Monday, July 26, 2010
Psst, Wanna Borrow Some Shares?
Author’s note: I think this should have been headlined, “Psst, wanna LOAN some shares?”
Some brokerages now allow certain customers to lend shares to short sellers, nabbing profits in the process.
SEVERAL BROKERAGES RECENTLY instituted programs allowing wealthy investors with big positions in hard-to-borrow stocks to lend those shares to short sellers, generating interest income in the process.
The ability to place shares into the lending market differs significantly from selling a covered call, which nets the seller income, or premium, in return for giving the buyer the right to purchase the stock at a particular price at a future date. If the stock doesn’t hit that price, the call seller gets to keep his shares, as well as the premium.
Lending shares affords an investor who doesn’t want to risk having a stock called away an opportunity to maintain ownership and also profit from the loan.
Says Fidelity (http://www.fidelity.com) customer Ron Kimmich of Chardon, Ohio: “I’ve been fortunate to have stocks that people want to borrow—and they have paid me handsomely for” the shares.
Kimmich has about 100 stocks in his portfolio, and is lending shares of eight companies. He says that Fidelity Capital Markets contacted him in March 2010 and informed him he had several stocks that were in demand by short sellers, who make bearish bets on securities. The shorts sell borrowed shares, in the expectation that they will be able to buy them back at lower prices later.
Kimmich says he was “uncomfortable” with the idea initially, but that the steady income stream has changed his view. He says he uses the income generated from lending to help defray trading costs for his shorter-term holdings.
Not every broker allows investors to lend out shares, and not every investor qualifies for the opportunity. The obstacles are partly technological, but also relate to whether customers hold stocks that others want to borrow. According to Peter Sosnowski, senior vice president of retail brokerage at Muriel Siebert (http://www.siebertnet.com), “it’s for more sophisticated clients, and for people looking to generate a little incremental revenue while they own a position—as long as there is a demand for those securities in the marketplace at that specific time.”
Although the criteria vary from broker to broker, those we consulted said a qualifying customer must have more than $500,000, and in some cases $1 million in assets in an account, and hold a large number of shares of the in-demand stock. Brokers report that equity-index and currency exchange-traded funds, and equities such as American International Group (ticker: AIG), Sears Holdings (SHLD) and Garmin (GRMN), are most in demand.
In most cases, candidates for lending are informed by their brokerage that they hold stock of value to short sellers, and are asked if they would like to participate in the brokerage’s program. The annual interest rate varies from stock to stock; the lowest rate is around 2% of the value of the shares loaned, but rates can range as high as 80%.
CUSTOMERS OF FIDELITY AND MURIEL SIEBERT can participate in the stock-lending program administered by Fidelity Capital Markets. Both firms clear through National Financial, a subsidiary of Fidelity. Making a stock available to lend out involves some administrative work, including the signing of a lending agreement with Fidelity Capital Markets.
Customers of Interactive Brokers (http://www.interactivebrokers.com) can lend their shares via a specialized trading tool integrated into the company’s trading platform, Traders WorkStation (TWS). The tool is available to IB customers who qualify to buy securities on margin, and it provides access to the stock-loan market. IB’s clients list their securities on the AQS platform, an all-electronic, direct-access securities-lending market for U.S.-based stocks operated by Automated Equity Finance Markets.
Another IB tool, the Yield Optimizer, lets customers see which of their holdings could be generating interest income for them if they lend these holdings out. The Yield Optimizer also helps short sellers determine whether it is cheaper to borrow stock through AQS or directly from IB.
Kimmich, the Fidelity customer, says that the stocks he is lending are displayed in his portfolio report, and are flagged with a “loan” marker. Fidelity deposits the interest income into his account around the fourth of each month in a single transaction; he can obtain a detailed report online of the interest rate he’s getting for each stock.
Fidelity enhanced its program in February, making more information available online about securities on loan. It is possible to sell a stock that you are lending out by using the usual online tools. Previously, any transactions affecting loaned stock had to be done with broker assistance. When you click on the “Loan” link in the portfolio display, you’ll get an online summary of the securities you are lending, including the current value of the loans and the interest rate accrued.
Involving retail clients in lending “has been in and out of favor on a global basis for the past 20 years,” says Tim Smith, a senior vice president of SunGard Securities Finance. “The main stumbling block has been the lack of transparency in terms of both risk and reward, and the [assurance of] protection to someone who would not be an expert in this activity.”
Loaned securities aren’t protected by SIPC (the Securities Investor Protection Corp.) if your broker or clearinghouse fails. Therefore, the clearing agent must post collateral of cash and securities equal to or greater than the value of the securities on loan, marked to market at the close of each trading day. In theory, then, the loan is 100% covered—even better than they would be by SIPC. Should the borrower go bankrupt, the shares are returned to the lender.
THERE ARE A FEW OTHER wrinkles associated with lending shares. Dividends earned on stocks lent to others are taxed as non-qualified income, meaning you’ll pay ordinary rates, not the 15% rate on qualified dividends. You’ll also lose voting rights on lent shares, although you can recall the shares if there is an important issue you’d like to vote on.
A bigger issue is the possibility that you might be betting against your own net worth by loaning stock you hold to those who believe the price will go down. According to Gregg Murphy, Fidelity’s Senior VP of retail brokerage, “those who think that way just don’t participate. Typically, we see very educated investors take part in the lending program.”
Brokerages such as E*Trade and MB Trading don’t have programs to let customers lend securities. But the success of the early adopters could mean more initiatives soon will be under way.
Published in Barron’s, July 19, 2010.