The Advantages of Stock Loans Over Margin Loans
Investors often assume that a stock loan is the same as a margin loan, with the primary difference being that margin loans are offered by brokers and stock loans are extended by independent lenders. In reality, the differences between these two types of loans are significant, and in almost every case a stock loan offers investors better terms with fewer risks and limitations.
The advantages of stock loans over margin loans are apparent when the key features of both loans are compared and contrasted with each other:
- Margin loans are available only for stocks that trade above US$5.00 per share, whereas stock loans can be collateralized with virtually any securities that are traded on an open public market, including stocks issued through initial public offerings and lower-priced securities.
- Brokers offer margin loans under non-negotiable terms for rates, fees, and other critical conditions, with no opportunity for a borrower to negotiate those terms. Investors have a far better opportunity to negotiate terms and conditions and to craft a customized loan with a stock loan lender.
- Margin loan interest rates are often very high, and interest payments can erode the benefits that an investor seeks with a loan. Further, margin lenders might require investors to deposit a certain minimum amount of capital with the broker to qualify for a margin loan. These conditions are only rarely required for stock loans.
- Investors leverage their stock holdings with margin loans, which exposes them to a high degree of risk. Sharp declines in equity markets can lead to margin calls by a broker. In certain circumstances, a margin loan investor can be required to deposit more cash with a broker than the original value of the underlying investment. Stock loans pose no similar risks.
- Stock loans are almost always offered on a non-recourse basis. If a stock loan goes into default, the lender can only recover the principal balance of the loan from the securities that are pledged as collateral for that loan and the investor’s other assets are shielded from the lender.
- Unlike margin loans, which are used to purchase securities, stock loans typically have no restrictions on the use of loan funds. An investor can use stock loan proceeds for virtually any purpose.
- The stock loan underwriting process is more straightforward and relies primarily on the relative liquidity of the securities that are pledged as collateral for the loan. The creditworthiness of the borrower is generally not a significant underwriting factor for a stock loan.
Even with all of their advantages over margin loans, stock loans are a product that only sophisticated investors should consider when they are seeking sources of liquidity. The stock loan industry is subject to the same laws, rules, and regulations that generally apply to the domestic and international securities markets, but it is a lightly-regulated sector of those markets. An investor that is seeking a stock loan should do thorough due diligence and analysis before completing the transaction, including reviewing all stock loan documents and materials with the investor’s legal, tax, and accounting advisors, and verifying the investor’s understanding of the benefits and risks that a stock loan provides.
Stock loan investors should also stay closely attuned to changes in the market price of the collateral that the pledge as securities for loans. Lenders that originate stock loans will not make the same kind of margin calls that brokers will make for margin loans. Nonetheless, the loan agreement that is part of a stock loan transaction might allow the lender to terminate the loan and to take full legal and equitable ownership of the collateral if the per-share price of the pledged stock falls below certain floor values that are defined in the loan agreement.
Alternately, if the per-share price of the collateral increases during the term of the loan, the investor may have an opportunity to modify a stock loan to increase the loan’s principal balance and to draw more liquidity in relation to the stock’s appreciated value. Stock loan investors also retain the right and opportunity, upon repayment of a stock loan’s principal, to receive the full value of stock or cash dividends that an issuer declares on the collateral shares that an investor pledges for a loan.
Astor Capital Fund offers stock loans that are collateralized by securities that are traded on most international public exchanges. Please contact one of our stock loan agents or call Astor Capital Fund directly to speak with a specialist who will show you how to unlock the liquidity of your publicly-traded stock assets with a negotiated stock loan.