What Is a Stock Loan Fee?
A stock loan fee, or borrow fee, is a fee charged by a brokerage firm to a client for borrowing shares. A stock loan fee is charged pursuant to a Securities Lending Agreement (SLA) that must be completed before the stock is borrowed by a client (whether a hedge fund or retail investor).
A stock loan fee can be contrasted with a stock loan rebate, which is payment received by those who lend stock to others.
- Stock loan fees are charged to clients of brokerages for borrowing stock. This is typically done for the purposes of short selling.
- The more difficult it is to borrow the stock, the higher the fee.
- Traders should carefully consider the risk/reward ratio of trades in terms of associated fees before implementing a short sale strategy.
How a Stock Loan Fee Works
The stock loan fee amount depends on the difficulty of borrowing a stock—the more difficult it is to borrow, the higher the fee. As short sellers immediately sell the borrowed stock, the borrower must reassure the lender by putting up collateral such as cash, treasuries, or a letter of credit from a U.S. bank. If the collateral is cash, the interest paid by the stock lender on it to the borrower may offset part of the stock loan fee.
Most shares held by brokerage firms on behalf of their clients are in “street name,” which means that they are held in the name of the brokerage firm or other nominee rather than in the name of the client. This way the brokerage can loan the stock out to other investors.
Stock is generally borrowed for the purpose of making a short sale. The degree of short interest, therefore, provides an indication of the stock loan fee amount. Stocks with a high degree of short interest are more difficult to borrow than a stock with low short interest, as there are fewer shares to borrow.
Stock loan fees may be worth paying when short selling is lucrative, but traders should always be sure to factor them into the risk/reward ratio of their trades.
Stock Loan for Short Selling
A short sale involves the sale of borrowed securities. These securities must be first located and loaned to the short seller in a margin account. While the shares are being borrowed, the short seller must pay interest and other charges on the loaned shares.
The goal of the short seller is to sell the securities at a higher price and then buy them back at a lower price. These transactions occur when the securities borrower believes the price of the securities is about to fall, allowing them to generate a profit based on the difference in the selling and buying prices. Regardless of the amount of profit, if any, the borrower earns from the short sale, the agreed-upon fees to the lending brokerage are due once the agreement period has ended.
Rights and Dividends
When a security is transferred as part of the lending agreement, all rights are transferred to the borrower. This includes voting rights, the right to dividends, and the rights to any other distributions. Often, the borrower sends payments equal to the dividends and other returns back to the lender.
The stock loan fee is an often overlooked cost associated with shorting a stock. While short selling can be lucrative if the trader’s view and timing are right, its costs can be quite substantial. Apart from the stock loan fee, the trader has to pay interest on the margin or cash borrowed for use as collateral against the borrowed stock and is also obligated to make dividend payments made by the shorted stock.
Traders who are considering short-selling a stock should carefully consider these fees when determining the risk/reward ratio of their trades to avoid any unexpected surprises.
Example of a Stock Loan Fee
Assume a hedge fund borrows one million shares of a U.S. stock trading at $25.00, for a total borrowed amount of $25 million. Also, assume that the stock loan fee is 3% per year. The stock loan fee on a per-day basis, assuming a 360 day year, is therefore ($25 million x 3%) / 360 = $2,083.33.