Securities-Backed Loans Draw FINRA’s Eye

Banks’ wealth-management divisions are underwriting loans collateralized by clients' growing securities portfolios.
Katie Kuehner-HebertJanuary 7, 2015
Securities-Backed Loans Draw FINRA’s Eye

The growing popularity – and potential risks – of a new form of loan backed by stocks and bonds has put it on the 2015 watchlist for the Financial Industry Regulatory Authority.

In its 2015 Regulatory and Examination Priorities letter released Tuesday, FINRA said that it was concerned about securities-backed lines of credit (SBLOCs) and how they were being marketed. In particular, FINRA is concerned that financial advisers may not be fully disclosing all of the potential risks to investors. The independent regulator defines SBLOCs as revolving loans collateralized by stocks, bonds and mutual funds that are held in fully-paid cash accounts.

In a Wall Street Journal story Tuesday, FINRA chairman and chief executive Richard Ketchum said that securities-backed loans “carry significant credit and call risk.”

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“In addition, they are difficult to value, have longer settlement time than other investments and are relatively illiquid,” the regulator said.

Broker-dealers offering SBLOCs should have “proper controls in place,” FINRA said in its report.

“Customers should be fully apprised of program features, including loan restrictions and how changing market conditions may affect their brokerage account and their ability to draw on the SBLOC,” the report’s authors wrote. “Moreover, firms should have operational procedures that enable them to interact with the lending institution to monitor the customer’s account, keep adequate records and ensure that customers are promptly notified when collateral shortfalls occur.”

While there have been no disciplinary actions within the industry over such lending practices, Ketchum said that FINRA was concerned about investors over-leveraging their portfolios, which can fluctuate greatly and come back to bite them – in much the same way that many homeowners over-leveraged their mortgages with home equity lines of credit before the financial crisis hit in 2008.

FINRA’s report, the 10th edition of providing guidance to firms on issues of particular concern to the regulator, cited other trends it was watching closely, including the sale and supervision of interest-rate-sensitive and complex products such as alternative mutual funds, cybersecurity risk management and the treatment of senior investors.