SHARED-BASED LOANS

What is share-based loans? New age share-based loans are lending facilities that allow investors to utilise their share account like a bank account with an overdraft facility. The investor can access the funds as long as they stay within the limits of the loan agreement. When they require the loan their trading account goes into debit. As and when they receive dividends, sell shares or deposit cash, the loan on their trading account is credited. It doesn’t require all the administrative paperwork involved with a non-collateralised loan and can be arranged within one week. Lastly, there is no fixed loan amount or repayment period on these loans.

How does it work? The investor has to cede or pledge their share portfolio as collateral with their stockbroker or the funding institution. This means in case of a default, the stockbroking firm has the right to sell shares in the investor’s portfolio in order to settle the loan amount. Importantly, the investor still has control of their account and can buy/sell shares within the limits of the share based loan agreement. The reason for this multi-control structure is that any proceeds from a sale in the share portfolio first go towards repaying the loan.

What are the requirements? Most stockbroking firms would have a minimum equity portfolio size they’d offer this service to (to ensure the admin and controlling of the account is worth the effort). The liquidity of the shares within the portfolio also plays a massive role. At Vista Wealth Management a client’s share account must have a minimum value of R1million worth of Top 100 shares. If the National Credit Act applies to the investor, the investor has to complete an asset & liability and income & expense statement in order to determine affordability.

How much can I borrow? The loan amount depends on the investor’s share portfolio. At Vista Wealth Management a client can borrow as much as 60% loan-to-value (LTV) against a well-diversified liquid portfolio. This LTV will vary and move up and down as the underlying share’s values increases and decreases. Once an investor breaches the LTV, the investor would have to repay a portion of the loan, pledge more shares or sell shares. On a portfolio which is not well-diversified and for example only consists of one share, the investor would only get about 10% LTV. It is not advised that investors borrow the max as a decline in the share market could cause the share portfolio to fall below the allowed LTV and therefore triggering a margin call.

What can I do with the money I borrow? The investor can withdraw the cash or use it to buy more shares. Most stockbrokers would prefer the investor has this facility available to allow the investor to buy more shares should market opportunities present themselves. It is in reality a very efficient and easy way of obtaining bridging finance if the investor needs funds in a rush.

What interest rate do I pay? The interest rate varies from stockbroker to stockbroker and often depends on the size of the loan. At Vista the default interest rate for most share-based loans is the prime interest rate. Interest is calculated monthly and investors can decide to pay interest monthly or allow it to be added to their loan account. But be cognisant of the impact of interest-on-interest. Any dividends that gets paid or shares that get sold will first go towards repaying loan.

Tax implications? Before this facility was available investors were required to liquidate their share portfolio in order to access their funds. The selling of shares could trigger income or capital gains tax. Investors used to only be able to gear their share portfolios through instruments like CFDs and SSFs. Trading activity in these derivatives would however always trigger income tax while investors utilising share-based loans to gear their portfolios would only trigger capital gains tax if they stay invested in the shares for longer than 3 years.

Articles? Vista recently wrote an article for Finweek and Fin24 about this product. Click here to read more.

# Positives summarised
1. Quick, cost efficient way of obtaining short-term liquidity without liquidating your share portfolio
2. One account housing trading portfolio and share-based loan
3. No fixed loan amount or repayment period as long as user remains within loan parameters
4. Less administrative paperwork and requirements compared to non-collateralised loans
5. Investor can still buy/sell shares even though the portfolio is pledged as collateral for loan
6. Very competitive interest rates
7. Shares sold, cash deposits or dividends received automatically contributes to repaying loan
8. Tax efficient

 

# Negatives summarised
1. A decline in the market and share prices can trigger a margin call
2. When gearing your portfolio, returns are not guaranteed to be more than funding cost

 

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