lender’s cost of buying them back from the market, because the price would have gone up.

The amount the client was paying to repay the loan was therefore insufficient to cover the lender’s cost of buying them back from the market and now the reverse befell these lenders: now they had to reach into their own (usually limited) pockets for the difference between what the client had paid and what it cost to buy back all the shares the lender had already sold to fund the “loan” (actually a sale, said the IRS tax court, since the stocks were sold to generate the funds for the “loans”).

These nonrecourse stock loan firms fell one by one as they found themselves compelled to manipulate and deceive their referring brokers (“everything’s fine”, “we’ve hedged all the stocks, no worries”, “bring ’em on” etc.) to keep the new client referrals and stocks coming in sufficient to get enough cash to return stocks to the previous clients who had already paid off their loans and who, of course, expected to see their stocks promptly returned. More clients, more sales, smaller or nonexistent profits as the lenders used the proceeds of one sale to buy back shares to return to waiting borrowers who had paid off their loans. A disaster in the making. 

Before long many innocent parties were unwittingly enmeshed in what amounted to a Ponzi-like situation where new clients were required by the lenders to pay off the prior paid-off loan clients. Many of these hapless clients found themselves with new tax bills courtesy of the sale of their securities — which they had reported as loans based on the lender’s assurances.

The Institutional Stock Loan Was Alive But Limited 

Today, thankfully, virtually all “nonrecourse stock loan” lenders are long gone and many of their former owners behind bars for a wide range of transgressions, most of which involved direct falsehoods to both brokers and clients regarding the selling and hedging of their client’s securities. By failing to be honest to both client and broker alike, these lenders in essence denied the full facts needed for all parties to make informed decisions about whether or not to proceed with this type of financing for their clients, and so their demise was inevitable.

Major brokerages had always offered some sort of credit line program for their premium, high-net-worth clients. The standard “margin loan” for example, was in essence a loan of credit to purchase more of the same stock and put more buying power to work. But it involved many risks, did not provide very much loan value, was very expensive, and was intended not for investment in business or real estate, but for buying more stocks. Still, it was through licensed institutions and did not involve any form of sale to fund. All these institutions were members of the SIPC and FINRA, too, the major regulatory agencies for institutional integrity.

A Client-Informed Idea Takes Root

With lending windows closing even for clients with stellar credit, the time was ripe for something new. Around this time, with the shell-shock of the financial crisis consuming aspiring new business owners across the country, I began to explore the concept of starting from scratch and aiming the end product into the entrepreneurial arena: the franchise and commercial real estate markets that were truly suffering at the time. Here the idea was to open our eyes to whatever it would take to help these core markets get through the eye of the financial hurricane and possibly open up a new financial relationship with a major licensed institution that could be advantageous later on. Many ideas were examined. Most had little upsides for our target clients — until we revisited the old securities loan idea in-depth from by starting with its most basic characteristics and rebuilding from there.

What, we asked, would it take to create a stock loan that was the diametric opposite of the old “nonrecourse” stock loans of the past? What would such a lending program look like? What would it take to provide a stock loan product that was not just fully legally compliant, but that also met the very specific demands of these niche markets for a truly competitive, low-cost, low-doc financing tool?

First, security. The product would need to be managed by and through a major, licensed SIPC-member institution and its fully licensed FDIC-member banking division. Full responsibility for all aspects of the credit line would have to begin and end there. Lender advising and management could only be through individuals with flawless FINRA records and all of the appropriate licensing needed for the task, (e.g., Registered Investment Advisers, Certified Financial Planners, etc.)

The clients’ securities could only rest in an account that was owned by the client alone — no joint ownership, no third-party ownership, no “beneficial” ownership — just an account like any major U. S. online brokerage account at, say, Charles Schwab or TD Ameritrade. The same. A simple lien on the account would be the only recourse for the lender — and absolutely no sale of the securities in any manner, for any reason, could ever be used to fund the line of credit.

Those were the safety and security requirements, all key, all critical, all important. But none of that would matter if the product itself were not competitive and tailored to the market it served.

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. 

That was a very tall wish list indeed, and for a better part of a year we at A. B. Nicholas failed to achieve our goal. Hundreds of brokers and advisors at major and minor licensed institutions were interviewed for the job: all insisted on tacking fees onto their services, limiting loan value, or increasing rates. We were repeatedly informed that we were being unrealistic. At one low point we were even ready to surrender our “wish list” and throw the concept out the window.

A New Financing Option

But perseverance often pays. In time we found the right person with the right licensing and authority and the right knowledge working within a major licensed, U. S. brokerage and banking institution: he “got it”. He understood what our market needed. LeverageLine at A. B. Nicholas — the company I now work for — rose from the ashes.

