Mistakes Made in Stock Loan Lending
From the perspective of the lender, stock loans can have a number of pitfalls if not
handled correctly. Usually, this occurs as a result of an unscrupulous third-party
lender attempting to operate outside standard guidelines. These lenders often
market their loans as "non-recourse" in nature, which means that there is very
little risk to the borrower. And this part is true, however, it results in certain
serious risks for the lenders.
In a non-recourse loan, it is agreed upon beforehand that the lender will take no further action to collect on the loan other than retaining the stocks which were given as collateral. Collection agencies and further asset seizure are not options for the lender. This means that borrowers can simply choose not to pay their loans back at the end of the lending period if the stocks they gave as collateral have depreciated to be less than what repayment would cost. And there is nothing the lender can do about it.
Given that many loans come with high interest rates (as much as 15 percent), it does not take much fluctuation in the market for lenders to find themselves holding onto stocks that are worth less than the debt for which they kept the collateral. This puts the lenders at a disadvantage since they are bound by the terms of the loan and cannot ask for further collateral. They are relying on the goodness of the borrower to pay back the loan: a decision that would be financially irresponsible.
Some lenders will lend money against a stock that will eventually crash and the borrower had signed a personal guarantee, making the borrower responsible for the entire loss of the stock.
Another mistake is when a borrower is not able to repay the stock loan and is forced to walk away, leaving the stock with the lender which is worth more than the loan balance.
Borrowers paying high fees for the stock loan or transferring the securities to shady lenders, who sell the stock immediately to fund their crooked stock loan operation.
Selecting a reputable stock loan broker is critical in deciding if a stock loan is right for you.