By Andrew Bary

In a stock market that has become a bit of a wild ride, a little bit of income can go a long way. Securities-lending programs, once the purview of institutional investors, can provide some extra cash for small investors when market conditions are favorable.

The programs shouldn't be confused with popular plans that allow investors to borrow from their brokers, using their securities holdings as collateral. Rather than borrowing money to buy more stock, investors are paid for lending out their shares or exchange-traded funds to investors looking to bet against a company or industry, something that can be very profitable when securities-lending rates are high.

Rates have been known to top 100% or more -- on an annualized basis -- for stocks that are in particularly high demand from short sellers. During the past year, there were high rates available on stocks such as Sirius XM Holdings and Endeavor Group Holdings, which has since gone private.

Fidelity, Charles Schwab, Interactive Brokers, Robinhood, E*Trade, and several full-service brokerage firms offer these programs to investors, but few take advantage of them. Schwab says a "very small percentage" of retail accounts participate, and the situation is similar at Fidelity. Interactive Brokers, which caters to more-sophisticated individual investors, appears to have the greatest participation. The firm says that over 800,000 clients globally -- about 25% of its accounts -- are enrolled in what it calls its Stock Yield Enhancement Program.

"This used to be an extremely opaque area," says Steve Sanders, executive vice president of marketing and product development at Interactive Brokers. "We've worked to make the process transparent."

With securities lending, interest accrues daily and investors retain full economic ownership of their stocks. They can sell covered call options against their holdings and can sell the shares or recall them when they like. The area has long been popular with institutional investors, who deal with stock-loan departments and prime brokerage areas at brokerage firms, even if it's less well-known among the retail crowd.

The vast majority of stocks don't offer any special rates and are known as "general collateral." The rates on these stocks and ETFs can be just 1% to 2%. High-rate stocks, by contrast, are said to be "on special." The highest lending rates generally are available on smaller speculative stocks that often are the target of short sellers. There also can be high rates on stocks involved in takeover situations if arbitragers are selling them short. Recently, annualized rates of 50% or more were available on Beyond Meat and a group of biotech companies including Pacific Biosciences of California. Some ETFs, particularly leveraged ones, also can offer relatively high rates.

There is no such thing as free money, and securities lending carries risks. Loans reprice daily, meaning that a high rate can evaporate quickly if tight borrowing conditions loosen up. Investors also give up voting rights while shares are on loan, and they become creditors of their brokerage firms, which creates a very small default risk even though the firms post collateral against the loans equal to 102% of value of the stocks.

Complicating matters, particularly for income-focused investors: They get a payment called "cash in lieu" instead of a dividend if the securities are on loan when the payout is made. That's a negative from a tax standpoint, says tax expert Robert Willens, who notes that these payments are "taxed at the lender's highest marginal tax rate, not the preferential capital-gains rate." For this reason, investors who loan their securities typically call them back before the record date to collect dividends.

Fidelity and other firms have made it easier to participate by lowering minimums and simplifying the process. Fidelity clients now need to have $25,000 in their accounts to lend their stocks, compared with $250,000 in household accounts a few years ago. At Interactive Brokers, investors are required to have at least $50,000 in a cash account or be approved for a margin account. Investors there can even view a list of securities with high rates, while Fidelity alerts them on their client account page if one or more of their securities offers a high lending rate. The loans can run for days, weeks, or months. Investors generally need to have full ownership of the securities -- margined stocks usually can't be pledged.

The proceeds are split between the firm and the investors. Fidelity offers the best deal -- customers get 60% of interest, with the firm keeping 40%. At Schwab and Interactive Brokers, the split is 50/50, and a t Robinhood, investors get to keep just 15%, with the firm getting 85%.

The amount of interest varies and is based on the size of the holding. One investor, for instance, told Barron's that he lent $1.35 million of the Direxion Daily Financial Bull 3X ETF (ticker: FAS) in his Fidelity account in February and was earning about $75 a day after getting credited with a 2% annual rate.

Given that daily income can be small, some investors conclude that it isn't worth participating in lending programs. One investor told Barron's that it amounts to "picking up nickels in front of a steamroller" -- modest income in return for the very small chance of a problem that could occur in a financial crisis.

For Wall Street firms, securities lending has long been a low-profile, low-risk, and profitable business. Robinhood, which breaks out the numbers, reported revenue from the business of $70 million in the fourth quarter, double the amount from the same quarter the year before.

Retail investors will never reach those lofty levels, but securities-lending programs still offer a nice way to supplement income with minimal risk in an area that was once the province of institutional holders. It's worth a look.

Write to Andrew Bary at andrew.bary@barrons.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

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April 24, 2025 01:45 ET (05:45 GMT)

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