Mistakes Made in Stock Loan Lending

Pitfalls of Stock Loans: Risks for Lenders

From the perspective of the lender, stock loans can have some pitfalls if not handled correctly. Usually, this occurs as a result of an unscrupulous third-party lender attempting to operate outside standard guidelines. These lenders often market their loans as “non-recourse” in nature, which means that there is very little risk to the borrower. And this part is true, however, it results in certain serious risks for the lenders.

The Illusion of Non-Recourse

In a non-recourse loan, it is agreed upon upfront that the lender will take no further effort to collect on the loan other than holding the stocks which were supplied as collateral. Collection agencies and additional asset seizure are not possibilities for the lender. This implies that borrowers might simply opt not to pay their loans back after the lending term if the stocks they offered as collateral has depreciated to be less than what repayment would cost. And there is nothing the lender can do about it.

Vulnerability to Market Volatility

Given that many loans come with high-interest rates (as much as 15 percent), it does not take much volatility in the market for lenders to find themselves hanging onto equities that are worth less than the debt for which they maintained the collateral. This puts the lenders at a disadvantage as they are constrained by the conditions of the loan and cannot seek for extra security. They are counting on the goodwill of the borrower to pay back the loan: a move that would be fiscally imprudent.

Additional Risks and Considerations

Some lenders may lend money against a stock that will later fall and the borrower has signed a personal guarantee, leaving the borrower accountable for the total loss of the stock. Another problem occurs when a borrower is not able to repay the stock loan and is forced to walk away, leaving the stock with the lender which is worth more than the loan total. Borrowers paying high fees for the stock loan or transferring the securities to shady lenders, who sell the stock immediately to fund their crooked stock loan operation.

Choosing a Reputable Broker

Selecting a reputable stock loan broker is critical in deciding if a stock loan is right for you.