A Securities-Based Line of Credit (SBLOC) allows an individual to leverage their investment accounts as collateral for a line of credit.
In this blog, we will explore what exactly an SBLOC is and how it can be used in an individual’s financial plan.
What is an SBLOC
An SBLOC is an interest-only line of credit that is taken out using a non-qualified investment account, or multiple accounts, as the pledged collateral.
For example, if an entrepreneur has a non-qualified investment account with $1,000,000 worth of investments, then they could borrow a percentage of that $1,000,000 and pay interest only on that line of credit indefinitely if they choose to.
There are some common benefits and risks associated with an SBLOC, which we will look at later.
Here are two quick examples:
A family is trying to move closer to their business to allow for a better work / family balance by cutting out the commute. Their realtor presents them with the perfect pocket listing 5 minutes away from their office building in Novato. Like most entrepreneurs, their net worth, while high, was illiquid. Instead of liquidating their investments, they leverage an SBLOC to quickly close the deal and repay the SBLOC when they sell their current home. The SBLOC allows them to keep their current investment strategy and avoid a taxable event.
This is a real example of an entrepreneur I know, we will call him Jim. Jim built a successful business in the Bay Area. Over the years, he put every dime he could save into the stock market. By 2007, he had a significant portfolio built up and was considered a high-net-worth individual. When the housing market crashed in 2008, he took out an SBLOC and used it as bridge financing to snap up foreclosures all around the North Bay area. He was able to keep all his market exposure and also buy 8 pieces of real estate at rock-bottom prices. Since 2008, his stock portfolio and real estate portfolio have increased significantly and now he is considered an ultra-high-net-worth individual.
Common Uses of an SBLOC
The SBLOC can be used to fund almost anything, except to buy additional securities.
There are many reasons an entrepreneur and their family might want to open an SBLOC with their financial advisor.
Most common client needs:
- Expanding a business
- Real estate investing (commercial & residential)
- Home Renovations
- Startup / Seed Funding
- Tax Obligations
- Funding an emergency
- Debt refinancing / Consolidation
- Luxury purchases
- Investment fund capital call
- Diversify family investments
- Cash management
Let’s take a closer look at the benefits of a SBLOC.
Benefits to an SBLOC vary and completely depend upon what you are using the SBLOC to fund.
For example, if we expand on the example from above. An SBLOC line of credit would not require the buyer to do an appraisal, there wouldn’t be any closing costs on the loan, and using an all cash bid can make the deal much easier to get done.
Here are some more benefits:
- Access to cash without disrupting current investment strategy
- Potentially defers taxes
- Interest-only payments
- No established principal repayment terms
- Competitive interest rates (variable or fixed)
- Generally a simple underwriting process
- Generally, no credit pulls
- No application, origination, closing, or annual fees
- Quick approval process (generally 5 business days)
- Can be used with a number of different account types
- The borrower and the pledger of the loan collateral can be different parties
While the benefits are great, there are also some risks with borrowing against a security portfolio.
How much can you borrow using an SBLOC?
How much an individual can borrow is dependent upon the amount and quality of assets within the pledge account(s).
The release rate or advance rate is the percentage of security the institution will lend you in the form of a securities-based line of credit.
For example, a lender like Pershing might lend 70% of the market value of qualified equity, mutual funds, and investment-grade bonds and up to 90% on U.S. Treasury securities.
Each lender has different advance rates and depending upon the entrepreneur’s investment strategy and portfolio holdings will determine what lender might be the best fit.
Lenders typically will have a minimum for an SBLOC. It could be $50,000 or $750,000. Each lender is different.
The same is true for the maximum size of an SBLOC. Some lenders will lend up to $20,000,000 but will require a more in-depth underwriting process. At $10,000,000 lenders generally become very competitive over the loan. This is where it can be a great opportunity to shop around and get competitive offers from different lenders.
Next, we will discuss the risks associated with an SBLOC.
What Accounts can be pledged?
Instead of focusing on what can be pledged, let’s take a look at what can not be pledged for an SBLOC.
The IRS has prohibited the use of qualified accounts as collateral for loans, including SBLOCs.
Now, there are some ways to borrow from your retirement accounts, but in general, they can not be used as collateral for a loan.
This would include Roth IRA, Traditional IRA, 401(K)’s, Simplified employee pensions, and self-directed accounts to name a few.
A few types of accounts you can use for an SBLOC are individual investment accounts, trust accounts, and corporate accounts.
An SBLOC may not be appropriate for every investor and is definitely not appropriate for every situation.
Let’s take a look at some risks associated with a Securities-based Line of Credit.
Loss of Value
A pledged account can lose more than its initial investment.
You may be required to repay the loan in full before you can move your account to another financial institution. There are other lenders who will transfer your SBLOC, meaning they will open a line of credit for you based on your account holdings and pay the old SBLOC off at your old financial institution.
Just as with all stock portfolios, if the market drops in value so does the value of the portfolio. When you are using an SBLOC and the market drops enough to trigger a collateral call, the borrower will be required to take steps to ensure the loan-to-value ratio is compliant.
