With all the talk of stimulus, bailouts and recession busting in general, the reality is small business owners have been overlooked and remain caught in a credit and liquidity squeeze hurting their survival. Doctors, dentists and other professionals have seen their credit lines reduced by their banks. Because of their self-employed status, finding ways and means to replace the liquidity they lost often involves a second mortgage or a refinance of a primary residence to support the business. Most professionals try to avoid tying up their personal assets to finance their practices.
From a financial advisor's point of view, professionals and small business owners in general constitute 60%-70% of potential clients with more than $1 million in investment assets, and are primary candidates for financial advice and the services provided by an advisor. For a long time, the banks that finance the professionals' practices has had a lock on their investment business through their private client and wealth management divisons. But now there is an opportunity.
Not long ago a friend of mine who has run a multimillion optometry practice for 25 years lamented he had to sell securities to raise cash to replace the liquidity he lost when American Express cut his line from $100,000 to $15,000 without notice (and no change in my friends circumstances). I asked him if his bank could help (no), and if anyone there had suggested he use his securities as loan collateral instead of cashing them in (no again). Private client divisions of banks are organizationally remote from their affiliated broker-dealers, and making such loans are for them paperwork nightmares that the bankers want to avoid.
However financial advisors typically have access to margin and nonpurpose lending products that are integrated with the trading platforms they use in their securities and funds business. From the client's point of view, the rates are very reasonable, averaging about 4.5%. From the advisor's point of view, at a minimum they retain the securities that would otherwise be sold, and simultaneously a new source of revenue from the loan is created which is often shared with the advisor.
The chief impediment to offering this service is the advisor's own lack of understanding about the nonpurpose loan product. Unlike margin lending, in the nonpurpose structure, the client can use the funds for any purpose. Because margin lending is essentially borrowing against one security to buy more securities, regulators and compliance officers have imparted a kind of "doubling down" buzz to the margin product, and it is therefore utilized by a small fraction of advisors for only their most saavy clients.
Here at Heitman Financial Services Consulting, we recently conducted an informal survey with the product managers of the nonpurpose lending function at four major broker-dealers. Among our findings:
1. The use of nonpurpose lending by advisors has grown in double digits in the last 12 months.
2. The use of the product often results in new assets to the recommending advisor, because the lending process lends itself to a discussion of where other pockets of investment assets may exist that can be pulled into the eligible lending pool if brought into the advisor's firm.
3. However advisors remain poorly equipped by their firms to market this service. Debt is a complex thing. Leverage can be good or bad depending on what use the lending proceeds are put to. Advisors need help in presenting the product in a straightforward way.
At some point the tide will turn again and banks will be eager to make loans to high-net-worth doctors and dentists. The opportunity to gain their loyalty and business for the long haul exists right now. If advisors make these suggestions, they will find the demand is there. Firms should spend a little money to make these offers visually attractive and advertise them as a way to support the advisor's efforts.
Richard Heitman is owner of Heitman Financial Services Consulting (www.heitmanfsc.com), a Minneapolis-based firm that which specializes in margin and nonpurpose training for financial advisors. He can be reached at [email protected] or (612) 590 8634.