Through the new Fully Paid Lending Income Program, qualified applicants can earn income on stocks and exchange-traded funds by lending out the shares they already own.
In an era of historically low interest rates, income-seeking investors often choose to look beyond traditional bonds to target income. Some investors seek income from equity holdings, such as dividend-paying stocks or preferred stock.
Now there’s another way to earn income on stocks and exchange-traded funds (ETFs): lending out the shares you already own.
Through TD Ameritrade’s new Fully Paid Lending Income Program, qualified participants can earn passive income by loaning out stocks and ETFs while still maintaining full ownership of the security. Securities lending is straightforward and transparent.
It’s free to enroll and can be done online. Currently, cash accounts and margin-approved IRAs (limited margin IRAs) are allowed to enroll, and clients can exit the program at any time. TD Ameritrade facilitates the lending process, which generates income from borrowing fees, which is then shared in a 50/50 split between the owner and TD Ameritrade.
Individual traders, banks, hedge funds, and other entities who want to sell a security short first need to find an owner of the stock or ETF to borrow those shares. Owners who float their shares to the marketplace for borrowing need to be reimbursed for creating liquidity. The borrowers pay the owners a fee to sell short the security, while the owners generally keep control of their shares.
Finding borrowers can be difficult and time-consuming because there’s not necessarily short-seller demand for every security, and that demand changes frequently. That’s where brokerages like TD Ameritrade step in to facilitate the process by matching up potential stock borrowers with share owners. TD Ameritrade charges a fee and evenly splits the proceeds with the owner.
Scarcity of the stock or ETF is the driver of short-seller demand. For example, it’s unlikely borrowers will have trouble finding shares of mega-cap companies such as Alphabet (GOOGL) or Microsoft (MSFT) to sell short. The liquidity crunch is more likely to occur in smaller-cap companies where only a few entities hold concentrated positions.
Clients with cash accounts or limited margin IRA accounts can enroll online. Currently, employer-sponsored retirement plan accounts are ineligible. Eligible clients are preferred to have positions in at least one stock or ETF that has a market value of more than $10,000.
Once clients are approved, TD Ameritrade will find interested parties for the shares. Loans are decided through a lottery process and securities are randomly selected. Not all securities will be loaned out—it will vary based on demand. Clients can find their daily statements online to see which of their shares were loaned out.
How much income a security’s owner receives for lending out shares depends on demand, so the interest received can vary for each security. For example, suppose a program participant lends 1,000 shares that have a market price of $50 per share, for a total notional value of $50,000. At a lending rate of 10.5%, the owner could earn $218.75 monthly by lending out shares.
Shares that are on loan are backed by cash, which amounts to 102% of the share value and is held by a third-party bank to help protect investors in the unlikely event of a default.
Investors who own dividend-paying ETFs or stocks will continue to receive income on those shares on top of the interest from loaning out their shares. However, owners should understand that the total money they receive won’t be considered a dividend payment under tax law. Instead, they’ll receive a substitute payment known as “payment in lieu of dividends.” Owners will still receive a 1099 tax form, but how this payment is treated under tax law may be different, so check with a tax expert before enrolling. For more on substitute payments and other tax considerations regarding short selling, here’s an overview.
Options traders who currently write covered calls can still do so on loaned-out shares. Those traders will receive interest payments from the loan and the premium for selling the call. However, if the call option is assigned and the shares are called away, the loan is terminated.
The Fully Paid Lending Program might be a good fit for long-term security holders who have large positions in a single security and don’t have short-term liquidity needs.
Clients with securities on loan can sell their shares at any time, which will close out the loan. Additionally, while the shares are out on loan, owners will give up their shareholder rights to vote on proxies.
Loaning out shares is a common way many security owners reap extra income over time, and it’s a way to potentially make a little extra money without much effort.