The past decade has been a prosperous one for retail investors. In the age of online, decentralized brokers, the way people invest has changed and with it, new and exciting incentives have emerged. It started with zero-commission trading. Then, fractional share investing. Now, thanks to discount brokerages like Robinhood, fully paid securities lending is on the rise.
As trading activity ramps up and retail investors occupy a larger and larger portion of the float, brokers have begun looking for new ways to promote and maintain liquidity among traders. Enter: securities lending.
What is Fully Paid Securities Lending?
Fully paid securities lending programs are yet another way retail investors can capitalize on the moneymaking ability of their portfolios. Yet, in a twist, they have the power to profit regardless of current market conditions or overall portfolio performance. So long as they hold securities with market demand behind them, investors can position themselves as lenders, earning interest on stocks that other investors borrow from them.
Fully paid securities lending isn’t a new concept; however, it’s largely been an institutional practice up to this point. Now, with more retail investors accessing the markets, demand for share liquidity is on the rise. Discount brokerages like Robinhood have created exposure to the concept among eager retail traders and now, major brokerages like Fidelity, TD Ameritrade, Ally and Charles Schwab (among others) have begun advertising these programs
To the uninitiated, securities lending sounds complicated and risky. Yet, it stands as a simple, secure way to accumulate wealth through a passive channel.
How Does Fully Paid Securities Lending Work?
The premise behind fully paid securities lending is simple enough to understand. Essentially, individual investors become securities lenders to other investors seeking to borrow them (usually for short sales).
Say, for example, your portfolio includes 250 shares of the Global Robotics and Automation Index ETF (ROBO). Due to the semiconductor shortage crisis, a flood of bearish investors might want to short this ETF; however, your broker might run out of shares to lend. Fully paid securities lending allows your broker to lend your shares to continue facilitating trading action.
Since you’re providing the shares and the broker facilitates the trade, you capture the benefits associated with being the lender:
- Lenders gain interest commission for loaning out their securities
- Lenders receive collateral for the duration of the loan period
- You’ll continue to own securities, even though they’re loaned
- You can sell shares at any time, even while they’re out on loan
There are some drawbacks, though. For starters, you can’t pick and choose which securities you lend. If you sign up for fully paid securities lending, your entire portfolio becomes fair game for lending. You also lose some shareholder rights such as voting while your shares are out on loan.
Also, keep in mind that there are unique tax considerations that accompany fully paid securities lending. For instance, if you own a dividend-paying stock, you’ll receive cash instead of your regular dividend payment, which usually means a higher tax rate. It’s best to consult with a tax or investment professional to understand any tax implications your portfolio might carry.
How to Make Money Through Fully Paid Securities Lending
The draw of securities lending is that investors have the ability to earn passive income. After being approved for a brokerage’s securities lending program, investors have virtually no active role in the process. So long as they own securities and authorize the brokerage to lend them out on their behalf, investors can sit back and collect the interest.
How much passive income an investor can make depends on a great many factors: the securities they hold, number of shares loaned out, share price and the annualized interest rate of the broker’s securities lending program, for starters. Discount broker e-Trade offers the following example breakdown for its own fully paid securities lending program:
- Number of shares on loan: 1,000
- Previous day’s closing price per share: $50
- Market value (at 102% in cash collateral): $51,000 (1,000 x $50 x 102%)
- Annualized lending interest rate: 10%
- Income per day: $14.17 ($51,000 x 10% / 360 days)
- Hypothetical weekly income (includes weekend and holidays): $99.17
It’s important to keep in mind that the efficacy of this model depends heavily on the stocks in your portfolio. Brokers will generally lend their own shares before they lend the shares of participants in the securities lending program. This means that investors have the best prospects if they hold securities that are either in extremely high demand or obscure enough that a brokerage doesn’t hold shares.
Investors also need to keep in mind that there’s no guarantee someone will borrow their shares. And, if they do, there are no guarantees for which ones, how long or in what volume. There’s a lot left up to chance, which can greatly impact the earning model for a securities lending strategy.
Is Fully Paid Securities Lending Worth it?
Fully paid securities lending is something of a novelty among everyday retail investors. If you only own a few stocks or a small quantity of stocks from a variety of companies, there’s a low likelihood that your portfolio will become a repository for securities lending—let alone approved for your brokerage’s program. That said, investors with the right mix of securities and a healthy allocation of shares could find themselves with an opportunity to accrue passive income as lenders.