What is Stock Lending?
Stock lending could work in several ways. That said, essentially, stock lending works by you lending securities in return for a fee. If your stock goes up, you also earn that income from your stock. The length of time that you temporarily transfer the title of the security is up to you. You can also choose to sell it at any time.
That said, most people choose to stock lend to earn some income while they’re waiting for the price of their security to increase.
Who Organizes Stock Lending
With securities lending, the process isn’t usually facilitated by individual investors. Brokers and dealers normally conduct this process. They draft a contract and ensure a lending agreement is completed to finalize the transaction. It includes:
- The length of the securities lending agreement
- the interest rates
- any fees and collateral included in the transaction
Collateral Required for Stock Lending
When you’re borrowing stock, the collateral required to borrow the stock is based on the market value of the security being borrowed. That said, it’s normally 100% of the securities market value that is required. However, the minimum initial collateral is typically 102%, including any accrued interest. There are also lending fees and sometimes monthly fees included.
Reasons Investors Borrow Stocks
You may be wondering why some people are choosing to borrow securities. Well, there are actually quite a few different reasons. Let’s take a look at some of these reasons.
- Collateral: This is the most common reason for borrowing securities. Firms and businesses may be required to post securities to borrow money or to operate day to day. If they don’t have the securities required, they often just borrow them.
- Cover Deficits: When firms and businesses are required to hold a certain number of securities, but they don’t quite meet the requirements, they can borrow them. This is often temporary until it’s possible to acquire the securities needed.
- Participate in Corporate Decisions: To participate in corporate decisions, you have to be a shareholder. Some, instead of purchasing the shares, borrow them for a short period for voting rights.
Fully Paid Stock Lending
With stock lending, the process used for lending is decided by the brokerage firm you’re using. One of these processes is called fully paid stock lending. It’s up to you whether you want to loan out your whole portfolio, including all the securities, or just individual stocks. From there, other financial institutions and brokerages will be notified of your intent to take out a loan, and the process can start there.
If your shares are borrowed, the lender will sell them at the current price and then buy them back later to return them to you. Ideally, the borrower will purchase the stocks at a lower price and earn an income. However, that’s not always the case.
Sometimes, the borrower pays a higher price to buy the securities back and still gives you the stocks. In this case, they’d lose money. This process, often called shorting a stock, doesn’t always work. That said, though, either way, the borrower is still supposed to return your shares.
Best Canadians Brokers That Offer Fully Paid Stock Lending
Now that there are so many brokerages in Canada that offer fully paid stock lending, it can be difficult to pick the right one. That said, some brokerages are better than others. Let’s take a look:
TD Direct Investinging a stock, but it doesn’t always work. That said, though, either way, the borrower is still supposed to return your shares.
- Interactive Brokers
- Wealthsimple
- Questrade
- National Bank Direct Brokerage
Stock Lending Requirements
When it comes to stock lending, many of the requirements that you need to meet are dictated by the bank or broker that you’re dealing with. For most larger financial institutions, a minimum lending amount of $50,000 to $100,000 is required. That said, other brokers like Wealthsimple have no minimum lending requirements and no account minimums.
When it comes to lending stocks, certain securities aren’t eligible. These include the following criteria:
- Fractional shares
- Securities that don’t have high demand
- Securities that aren’t earning accretive
You can also lend out different kinds of securities. It’s less common to lend mutual funds and ETFs.
Stock Lending Rates
With stock lending rates, the amounts vary. It’s also based on the brokers you’re dealing with, as well as which specific securities you’re lending out. That said, there are some things to consider regarding price. First, high-demand stocks, which are stocks and ETFs that are hard to borrow, have much higher lending rates than low-demand stocks.
Another impact on the price you receive when lending stocks is the brokerage program. Each has a different revenue share that they split with you. While Questrade and Wealthsimple’s revenue share is 50/50, not all brokerages will split it that evenly.
Stock Lending Program
In Canada, there are many ways to participate in securities lending. One of these is by participating in the Securities Lending Program through the Bank of Canada. With this program, instead of purchasing government securities, they can be borrowed. As with other government securities, the process is conducted through an auction.
The Stock Lending Program uses a multiple-rate competitive auction. Once an auction is listed, they provide the date, amount, minimum bid rate, and any other relevant information. However, regardless of the security you borrow, the maturity term is one business day.
Pros and Cons of Stock Lending
While stock lending isn’t as common as buying and selling securities, it is becoming increasingly popular. That said, like with anything, there are positives and negatives to the process. Let’s take a look at some of these for stock lending.
Pros
The main reason investors choose to be stock lenders is to earn additional income. Depending on your investment, you can also turn a dormant one into one that starts earning income again. It can also add liquidity to the short-seller market.
Cons
Unfortunately, when it comes to stock lending, there are more cons than positives for stock owners. However, that doesn’t mean that you shouldn’t stock up. You should just be careful. Let’s take a look at these cons.
