Mastering Stock loan Rebate

A rebate commonly refers to a portion of interest or dividend payments paid by a short seller to the owner of the stock or holder of bonds shares that are short traded.

stocks loan rebate refers to a form of cash payment granted by a broker to the client or customer who lends stock as cash collateral to short-sellers who need borrowing stock. A loan fee is charged to the borrower of the shares in addition to any interest due on the loan when the security is loaned out. Holders of the loaned securities receive a portion of the loan fee as a form of a rebate from their associated brokers.

In events where a short seller might borrow shares to make delivery to the buyer, the seller must pay a rebate fee, which depends on the amount of the sale and the availability of the shares in the marketplace. In a scenario where the Shares are expensive or difficult to borrow, the associated rebate fee tends to be higher.

Some brokerage firms force the short seller to purchase securities in the market before the settlement date. This is known as a forced buy-in. The brokerage firm may consider a forced buy-in if they think that the shares might not be available on the date of the settlement. It is also advised for traders to consult with their brokers, to check on the short sale rebate fee for the stock before going short. If the rebate fee is very high, shorting the stock may not be the right step.

It is common knowledge for traders who are accustomed to buying stocks on margin or selling short, that their brokers tend to charge interest for the funding for purchasing those shares. Only if the trade is held for a few days, do the charges tend to be minimal and typically amount to an annual rate in comparison to a lower-rate credit card.

The lending broker continues to accrue all the interest on the capital used by the investor to purchase the stock on margin. In most cases, the broker is entitled to all associated interest payments.

Why Are Stock Loan Rebates Offered?

For example, investor A with an account balance of US $100,000, purchases 1000 shares of a stock PQR at a price of US $200 per share, and is required to do so on margin, while incurring an equivalent of US $100,000 loan. The interest that investor A is required to pay is equivalent to an annual rate of 6%. Similarly, considering that investor B is keen on opening a short position of 500 shares of PQR at the same time. The 500 shares sold by Investor B are half of the shares that have been purchased by Investor A. If Investor B provides the cash collateral required to open the short position it is viable for Investor A to afford the margin position in PQR.

Basis this scenario, it is only fitting for Investor B to be offered an interest payment from their short positions. This is what drives brokers to offer a stock-loan rebate to their sizable clients.

Usually, retail investors or traders with not very large accounts are not offered a rebate for opening a short trade, but large institutional customers may get a rebate to attract their sizable accounts or order flow. The size of the rebate being offered is determined per the Securities Lending Agreement, which is established between the lender and the borrower. The rebate also typically offsets some part of the lender’s stock loan fee. It is also important to note, that the term and size of the stock loan fee and the rebate are all mentioned as part of the Securities Lending Agreement as provided by the brokerage to their customers.

Securities lending is the main feature of short selling, wherein an investor tends to borrow securities to short sell them, aiming to book profit by repurchasing the securities at a lower price. A fee is offered to the lender as compensation, which enhances the returns on the securities. The securities are also returned to the lender at the expiration of the transaction. The stock loan rebates are usually only available to larger-scale clients with cash, such as professional traders, brokers and dealers, and institutional investors.

In addition, borrowers who do not utilize cash as collateral are not entitled to receive stock loan rebates. Those who put up other kinds of assets as collateral are usually responsible for the lender’s fee, even if the collateral is in some form of securities that are closest comparable to cash. These may be some treasury bonds or bills.

Example of a Stock Loan Rebate

In a scenario where a hedge fund borrows a million shares of a certain stock for 30 days for US $20, the loan agreement will mention that the collateral on the loan is 102%, as a result of which the hedge fund will have to put up capital equivalent to US $20,400,000. If the contracted loan fee is mentioned as 3% with a rebate of 0.7% and a reinvestment rate of 1%. It is important to note, that the net investment rebate will be split in a 60-40 ratio, with 60% of the earnings going to the borrower and 40% to the lender. Considering a 360-day yearly period, the stock loan rebate for 30 days can be calculated as follows:

[(1 million * US $20) x 102% x 0.70%] x (30 360) = US $11,900

With reinvestment earnings calculated as below:

[(1 million * US $20) x 102% x 1%] x (30 360) = US $17,000

Excluding the rebate from reinvestment earnings, the new investment earning is equivalent to US$ 5,100. As per the 60-40 split ratio, US $3,060 is compensated to the borrower with the lender retaining a sum of US $2,040.

The borrower is also responsible for the annual fee on the stock loan of 3% which is equivalent to the US $50,000 fee for the time frame of 30 days. The portion of the net investment earning tends to offset this fee, so the borrower's monthly fee for the period can be calculated to be:

US$50,000 - US$ 3,060 = US$46,940