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Yet Another Ticking Time Bomb Wall Street Is Selling To Retail Investors

October 30, 2018 Blog

As the stock market skids downward and sees increased volatility, investors should take a close look at their secured loan portfolios.

All across Wall Street, securities-based lending is red hot, as The Motley Fool noted. And guess who the target is? You guessed it,  Mom and Pop.

Nearly a decade into a bull market, banks are encouraging customers to borrow against their stock and bond portfolios to paper over budget gaps and cash needs, rather than sell their investments. Clients of Morgan Stanley and Bank of America have borrowed more than $40 billion against their portfolios.

And even online discount brokers, Interactive Brokers chief among them, are pitching the ability to borrow against a portfolio at low interest rates.

Their pitch seemed simple but, in the midst of the current market turmoil, could prove to be lethal. The argument was, why sell your securities when you can borrow against them?

The market has continued its climb to record highs since it bottomed in March 2009. For almost a decade, it has looked like investors couldn’t lose. But then October, historically the month for stock market disasters, happened.

The broad market hit all-time highs on October 3 but then promptly reversed course and began a brutal sell-off. Since then, the Dow has lost more than 9% of its value through the start of this week, and many analysts believe there is more bad news ahead.

Borrowing against a stock portfolio is nothing new, the article noted. Margin loans have been around for a long time. But securities-based loans offered by Morgan Stanley, Bank of America, and other large wealth managers aren’t margin loans and carry specific dangers.

The proceeds aren’t supposed to be used to buy more investments. Instead, marketing materials commonly suggest using a securities-based loan to buy a vacation home, or cover retirement expenses, without needing to sell your investments.

How much one can borrow depends on the quality and safety of the collateral. Stock holdings might get an advance rate of 50%, whereas U.S. Treasury bills might have an advance rate of 95%. Thus, wealth management clients can borrow $0.50 for every $1 of stock they own or $0.95 for every $1 of U.S. Treasury bills in their portfolios.

Loans can extend to five years or more, though most are slated to mature within a year. At that time, investors either pay the loan off or roll it over.

Financial advisors pitched borrowing at low interest rates while stocks were rising as a great way to pay for everyday needs and luxury items. Now, with rising interest rates and declining stock prices, investors are likely to have their loans called and stocks sold at rock bottom prices.

This situation is reminiscent of numerous Puerto Rico investment fraud claims against UBS, Santander and Banco Popular. These banks encouraged their clients to take out credit lines against their Puerto Rico bond portfolios which crashed in 2013, destroying retirement and life savings.

Recently, FINRA issued an investor alert warning that secured loan portfolios faced premature sale of stocks, high interest charges and possible adverse tax consequences.

Investors beware of secured lending against your portfolios. The current market turmoil could prove to be disastrous.

Zamansky LLC is a New York law firm which represents investors in court and arbitration cases against securities brokerage firms and issuers.  The firm may represent investors in cases against companies mentioned in this blog.  Zamansky LLC also represents investors in arbitration cases against UBS and other brokerage firms regarding Puerto Rico bonds and UBS closed end bond funds and other investments.