Issue link: https://resources.envestnet.com/i/1527631
Leveraging Both Sides of the Balance Sheet to Help Build Wealth l 6 While a SBLOC can be a powerful tool, allowing leverage for the borrower, an investor must be aware of the risks. A securities-backed line of credit is most attractive when the market is producing strong returns. When the market experiences volatile price changes, investors risk amplifying their losses. In the event of a maintenance call, investors might be required to post additional collateral, repay the loan, or risk liquidation of securities. While individual circumstances will vary, there are a few considerations if a maintenance call were to occur: • The investor may end up paying more in interest costs for the SBLOC than they are earning on the portfolio, resulting in a net loss. However, the interest costs should be weighed against other financing options, the tax implications of selling assets and the return on the use of the loan proceeds. • If underlying investments lose value, the lender may liquidate securities to get their interest payment, which could result in a net loss for an investor and potential negative tax consequences. The use of credit can include terms with adjustable rates that can increase or decrease based on a designated reference rate. In a market environment where rates are forecasted to rise, the interest costs of a loan may materially increase compared to when the loan was originated. The opposite can also happen in a falling rate environment up to a certain point. In order to hedge the interest rate risk, some lenders have fixed rate options with different terms to "match fund" to the use of proceeds. When utilizing a securities-based line of credit (SBLOC), pledged assets may become restricted from trading into other asset classes and option activity. If pledged assets are currently administered by a third-party manager, an account could see significant allocation and performance deviations relative to the manager's target model and the client's own financial plan over the long-term. It is also important to consider if portfolio dividends will be used in the repayment of an SBLOC, which has the potential to disrupt expected cash flow. In the case of option activity, the reduced income available from covered call or spread writing could also be restrictive to cash flow needs. When utilizing a securities-based line of credit (SBLOC), pledged assets may become restricted from trading and option activity. Credit Risks © 2023 Envestnet, Inc.