Securities-Backed Lines of Credit: Using Your Investment Portfolio as Collateral

An increasing number of securities firms are marketing and offering securities-backed lines of credit, or SBLOCs, to investors.  SBLOCs can be a key revenue source for securities firms, especially in times of solid market returns and growing investment portfolios, when investors may feel more comfortable leveraging their assets. Firms market SBLOCs as a type of financing and liquidity strategy that can unlock the value of your investment portfolio.

SBLOCs are loans that are often marketed to investors as an easy and inexpensive way to access extra cash by borrowing against the assets in your investment portfolio without having to liquidate these securities. They do, however, carry a number of risks, among them potential unintended tax consequences and the possibility that you may, in fact, have to sell your holdings, which could have a significant impact on your long-term investment goals.

Set up as a revolving line of credit, an SBLOC allows you to borrow money using securities held in your investment accounts as collateral. You can continue to trade and buy and sell securities in your pledged accounts. An SBLOC requires you to make monthly interest-only payments, and the loan remains outstanding until you repay it. You can repay some (or all) of the outstanding principal at any time, then borrow again later. Some investors like the flexibility of an SBLOC as compared to a term loan, which has a stated maturity date and a fixed repayment schedule. In some ways, SBLOCs are reminiscent of home equity lines of credit, except of course that, among other things, they involve the use of your securities rather than your home as collateral.

Many firms might offer you the opportunity to pursue an SBLOC, including your brokerage or advisory firm, a clearing firm (a firm that maintains custody of your securities and other assets, such as cash in your account), or a third-party lender like a bank. To set one up, you and the lender execute an SBLOC contract. The contract specifies the maximum amount you may borrow, and you agree to use your investment account assets as collateral. If the value of your securities declines to an amount where it is no longer sufficient to support your line of credit, you will receive a “maintenance call” notifying you that you must post additional collateral or repay the loan within a specified period (typically two or three days). If you are unable to add additional collateral to your account or repay the loan with readily available cash, the firm can liquidate your securities and keep the cash to satisfy the maintenance call.

SBLOCs are non-purpose loans, which means you may not use the proceeds to purchase or trade securities. However, an SBLOC still provides a fair amount of flexibility when you consider the restrictions on other types of loans, such as a mortgage or auto loan, or borrowing on margin. Those types of loans all require that loan proceeds be used for a specific purpose. Money from an SBLOC can be used to finance virtually anything you might want, from home renovations and real estate purchases, to personal travel or a new business venture. They also can be used, for example, to fund education expenses or to pay an unexpected tax bill.

An SBLOC may allow you to avoid potential capital gains taxes because you don’t have to liquidate securities for access to funds. You might also be able to continue to receive the benefits of your holdings, like dividends, interest and appreciation. Marketing materials for SBLOCs also promote the flexibility of spending that comes with an SBLOC as a key feature. And, some firms market SBLOCs as part of a retirement income strategy to fund short-term expenses.

However, as with virtually every financial product, SBLOCs have risks and downsides. Be aware that marketing materials touting the advantages of SBLOCs may suggest benefits that you may not achieve given the risks. For instance, if the value of the securities you pledge as collateral decreases, you may need to come up with extra money fast, or your positions could be liquidated. So even if an SBLOC may be an appropriate solution for you, it always pays to ask questions.