- Increased risk of default from the borrower
- You may need to qualify to participate
- Taxed at marginal rates on payments instead of how you would be taxed on dividend payments
There are also many reasons why securities lending is facilitated by brokers and dealers, not by individual investors. This provides a little more security and helps to mitigate these risks. That said, there are risks when it comes to investing in general, so you do have to make calculated decisions. It’s also a reason that other investors choose not to lend securities.
Risks of Stock Lending
When it comes to stock lending, there are many risks to consider. This is why investors don’t use stock lending as a long-term solution. It’s often just used on a short-term basis to earn some extra income.
With the stock market, stock prices vary all the time. This is why using stocks as cash collateral for a loan is a short-term solution. If the stock starts to lose value, the collateral is insufficient to cover the loan amount. In a case like this, the borrower may default on the loan and be unable to repay the full amount. In some cases, the shares can drop to zero, and the loan can go unpaid.
What You Can Make From Stock Lending
The amount that you can earn from stock lending depends on how much stock you’re lending out and what the cost of the stock is. It’s also based on supply and demand. This means the more popular the stock that you have, the more you can earn. You also have to factor in the split with the broker you’re using to lend stocks. That said, though, the split is usually 50/50.
While a 50/50 may not seem ideal, you don’t have to do anything when it comes to stock lending. This is all done by the broker or dealer you’re dealing with. All you need to do is own the securities. Let’s take a look at an example of what you can earn.
For example, let’s say you own 250 shares of a stock that is currently selling for $28 per share. The value of that is $7,000. If your stocks continue to do well and you earn 10%, the total is $700. If you split it 50/50, you earned $350. This is pretty good for passive income. You’re letting your money earn more money without having to invest anything else.
Stock Lending with Wealthsimple
One of the most popular online brokerages in Canada that offers stock lending is Wealthsimple. You may also find that this is referred to as Fully Paid Securities Lending. You can lend out your eligible securities to borrowers that Wealthsimple finds, and earn some passive income. This is because you earn a fee on the securities you loan out. However, it can take some time to get paid.
The payout for stock lending with other dealers varies, but with Wealthsimpl, it is 10 business days into the month. However, these are only the borrowing fees for the previous month’s Canadian securities. Since you get to keep the stock during this process as well, it’s much different from short selling.
A really nice part of stock lending with Wealthsimple is that they protect your assets. Your investment is secured by cash collateral equal to up to 100% of your loaned-out security accounts. Any other cash collateral from the borrower will also be added to this cash account.
Opting Out with Wealthsimple
When it comes to opting out of stock lending with Wealthsimple, it’s actually pretty easy. All you have to do is log in or open the Wealthsimple app. Once you’ve done that, you hit the invest tab and open the account that your loaned securities are in. Scroll down to Stock Lending, then click Manage. From there, you can toggle the stock lending off. Once this is done, it can take up to 5 days for any active loaned stock to be turned off.
Receiving Dividends While Lending Stocks
When you loan out your stock, you don’t directly receive dividend payments. This is because the legal title of the stocks transfers to the borrower. Instead, you’ll receive substitute payments. The borrower or the broker provides this and matches the exact cash amount you should have received.
Tax Treatment of Stock Lending Payments instead of Dividends
When it comes to taxes, substitute dividends are treated as ordinary income rather than qualified dividend income. This can result in higher tax amounts depending on your total income amount.
Voting Rights and Stock Lending
Since you’re technically transferring over the legal title of the stock, you no longer have proxy voting rights for the stock. If you want voting rights. You’re going to have to recall the stock.
Lending Stocks Held in a TFSA or RRSP
Your stocks don’t have to be held in non-registered accounts to lend them out, since TFSAs and RRSPs are considered eligible accounts. To participate, you must opt into your specific asset management firm’s program. Any dividends you receive won’t be subject to tax, and the earnings can be used for retirement savings instead of or alongside pension plans.
Stock Lending Vs. Covered Call Writing for Income
While both are ways to earn passive income, each involves different risks. Covered calls have a lower risk tolerance but offer higher, more active income. Stock lending provides low-effort, low-risk income. They both operate under a regulated framework, and each has different collateral requirements.
What Happens if Your Broker Goes Bankrupt While Lending
If your broker goes bankrupt while lending out your securities, you could potentially lose them since they aren’t covered by the Canadian Investor Protection Fund (CIPF). This is because you temporarily transfer ownership to the brokerage while lending them out. However, collateral can be used to recover your loss. The borrower is required to offer over 100% value in collateral just in case.
Stock Recall
For various reasons, including market demand, lenders may request a stock recall. This means that they’re requesting the shares they previously loaned out back. There are many reasons a stockholder may wish to do this.
Why Short Interest Makes a Difference for Stock Lending Fees
Short interest affects stock lending fees by directly controlling supply and demand. It can also dictate how expensive it is to short-sell a stock.
