Investment strategiesIs a securities-based line of credit right for you?

Key things to know

  • A securities-based lending product is a revolving line of credit backed by marketable securities that can be used to meet liquidity needs.

  • By borrowing against the value of your investments rather than selling them, you can defer paying capital gains tax on appreciated assets.

  • Risks of securities-based lending include interest-rate risk and a depreciation of the assets you’ve borrowed against.

When liquidity needs arise, individuals and families with significant wealth have several different options.

The simplest is to withdraw funds from cash equivalents such as savings or money market accounts. If more money is needed than available in accounts like these, you might have to sell investment securities to generate cash.

But there are potential drawbacks to this approach, starting with hefty capital gains taxes that are due upon the sale of appreciated assets. It also moves performing assets out of the investment portfolio, removing the potential for future income generation.

An alternative option is to borrow against the value of the investments, a strategy known as securities-based lending.

“If you sell low-basis stock to generate liquidity, you may have to pay tax on the capital gains. But if you borrow against the value of the securities instead of liquidating them, capital gains tax is likely not due.”

- Scott Breiler, senior vice president and director of private banking, Ascent Private Capital Management

Scott Breiler, senior vice president and director of private banking for Ascent Private Capital Management of U.S. Bank, says this type of lending product is very common among his clients. “There are some key benefits to securities-based lending that make it very appealing for high-net-worth individuals and families,” he says.


What is securities-based lending?

A securities-based lending product is a revolving line of credit backed by marketable securities, such as stocks, bonds and mutual funds. The bank will lend money at an advance rate against different types of investments, including closely held stock, in some situations. Once the line of credit is approved, you can borrow up to your approved credit limit for almost any purpose you desire.

The bank will establish a lending value for each type of security pledged as collateral and lend up to a certain percent of its market value.

  • The initial lending value (ILV) is the maximum amount that can be borrowed against the portfolio.
  • The maintenance lending value (MLV) determines how much equity must be held in the portfolio. This is usually higher than ILV.

“One of the biggest benefits of a securities-based line of credit is that you can meet short-term cash needs without having to liquidate securities,” says Breiler. “If you sell low-basis stock to generate liquidity, you may have to pay tax on the capital gains. But if you borrow against the value of the securities instead of liquidating them, capital gains tax is likely not due.”


When might you need a securities-based line of credit?

According to Rick Loch, senior vice president and managing director of private banking for Ascent, securities-based lines of credit are one of the most popular lending products among individuals and families with significant wealth.

“Our clients have used securities-based lines of credit for many different purposes,” he says.

These include:

  • Purchasing real estate
  • Acquiring a business
  • Buying high-value lifestyle assets, such as artwork, private aircraft and yachts
  • Making major home improvements and renovations
  • Taking a once-in-a-lifetime vacation
  • Covering unexpected expenses, such as large medical bills
  • Paying outstanding taxes

“A securities-based line of credit can also be used to shore up family cash flow, similar to how a business line of credit can be used to manage business cash flow,” says Loch.


What are the benefits of securities-based lending?

High-net-worth individuals and families can reap a number of benefits from this type of lending product. Here are five key benefits:

1. You can stay invested. Borrowing against your investment portfolio allows you to monetize the value of your portfolio without liquidating your holdings. If your investments appreciate faster than the loan interest rate, you’ll benefit over the long term. “You can keep your investment plan in place and maintain your long-term investing strategy without disrupting your asset allocation,” says Loch.

2. There are potential tax advantages. As noted above, capital gains tax may not be due on appreciated assets unless they’re sold. This also applies to heirs, who will likely receive a step-up in basis when inheriting appreciated assets. When heirs eventually sell securities, they pay capital gains tax only on the appreciation that has occurred since they inherited the assets.

3. You retain financial flexibility. Only the interest must be repaid by the borrower each month, which can free up cash for other uses. “Principal repayment is generally due on demand, so there’s no maturity date,” Breiler explains. Also, there’s no term premium, which makes securities-based lending more cost-effective.

4. The lines of credit are cost-effective. Interest rates on securities-based lines of credit are typically lower than other types of personal financing, and there usually aren’t any setup or administrative fees. Interest is only charged on the outstanding balance, not on the entire credit line.

5. The application process is fast and easy. Securities-based lines of credit feature a streamlined underwriting process with limited disclosure. For example, financial statements and tax returns usually aren’t required from applicants unless the loan is over $5 million.


What are the risks of securities-based lending products?

Breiler notes that clients should be aware of the potential risks involved in securities-based lending. “One of these is interest rate risk,” he says. “Securities-based lines of credit feature variable interest rates, so if rates rise, the monthly payment will rise along with them.” Hedging tools such as swaps can help mitigate this risk for commercial/business purpose lines of credit.

Also, if the value of securities pledged as collateral declines, you could face a margin call and have to pledge additional funds or collateral to support the loan. This could necessitate selling some securities at a loss.

A securities-based line of credit could be the right solution to meet your liquidity requirements. Learn how Ascent can support your complex banking and financing needs.

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Investment products and services are:
Not a deposit • Not FDIC insured • May lose value • Not bank guaranteed • Not insured by any federal government agency

The information provided represents the opinion of U.S. Bank and is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific investment advice and should not be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation.

U.S. Bank and its representatives do not provide tax or legal advice. Your tax and financial situation is unique. You should consult your tax and/or legal advisor for advice and information concerning your particular situation.

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