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 that must be completed before the stock is borrowed by a client (such as a hedge fund or retail investor).
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.
[Important: Stock loan fees may be worth paying when short selling is lucrative, but traders should always be sure to factor them into the risk-to-reward ratio of their trades.]
Special Considerations for Stock Loan Fees
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, the costs involved with it 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-to-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 (360-day year is assumed) is therefore ($25 million x 3%) / 360 = $2,083.33.