Latest / The High Net Worth Podcast with Fexingo: Wealth Management, Tax Strategy, and Affluent Finance / How Family Offices Use Securities-Based Lending
Transcript
- Lucas: So, Luna, you know that moment when a client has a massive concentrated stock position, say fifty million dollars in a single founder's stock, and they need fifteen million in cash for a private equity capital call? They don't want to sell because that triggers a huge capital gains tax. What do they do? Luna: I mean, the classic answer is a margin loan, but that's messy. So what's the sophisticated play? Lucas: The sophisticated play is something called securities-based lending, or SBL. It's a loan collateralized by marketable securities, but it's structured differently than a typical margin account. The bank holds the securities as collateral, and you borrow against them at a loan to value ratio that's often more favorable than what a retail margin account offers. Luna: And the key is that you're not selling, so you defer the capital gains. That's the whole point, right? Lucas: Exactly. You get liquidity without triggering a taxable event. And for a family office, that's huge. Let's say you have a founder who's still got a large position in the company they built. Selling even a portion would mean paying long-term capital gains at twenty-three point eight percent if you're in the top bracket, plus the net investment income tax. On fifteen million, that's over three and a half million in taxes. Luna: Ouch. So instead, they borrow, and the interest is tax-deductible if the proceeds are used for investment, which a capital call is. Lucas: Right. And the interest rate on an SBL is typically tied to the bank's internal rate, which in the current environment of August 2026 is still relatively elevated, but it's often cheaper than a margin account. A bank might offer you SOFR plus one-fifty, while a margin loan at a brokerage could be SOFR plus three or four hundred basis points. Luna: So, you're saving on rate, you're saving on tax, and you're keeping your stock. But what are the risks? I mean, there's always a catch. Lucas: The catch is the loan to value ratio and the mark to market. If your collateral drops in value, the bank can issue a margin call. And in a volatile market, that could force you to either post more collateral or sell at the worst possible time. That's the nightmare scenario for a family office. Luna: So how do they protect against that? Do they just accept the risk, or are there structures? Lucas: They typically negotiate a covenant that gives them time to respond, like a ten-day cure period, rather than a same-day margin call. And they often borrow conservatively, keeping the loan to value below fifty percent even if the bank allows sixty. Luna: That makes sense. So, what's a realistic example? I mean, we've talked about a capital call, but what about a bridge loan for a real estate purchase? Lucas: Sure. Say a family wants to buy a ski property in Aspen for ten million. They have the cash, but they'd rather keep that cash invested in their portfolio. They could take out a securities-based loan against their equity portfolio, use that to buy the property, and then maybe refinance into a traditional mortgage later if rates drop. But they don't have to sell any appreciated assets. Luna: And the interest on that loan? If it's for a personal residence, it's not deductible. But they might not care because they're deferring a bigger tax hit. Lucas: Exactly. And that's a key point: the purpose of the loan matters. If the proceeds are used for personal expenses, the interest is not deductible. But if it's for investment, it can be. So a family office needs to be careful about how they structure the purpose. Luna: So, does this overlap with some of the other strategies we've covered, like exchange funds or 1031 exchanges? I mean, they're all about deferring taxes. Lucas: It's a different tool. Exchange funds solve concentration by swapping your stock for a diversified fund, but they have liquidity restrictions. SBL gives you cash now, but you keep the concentration risk. And 1031 is specifically for real estate. SBL is more flexible because you can use it for anything. Luna: So, what should a family office consider when they're setting up an SBL? I imagine it's not just walking into a bank and asking for a loan. Lucas: Right. The first thing is to shop around. Banks have different appetites for certain types of collateral. A bank might be comfortable lending against an S&P 500 ETF, but might be more cautious with a single stock, especially if it's volatile. So a family office might have to negotiate a lower loan to value for that concentration. Luna: And they'd also want to look at the fee structure. Some banks charge an origination fee, others don't. And there might be a maintenance fee on the line of credit. Lucas: Yes. And one thing that's often overlooked is the bank's ability to call the loan unexpectedly. Most SBL agreements have a clause that allows the bank to demand repayment at any time. That's rare, but it's a risk. So a family office should have a backup plan, like a line of credit elsewhere or access to cash. Luna: So, you mentioned that this is a big deal for family offices. How big is the market? Is it growing? Lucas: It's a significant part of private banking. In recent years, securities-based lending has grown as rates have risen, because it offers a cheaper source of liquidity than many alternatives. And with the current uncertainty in markets, families want to keep their investments intact while having cash available for opportunities. Luna: But it's not just for the ultra-wealthy, right? I mean, regular investors can do this too, but the rates and terms are often better for high net worth clients. Lucas: Exactly. A retail investor with a brokerage account can get a margin loan, but they'll pay a higher rate and have less flexibility. A family office with substantial assets can negotiate a customized agreement with a bank's private wealth division, getting better rates and more favorable covenants. Luna: So, what's the catch? I mean, there must be a downside. What if the stock goes to zero? You still owe the money, right? Lucas: Right. The loan is non-recourse in some cases, but typically it's recourse. If the collateral drops below the maintenance margin, you either post more collateral or the bank sells the securities. You're still liable for any shortfall. So it's not risk-free. Luna: And let's be honest, if your stock is dropping that much, you're probably already in trouble. So it's a double whammy. Lucas: That's why the best practice is to borrow conservatively and diversify your collateral. Some families even hold a separate pool of cash or Treasuries that they can use to meet a margin call without selling the concentrated stock at a bad time. Luna: So, it's all about being prepared. And that's something we talk about a lot on this show. You know, thinking through the worst case before you need the money. Lucas: Exactly. And that's actually why we're able to bring you these conversations without any ads in the middle. We deliberately don't run ads on these podcasts. If you want to support that choice, the link is buy me a coffee dot com slash fexingo. It's a small gesture that keeps this show going, and we appreciate it. Luna: Yeah, if our money talks have helped you think about a decision differently, that's the whole point. A coffee really does help. Lucas: So, back to the practical side. When a family office is considering SBL, they also need to think about the tax implications of the interest deduction. The IRS has rules about tracing the use of proceeds. If you borrow to buy municipal bonds, the interest might not be deductible. So you have to be careful. Luna: Right. And I've seen cases where a family office borrowed against stock to fund a private equity investment, but the PE investment was structured as a partnership interest, and the interest expense had to be allocated across the different asset classes. It gets complicated. Lucas: It does. That's why it's essential to work with a tax advisor who understands the nuances. But when done right, SBL can be a powerful tool for managing liquidity without triggering a tax event. And it's a strategy we'll continue to see family offices use, especially in times of market volatility. Luna: So, what's the one takeaway you want listeners to remember about securities-based lending? Lucas: It's not just a loan; it's a strategic tool. It lets you access your wealth without selling it, and that can save you millions in taxes. But it requires discipline and careful structuring. I'd say, if you're a high net worth individual, it's worth having a conversation with your private banker about whether SBL fits into your overall plan. Luna: And as always, don't try this at home without a professional. But it's good to know the options. Lucas: Absolutely. That's it for today. We'll be back tomorrow with another deep dive into wealth management strategies. Until then, stay curious.