Passive income is a foundational tool for most investors. Watching money flow into your account without an enormous investment of effort, supplemental of and building upon the assets you have worked so hard for is the ideal representation of making your money work for you. Today we explore a method for driving passive income that is not on many investor’s radars. A Fully-Paid Securities Lending Program allows you to take an investment and loan it for profit. This program can add a percentage to your passive returns.
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What is a Fully-Paid Securities Lending Program
A Fully-Paid Securities Lending Program allows your broker to loan out your securities to interested third parties. The most common reason would be to accommodate short interest in a security they may not have adequate access to. If one of your holdings is in demand for this program, you will receive a portion of the premium the third party pays. Commonly a broker will split this premium 50/50 with you as the owner of the lent security.
The program can be similar to taking a holding and giving it a cash yield much like a dividend. Note however, that this additional income comes with none of the positives a dividend often implies. A company that elects to pay a dividend often does so attesting to their profitability and positive cash flow. A holding being in demand for Fully-Paid Security Lending instead often indicates a level of short interest. This if often a sign that much of the market is betting against you.
Who Offers a Fully Paid Security Lending Program
Many brokerage companies offer this program, including E*trade and Fidelity. One notable exception appears to be RobinHood(RH). While RH offered this program in the past, the last I could confirm was that they placed the program on hold in late 2019.
A broker not offering this program does not mean they are not lending out your securities. Most (seeming including RobinHood) do, they may simply not share the interest they earn off of it with you.
What Accounts Qualify for a Fully Paid Security Lending Program
Eligibility for the lending program may vary by Broker. At E*Trade any account with assets greater than $10,000 was eligible for the program. E*Trade applies this requirement at the individual security account level. You could have considerable assets but a new IRA with a balance under 10k would not be eligible.
At Fidelity, it appears all accounts are eligible once you have a total of $250,000 assets cumulatively among your accounts.
How to Sign Up for Fully-Paid Securities Lending Program
Many Brokers will list a fully-paid security lending program under additional services and programs. I would suggest you google the same of your Broker plus fully secured lending and review the documentation they provide. You will often find that:
- There should be a small application form for you to complete
- You will select the accounts you would like to enroll in the program.
- You do not choose the specific securities you wish to enroll in the program. When you enroll an account, your Broker may loan any security within at their discretion.
- Your Broker will provide you with legal forms detailing the risks of enrolling in the program.
- Your Broker will review your application within a couple of days.
- If a holding within your portfolio is loaned out, you will earn passive interest each day.
What Is the Downside of a Fully-Paid Securities Lending Program
- Lose voting rights
- While your security is on loan, you are not technically a shareholder and thus lose all voting rights your shares might normally provide to you.
- The IRS taxes Cash in lieu of dividends Differently than Normal Dividends
- If your holding is loaned out over a dividend period, you may receive cash in lieu of dividends. This will be taxed as normal income and not at the qualified dividend rate. Depending on your tax situation, this could result in neutral or negative treatment. Several brokers attempt to avoid having qualified securities out on loan over these periods or may compensate you to mitigate the tax difference.
- The IRS will also tax the interest paid to you during the loan period as standard income.
- The interest paid to you during the loan period will be taxed as normal income
- The SIPC (Securities Investor Protection Corp) does not fully protect loaned Securities
- However, the FDIC does insure the collateral your broker secures from the lending party up to $250,000.
What Are the Risks of a Fully-Paid Securities Lending Program
Trying to be the smartest in the room is one of the quickest ways to lose money in any market. You might even be correct, but the market can afford to be wrong longer and more often than you can. If a holding in your portfolio is in demand, it is critical to understand the reasons behind it. The security in question is likely to have significant short demand, meaning a large portion of investors is betting against you. For your broker to be willing to share profits with you, the company must be one in which your broker is not invested enough to be able to cover themselves.