We thus began offering this new securities finance program to our clients and though it was sometimes difficult at first to break through the “never heard of it” and “not invented here” barriers, in time our unique, wholesale securities-based financing option became a mainstay not just for those seeking to fund their projects outright, but also those simply needing additional cash to supplement their resources without having to sell their securities to obtain those funds.

The value of our modern, secure, licensed, no-title-transfer variant of the old stock loan has now proved itself beyond a shadow of a doubt: net loan value has increased yearly by at least 10% every year, for example, and enjoys a growing reputation as a business-friendly securities finance program. Today we have not one but four major institutional partners willing to provide our clients the LeverageLine model of securities-based financing.

A Solution Nobody Knew Was There

Securities financing with these characteristics is clearly a means of solving immediate problems — lots of them, for a variety of business and real estate investors, every week.

Over the years we’ve established a glowing track record of solving often-intractable problems for first-time franchise, business-buying, and commercial real estate clients in a cost-efficient and speedy manner that has earned us kudos from the industry and many individual clients as well. We take great pride and enjoyment in seeing their enterprises grow and prosper, knowing LeverageLine was a component of that success.

Securities Based Financing for Real Estate – One Example

Take a recent client who needed to refinance her two commercial real estate properties, had plenty of stocks and bonds but didn’t want to sell them — thereby triggering a major capital gains tax hit and foregoing any future growth in her assets in a portfolio that was well-chosen and had promising long-term growth potential. On top of that, there was a sentimental reason for keeping her portfolio: she had inherited them from her father.

Her bank would not lend her anything near to what she needed to complete the refinancing, despite her perfect credit record, as she already had two real estate loans outstanding elsewhere for other properties and the recession had tightened financing for everyone. But she needed the financing soon: waiting 45-90 days for SBA or bank financing approval, along with the massive paperwork, detailed asset scrutiny, and tax returns plus no guarantee of financing in the end — would, even if successful, mean getting swamped with another huge high-interest payment on her property. But chances were the property would be long gone by that time anyway. She needs the cash quickly. On top of all this, she needed even more cash for overhead expenses that otherwise would soak up most of her remaining cash.

Our LeverageLine securities financing facility came to the rescue immediately. Within a week she was refinanced out of her money-bleeding 7.9% loans into our friendly, clear, and easy interest-only 2.24% APR credit line, the principal of which she will repay whenever she wants as there is no set maturity date and no prepayment penalties. In addition, because her portfolio was large, this represents a very significant savings. The loan is not reported to credit bureaus either (since by definition it is a private asset-based loan between the institution and the client) so it has no effect on her credit rating. Later, she hopes to build credit for the business by putting the loan in the businesses name and establishing a Dun & Bradstreet credit file for it with the cooperation and support of her LeverageLine brokerage — normal and standard service for a lending institution with expert advisors we’ve hand-selected because of their experience with our target markets.

Today her portfolio is still working for her, even though she has tapped it for cash and invested it in her business, which is growing. She has additional capital, lower costs, and since she has launched a relationship with a major institution “through the back door” (via ABN), which regularly refers its clients into that lending institution — she has received preferred service from the start. On top of all of that, after checking with her licensed accountant, she found that since she was using her credit line proceeds for direct investment in her business and had not sold any stocks in the process, she would have some tax advantages too. (Note to readers: Always confer with a licensed tax professional in advance for any matter related to loan interest deductibility in your specific case).

This modern, focused version of securities financing is flexible, secure, licensed, and managed by and through one of four “household-name” brokerage and banking institutions. It is simple, easy, fast, and comes with a suite of ancillary benefits custom-built into it by A. B. Nicholas for our clients.

Today’s Securities Based Financing Can Fill the Gap Well

Client-friendly to a fault, securities financing of this type fills a gap that almost no other type of financing can, and is informed by “what not to do” thanks to lessons learned over the last decade. It is solid and conservative, yet exhibits many of the features you’d normally ascribe to small, boutique-style financial products or custom private banking lending services normally reserved for the largest clients of the biggest wealth management firms. Its maintenance requirements are liberal and client-informed. It’s a long-term relationship-oriented facility where no client for A. B. Nicholas, for example, has ever defaulted or been called to shore up account value to date thanks to careful requirements in eligibility screening and loan-to-value quoting, and a proactive support policy.


Is securities based finance a solution for you? True, there are times when other programs may be more suitable. Eligibility does have some restrictions too: one would need securities that are not part of an IRA, that trade above $5 a share, that come to at least $80K in value at inception, and that are unrestricted, for example. The asset must have value as unimpeded collateral, in other words, and though pre-existing margin loans can be easily paid off in advance by your lender, the assets themselves must qualify.

But for those who do qualify, this 2015 iteration of financing using one’s securities can be a lifesaving option that prospective business buyers would be hard-pressed to ignore. (Visit the ABNicholas Homepage for more information).

Dan Stafford, Founding Partner

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