What Is a Stock Loan Rebate?
A stock loan rebate is a cash-back payment from someone who lends stock to an investor who puts up cash collateral to borrow stock. The most common application of this rebate is associated with short-selling, though the average retail trader who knew about short-selling would never know it existed.
- A stock loan rebate is only offered to select customers.
- It may come from the interest payments paid by margin borrowers.
- These payments can be offered to key customers to attract and retain them.
How a Stock Loan Rebate Works
In simple terms, a stock loan rebate is a payment to larger investors potentially available from a broker as the opposite side of the interest charged for borrowing on margin. To investors who never by stocks on margin, this is a foreign concept. Traders who buy stocks on margin know that when they buy shares of stocks on margin, their broker charges interest for cash used to purchase those shares. If the trade is only has the duration of a few days, the charge is minimal and practically unnoticed. It typically amounts to an annual rate comparable to a lower-rate credit card.
The lending broker will continue to accrue all interest on the money used by the investor to buy the stock on margin. But who is entitled to those interest payments? Most of the time it is the broker, but there could be another scenario where those payments could go to someone else.
Consider the following scenario: Investor A, with a $100,000 account balance, buys 1000 shares of stock XYZ, but at $200 per share, must do so on margin, incurring the equivalent of a $100,000 loan on the fly. The interest Investor A will pay is equivalent to a rate of 6% annually. Next consider that Investor B happened to want to open a short position in XYZ of 500 shares at the same time. So the 500 shares Investor B sold short are half of the shares that Investor A purchased. In this scenario, Investor B has provided the cash collateral necessary to open the short position, so ultimately, it is the cash from Investor B that is being used to afford Investor A to take the margin position in XYZ.
Based on this scenario, it seems only right that Investor B should be offered the interest payments from their short position. This scenario is what drives brokers to offer a stock-loan rebate to some of their more sizable customers. In fact they often do, but only for select customers, and not after substantial fees have been taken.
A retail trader or investor without a very large account will likely not be offered a rebate if they open a short trade, but a larger institutional customer might be offered such a rebate in order to attract their sizable accounts or order flow. The amount of the rebate is determined by the Securities Lending Agreement established between the borrower and lender, and the rebate typically offsets all or some of the lender’s stock loan fee. This size of this fee, which typically charged by brokerages to clients borrowing stock shares or the money to buy shares, is also spelled out in the Securities Lending Agreement.
Special Considerations for a Stock Loan Rebate
The stock loan rebate is a sweetener in securities lending. Securities lending is a key feature of short selling, in which an investor borrows securities to immediately sell them, hoping to profit by buying them back later at a lower price. The lender is compensated by the fees, which enhance its returns on the securities; it also has the security returned at the end of the transaction.
Usually, this type of arrangement is not available to the small individual investor. Stock loan rebates are typically only available to larger clients with sufficient cash on hand, such as professional traders, institutional investors and other broker/dealers.
Also, borrowers who do not use cash as collateral are not entitled to stock loan rebates. Those borrowers who put up other sorts of assets as collateral will typically still be responsible for a lender’s fee, even if that collateral is in the form of securities that are almost comparable to cash, such as Treasury bonds or bills.
Example of a Stock Loan Rebate
Consider a scenario in which a hedge fund borrows 1 million shares of stock worth $20 per share for 30 days. The loan agreement stipulates that the collateral owed on this loan is 102%, so the hedge fund puts up $20,400,000. The contracted loan fee is 3%, with a rebate of .7% and a reinvestment rate of 1%. Additionally, the net investment earnings after the rebate will be split, with 60% going to the borrower and 40% to the lender. For the purposes of this example, let's assume a 360-day year period.
So the stock loan rebate for the 30-day loan is $11,900, calculated as follows:
[($20 million x 102% x 0.70%)] x (30 ÷ 360) = $11,900
The reinvestment earnings are $17,000, calculated as follows:
[($20 million x 102% x 1.00%)] x (30 ÷ 360) = $17,000
Subtracting the rebate from the reinvestment earnings, the net investment earnings are $5,100. These earnings are then split 60/40, meaning that $3,060 goes to the borrower, and the lender retains $2,040.
The borrower is also responsible for an annual stock loan fee of 3%, which in this case is a $50,000 fee for the 30-day period. Their portion of the net investment earning offsets this fee, so the borrower’s monthly fee for this period would be $46,940, calculated as follows:
$50,000 - $3.060 = $46,940