‘Significant Benefit’
Loans also allow the ultra-wealthy to avoid the hit of capital gains taxes at a time when valuations are high and rates are poised to increase, perhaps even almost double. Postponing tax is a “significant benefit” for portfolios concentrated and diversified alike, according to Michael Farrell, managing director for SEI Private Wealth Management.
Critics say such loans are just one more wedge in America’s ever-widening wealth gap. “Asset-backed loans are one of the principal tools that the ultra-wealthy are using to game their tax obligations down to zero,” said Chuck Collins, director of the Program on Inequality and the Common Good at the Institute for Policy Studies.
While using public equities as collateral is the most common tactic for banks loaning to the merely affluent, clients further up the wealth scale usually have a bevy of possessions they can feasibly pledge against, such as mansions, planes and even more esoteric collectibles, like watches and classic cars.
One big advantage for the wealthy borrowing now is the possibility that rates will ultimately rise and they can lock in low borrowing costs for decades. Some private banks offer mortgages on homes for as long as 20 years with fixed interest rates as low as 1% for the period.
The wealthy can also hedge against higher borrowing costs for a fraction of their pledged assets’ value, according to Ali Jamal, the founder of multifamily office Azura.
“With ultra-high-net worth clients, you’re often thinking about the next generation,” said Jamal, a former Julius Baer Group Ltd. managing director. “If you have a son or a daughter and you know they want to live one day in Milan, St. Moritz or Paris, you can now secure a future home for them and the bank is fixing your interest rate for as long as two decades.”
Risks Involved
Securities-based lending does comes with risks for the bank and the borrower. If asset values plunge, borrowers may have to cough up cash to meet margin calls. Banks prize their relationships with their richest clients, but foundered loans are both costly and humiliating.
Ask JPMorgan. The bank helped arrange a $500 million credit facility for WeWork founder Adam Neumann, pledged against the value of his stock, according to the Wall Street Journal. As the value of the co-working startup imploded, Softbank Group Corp. had to swoop in to help Neumann repay the loans and avert a significant loss for the bank.
A spokesperson for JPMorgan declined to comment.
Still, for the banks it’s a risk worth taking. Asked about securities-backed loans on last week’s earnings call, Morgan Stanley Chief Financial Officer Sharon Yeshaya said they’d “historically seen minimal losses.” Among the bank’s past clients is Elon Musk, who turned to them for $61 million in mortgages on five California properties in 2019, and who also has Tesla Inc. shares worth billions pledged to secure loans.
“As James [Gorman] has always said, it’s a product in which you lend wealthy clients their money back,” Yeshaya said, referring to Morgan Stanley’s chief executive officer. “And this is something that is resonating.”
—With assistance from Tom Maloney.
This article was provided by Bloomberg News.