Robinhood Offers Stock Lending Program; understand what can go wrong

The era of meme stock selling has come to an end, and the online trading platform that fueled the surge is struggling to find alternative sources of revenue.

Robinhood has benefited greatly from the meme investors that have piled up on AMC, GameStop and other heavily sold stocks over the past year. Ironically, the company now thinks the key to its survival is allow investors to lend their securities to sellers uncovered.

In the first quarter of 2022, monthly active users of Robinhood dropped to 15.9 million, down from 17.7 million a year ago and 17.3 million in the previous quarter. The company’s average revenue per user was $53, down from $137 a year ago and $64 in the previous quarter.

Transactional revenue — the money made from investors buying shares — accounted for about three-quarters of the company’s revenue this quarter, but was down 48% from last year. In response, Robinhood has been offering a number of new products to diversify your income and revive user growth.

In late March, Robinhood announced expanded trading hours, and in early April, the platform launched cryptocurrency wallets to its customers. This month, the company announced a new equity lending program, in which customers can lend shares of companies they own to other market participants while charging a percentage of fees.

The bond lending business is booming: Global bond lenders generated $828 million in April 2022 revenue, up 20% from April 2021, according to research firm DataLend. Robinhood hopes to get some of that out of bigger institutions like BlackRock and State Street.

“We are excited to break down yet another barrier and democratize a product that has historically been preserved for the wealthy with high barriers to entry,” wrote Steve Quirk, Robinhood’s director of brokerage in a blog post about the new program.

To qualify, Robinhood users must have $5K in total account value and $25K in reported revenue or trading experience.

Quirk described the program as a way for clients to “put their investments to work, keeping them simple” and “add a potential source of passive recurring income to their portfolio.”

What could go wrong?

But some argue that traditionally there is a big barrier to entry into stock lending for a reason.

Stock lending is an important element of short selling, where investors borrow bonds and sell them immediately with the assumption that they will soon fall in price. The investor then expects to buy the stock back at a specific date in the future, ideally for much less money, and return it to the original owner of the stock along with a small fee.

But stocks don’t always behave as expected, and if they go up in value, the borrower (whoever receives the loan) is responsible for returning the bond anyway. If an interest-heavy short stock rises in price, short sellers exiting the investment often push it further, causing a short squeeze. Those moments nearly brought down billion-dollar companies and big investors.

Stock lending is risky for short sellers, but it is also risky for lenders. There is no guarantee that Robinhood customers who borrow shares will be repaid if a massive squeeze is too big for the company to handle.

“There is a risk that the company could fail to meet its obligations to you under the loan program and not return the borrowed securities,” the brokerage warned.

“If Robinhood defaults and cannot return the bonds you borrowed, you will not be able to trade those bonds as usual.”

The stock loan is not insured by the Securities Investor Protection Corporation – the entity that guarantees US investors ownership of their assets – so shareholders will have to rely on Robinhood if something goes wrong. The company said that “the participating shares are collateralized by cash collateral in a third-party bank for additional protection,” but did not specify by whom or the value of the cash collateral.

Securities creditors may also lose the right to vote at shareholders’ meetings and the right to receive dividends. Borrowers typically send cash payments equal to dividends to the lender, but these payments are taxed at a much higher rate.

Robinhood against the market

Robinhood launched in April 2013 and has been the beneficiary of a decade of markets traveling on a virtually straight upward trajectory – until now. About 50% of its customers are first-time investors, the company said, making it more susceptible to user dropouts during economic downturns.

In early April, Goldman Sachs downgraded the company to a neutral sell, citing headwinds as investors unlink due to falling markets.

Robinhood also benefited from the sugar rush from last year’s stimulus checks, which have already been spent. Customers with small balances are increasingly withdrawing and spending their money on everyday expenses, Goldman said.

Last month, Robinhood CEO Vlad Tenev announced he would lay off 9% of employees as the company’s stock hit a new low – it has dropped nearly 50% in 2022.

“We face a challenging macro environment,” Tenev said in a call with investors last month, “one that most of our clients have never experienced in their lives.”

Berkshire Hathaway Vice President Charlie Munger blasted Robinhood during the investment giant’s annual meeting last month, calling the platform “disgusting” due to its “short-term play and large hidden commissions and kickbacks and so on.” ”. Now Robinhood is “unrolling,” he said, adding, “God is making himself fair.”