Alternate name: Securities lending fee
Stock loan fees are often used to facilitate short selling. With short selling, an investor bets that the price of a stock will decline. To do so, they first need to borrow shares and pay a stock loan fee to the lender. The short seller then sells these borrowed shares with the intention of eventually buying the shares back at a lower price. The short seller then returns the purchased shares back to the lender and keeps the difference as profit. A stock loan fee could also be used in cases such as when an investor wants to borrow shares to have voting rights for a particular stock. For example, a large investor, such as a hedge fund, that wants to enact change at a company, like replacing someone on the board of directors, may want to increase the number of votes they have at a company’s annual meeting. To do this, the hedge fund might borrow shares so they have enough votes to make this replacement.
How Does a Stock Loan Fee Work?
Both retail investors and institutional investors, such as pension funds, can loan stocks and collect stock loan fees. Likewise, both types of investors can borrow stocks and therefore pay stock loan fees. For example, an individual investor who uses an online stock trading site may have the option to enroll in that brokerage’s stock loan program. The broker then tries to match the stocks available to loan from that investor with another investor looking to borrow shares. This process often involves working with other financial services firms and technology such as digital marketplaces to match stock borrowers and lenders. If there’s a match, the borrower pays a stock loan fee that varies based on the scarcity of those shares available for borrowing. The fee is typically expressed as an annual rate. So the longer the borrower waits to return the shares, the more total stock loan fees they’ll pay. Stock loan fee rates tend to be relatively low. In the second half of 2020, the average securities lending fee globally for equities was 0.74%, according to IHS Markit. But stock loan fees for certain stocks that are hard to borrow could be several hundred basis points. In other words, an investor could earn, for example, an extra 6% annually just by lending a particular stock not many other people are lending.
Are Stock Loan Fees Worth It?
As with any loan and investment, there are risks and opportunities associated with stock loan fees. For individual investors who lend stocks and collect stock loan fees, the benefit is that they can earn additional returns from their portfolios, beyond what happens with stock prices. However, investors need to weigh their potential returns with potential risks. In theory, a borrower might not be able to return the borrowed stocks. Typically, there are mechanisms in place to shield lenders from this risk, such as the borrower putting up collateral and the lending agent providing indemnification (meaning the agent ensures the lender is made whole if the borrower can’t return the securities). Still, investors need to read the fine print and speak with their broker or securities lending agent to ensure they’re comfortable with the arrangement. The value of a stock loan fee also needs to be weighed against potential downsides. For example, lenders may give up voting rights for shares and miss out on dividends. When a stock pays a dividend during the borrowing period, the borrower typically compensates the lender in cash instead. Yet cash could be taxed differently, such as at ordinary income tax rates as opposed to potentially tax-advantaged dividend rates. That said, stock loan fees are often worth it for many lenders, as evidenced by the trillions of dollars on loan at any given time. Plus, lenders often have the ability to recall stock loans, such as if they want to regain their voting rights or sell their shares.
How Can Individual Investors Earn Stock Loan Fees?
If you have a portfolio of individual securities, such as through a brokerage, see if they offer stock loan programs, and review their specific terms to determine if it’s worth it for you. For example, TD Ameritrade offers a stock loan program, but also states that it takes half of the earned interest. Odds are, if you invest in assets like mutual funds, you’re already benefiting from the additional return that these funds earn from stock loan fees. If that’s the case, you may want to consider whether you want to do the same with the individual stocks you own. Borrowing stocks isn’t always as readily available for individual investors, considering some of the risks involved. But if you do have this option available to you, such as through short selling, factor in the cost of a stock loan fee with your expected return. While it could be worth the fee and benefit from shorting a stock, it’s still possible that a particularly expensive stock loan fee makes short selling unattractive, and there’s always the chance your short position doesn’t actually work out.