Terms can Change
Loaning institutions often reserve the right to liquidate securities within an account that has a collateral call and can impose stricter collateral requirements without notice. Make sure you work closely with your financial advisor to fully understand the terms and conditions of the brokerage you are working with.
There are always risks associated with loans and investments.
There are steps that can be taken to manage the risks associated with an SBLOC but be sure to work closely with your financial advisor to better understand these risks and how they apply to your family’s unique situation.
What is a Collateral Call?
A prominent risk with an SBLOC is that if the market value of your pledged account or accounts drops below a certain amount, you may be required to deposit additional funds or securities into the account.
This is called a maintenance call or collateral call.
A collateral call is when the issuer of the loan calls for more collateral to be placed in the account or accounts.
A collateral call is triggered when the value of the outstanding line of credit is greater than a certain percentage of the underlying assets.
The ratio is predetermined based on the institution and the quality of assets being held in the pledged accounts.
You can respond to a collateral call by adding cash or securities, paying down the loan, or reallocating the account into higher-quality assets.
Here is an example:
An entrepreneur borrows $1 million from their SBLOC for their business. The total value of the 3 accounts pledge is $4,000,000. The loan-to-portfolio value ratio is 25%. If the loan was ever 70% of the outstanding assets, there would be a collateral call. For a collateral call to happen on the $1 million outstanding loan, the value of the securities in the accounts would have to fall almost 65%.
Let’s take a look at a few ways to manage the chances of a collateral call.
Ways to Manage the Chances of a Collateral Call?
There is no way to ensure that a collateral call doesn’t happen on an outstanding loan.
However, there are many different ways an investor can manage the chances that a collateral call is issued against their SBLOC.
Don’t Max Out Your SBLOC
One of the easiest ways to mitigate the risk of a collateral call is to not take the full amount of the SBLOC.
For example, if a real estate investor has a $2 million dollar SBLOC, they would want to consider only taking $1 million or less.
By taking out smaller amounts, you can increase the spread between your current loan-to-collateral value ratio and the collateral call ratio.
Diversify Your Pledge Accounts
All institutions that allow for SBLOCs will have advance ratios for different types of collateral types.
An advance ratio is the percentage of the asset you could borrow.
For example, a lender might release 50% of listed securities that are above $3 in value. Or they might release 96% of US Treasury Bonds.
Work with your financial manager to review your pledge accounts and potentially add more diversity and less volatile securities such as US Treasury securities, high-grade corporate bonds, blue-chip stocks, or even targeted outcome ETFs.
Remember that asset allocation does not ensure against a collateral call, it can potentially help to manage that risk.
Monitor Your Portfolio and Market Forces
Monitoring your portfolio and the market forces that might negatively impact your account is critical when taking out an SBLOC.
Market volatility is always a potential risk but keeping a close eye on your portfolio and being ready to take pre-emptive action can help protect your portfolio and your SBLOC.
For example, at Clear Creek Financial Management, we monitor thousands of data feeds that could impact the market. We focus primarily on economic data, trend analysis, and volatility. When the data begins to indicate we could be headed for harder times, we begin to take action to protect our client’s assets. This type of investment management process and monitoring allows an investor to be better prepared for a potential collateral call.
Leverage an Independent Financial Advisor
SBLOCs are available at some institutions for retail investors. If you are a do-it-yourselfer, then this might be the option you would want to use.
However, an independent financial advisor can have access to multiple institutions. This allows them to shop around for SBLOCs that the average individual wouldn’t have access to. Most institutions have unique terms, including different interest rates, collateral call triggers, line of credit minimums, and release rates.
Whether the SBLOC is for $50,000 or $10 million, having an independent financial advisor with access to multiple institutions can be hugely beneficial in finding the right terms and helping individuals access other specialized services such as mortgages, SWAPs, etc.
The market for SBLOC greater than $10 million get’s extremely competitive. So when a family or company (like a developer) is interested in getting one of these, an independent financial advisor can not only help negotiate better terms on the SBLOC but also other services that might benefit the borrower.
Broker Dealers do not have the same flexibility. They are often locked into the institution they work with and can not look outside the firm meaning you might be paying more and have less flexibility than you might find someplace else.
Independent financial advisors also have access to large amounts of research that can help you protect your collateral accounts and your line of credit.
Clear Creek Concussion
An SBLOC can be a great tool for an entrepreneur and their family to leverage under the right circumstances.
An SBLOC allows an investor to keep their market exposure, avoid a potentially taxable event, and have low-cost access to liquidity with flexible repayment terms.
There are risks associated with an SBLOC, one of those risks is a collateral call in which the individual has to contribute other assets to the pledge account or pay back the loan.
If you have any questions about how an SBLOC works or if you want a second opinion on your current SBLOC, please contact us.
About the Author: Located North of San Francisco, Jason specializes in financial planning, investment management, and tax strategies for families across the west coast.