The market can be wrong, and I have made money in the past both in betting against the consensus as well as from lending out my holdings. Always be cognizant that the money you may earn is not free. For you to profit someone else will lose, it is vital that you understand the reasoning of both sides to ensure you are on the correct one.
What Are the Advantages of a Fully-Paid Securities Lending Program
A Fully-Paid Securities Lending Program:
- helps to ensure and maintain liquidity in the market.
- provides additional passive income for those whose securities are on loan
- Supports short selling and other related strategies.
My Experience With the Fully-Paid Securities Lending Program
Five trading days after I first enrolled, I received notice that my first statement was available. The statement showed that around 35% of one of my holdings was now on loan. That statement clearly showed a collateral value covering the position, the interest rate I would receive (3.5%), and the projected daily income.
Over the next several months, the number of shares on loan fluctuated daily, along with the interest rate paid. The interest rate ranged between 3.5% down to 3.01% based upon the demand for the security at that moment.
Nine months into this program and this holding remains the only one in my portfolio selected for lending. Most of my portfolio resides in common holdings such as Apple and Amazon where my Broker has access to plenty of shares to meet demand without paying me to loan out my holding. I have a couple of smaller holdings in more speculative companies which I hoped might be lent out, but my experience aligns with the common understanding that a fairly limited set of stocks fit this program.
When your Brokerage lends one of your holding they will add cash to your account. When the lendee returns this holding, your Brokerage will return this cash out of your account. This produces a transaction history as your Broker moves collateral in and out of your account. While this accounting trail is vital, it does cause dashboard and account overviews to fluctuate a reasonable amount.
A Simplified Example
Let’s imagine a situation where you have 1000 shares in a company with a share price of $20. If that holding were loaned out you might see the following:
Shares on loan = 1,000
Value of Stock = $20
Lending Rate Shared with You – 3.5%
Monthly Income= ~$57
Annual Income= ~$690
FAQ
Do You Earn Income on Non-Trading Days?
Each Friday, my daily statement appears to reflect three days’ worth of interest. This indicates that you receive payment for the loan over weekends when the market is closed and that it is calculated in advance.
Is Income Static or Is It Recalculated Each Day Based on Market Value?
The income earned fluctuates each day in both the loan amount and the secure collateral based off of market price of underlying stock. Income typically calculated daily and paid out monthly.
Do Brokerages Only Loan Out Full Positions?
No, about 35% of my holding was initially placed on loan, a percentage that increased and decreased several times throughout the loan period.
Can I Loan Out Holdings I Purchased on Margin?
Eligibility depends on your broker. At some, such as E*Trade, holdings paid on margin are not eligible for the program. Other brokers allow you to loan out excess margin securities.
How Does Cash In Lieu of Dividends Impact Dividend Reinvestment Programs?
Cash in lieu of dividends will not impact your DRIPS status and dividends will continue to be invested into additional shares automatically.
Does Having a Security on Loan Impact My Ability to Sell the Holding?
Having your securities on loan does not introduce any issues when it comes to selling your position either in full or in part. Upon you placing a sell order your broker will cancel the load loan and the holding is yours to sell.
Is a Fully-Paid Securities Lending Program Worth It?
I’m a fan of adding additional passive income to any portfolio, but in my experience, the program does not scale. Early on, one of my holdings was in high demand. I had some additional cash flow into my account every month, which I reinvested in the same holding. Ultimately, that holding went up over 80% making for a solid return on the program.
The market adjusts. Short sellers closed their positions, and demand dried up. For the past six months, that holding has merely been another stock in my portfolio. Brokers are so large, and the market is so liquid that your holdings will rarely go on loan. When they do, you need to understand why. Take a step back and ensure you still hold conviction in the underlying company.
Fully-Paid Security Lending is not likely to make you rich. It can be an interesting lesser-known source of passive income when added to companies you already believe in. Aside from a few additional tax complications, the program is completely passive. If interested, enroll, but do not fall into the trap of structuring your portfolio around it.