Securities Lending For Dummies

Understanding Non-Recourse Stock Loans

Non-recourse stock loans can be very appealing to investors because they come with little risk. In a non-recourse loan, the lender requires stocks as collateral. At the end of the loan period, should the borrower not be able to pay back the loan, the lender keeps the collateral. This is the only form of recourse the borrower incurs. Anything more is forbidden by the terms of the loan. Since the collateral is something that is given freely before the loan begins, these are considered “non-recourse” because of the lack of action taken by the lender against a defaulting borrower.

Risks and Considerations

It is vital to note that many non-recourse lenders are unregistered and/or unregulated. Whether or whether the loan agency is financially solvent is frequently difficult to verify. Furthermore, lenders do not genuinely keep onto the stocks they get as collateral but rather utilize them as if they own them, frequently selling them for a profit. After the loan term, it is recognized that the lenders must deliver the stocks together with a percentage of any gains to the borrower, however, many lenders are frequently unable to do so owing to bad investment selections.

Regulatory Implications

It is also vital for any prospective borrowers to understand that unregulated loans may be construed differently by the Internal Revenue Service. Where the borrower and lender perceive a loan, the IRS may see a sale of shares and tax the transaction. This is particularly true when the lender sells the stock while in their possession or when the borrower decides to fail on payments owing to the stock having fallen in value. This would effectively suggest that they got money for the stock that was never taxed, something the IRS would attempt to address.