Securities Lending For Dummies

Non-recourse stock loans can be very appealing to investors because they come with
little risk. In a non-recourse loan, the lender requires stocks as collateral. At the end of
the loan period, should the borrower not be able to pay back the loan, the lender keeps
the collateral. This is the only form of recourse the borrower incurs. Anything more is
forbidden by the terms of the loan. Since the collateral is something that is given freely
before the loan begins, these are considered “non-recourse” because of the lack of
action taken by the lender against a defaulting borrower.

It is important to remember that many non-recourse lenders are unregistered and/or unregulated. Whether or or not the lending agency is financially solvent is often difficult to ascertain. Furthermore, lenders do not truly hold onto the stocks they obtain as collateral, but rather use them as if they own them, often selling them for a profit. At the end of the loan period, it is understood that the lenders must provide the stocks along with a portion of any profits to the borrower, however, many lenders are often unable to do so due to poor investment choices.

It is also important for any potential borrowers to remember that unregulated loans may be interpreted differently by the Internal Revenue Service. Where the borrower and lender see a loan, the IRS may see a sale of stock and tax the transaction. This is especially true when the lender sells the stock while in their possession or when the borrower chooses to default on repayment due to the stock having depreciated in value. This would essentially mean that they received money for the stock that was never taxed, something the IRS will aims to correct.