Market Volatility: Managing The Risk
It is important to know these lines are not without risk. If the advance rate is too high and the value of the collateral declines substantially, the portfolio can be liquidated to pay off the outstanding balances. It is important to know the trigger points, or default rates, when this will occur, and to understand your bank’s system to provide a notification if the advance rate becomes an issue. If a line does exceed the default rate and the lender sells assets to pay down the credit outstanding, this can result in similar tax consequences as previously detailed. It is important for a client to closely monitor the line of credit against the value of the portfolio, especially in volatile circumstances or sustained market downturns.
Look for a lender who will be proactive overseeing the relationship and securities line as this could lead to early communication of any potential margin issues, which is especially important during periods of market volatility. The client and wealth team working together with regular contact is critical in order to explore alternative solutions to liquidating, such as adding additional unencumbered liquid assets to the collateral, using excess cash to pay down the lines, or liquidating assets that will incur minimal tax consequences. While automatic liquidation of assets is an option on these lines of credit, a lender may be able to work with the client to avoid liquidation. Despite frequent communication between client and relationship team, it should be known that responsibility for the credit remaining within margin is 100% with the client.
In Summary
Securities-based lending should be an integral part of a wealth management plan. Whether a client needs financing or not, a securities-based line provides a low-cost enhancement of their financial flexibility. Moreover, it enables clients to leave their assets in the market to potentially capture additional returns and avoid tax consequences—thus affording them the opportunity to maintain or further build their wealth.
Dan Sullivan is a managing director and head of private banking and mortgage for CIBC Private Wealth, US, with more than 25 years of industry experience. In this role, he is responsible for developing client relationships to deliver CIBC’s broad array of private banking solutions to clients.