When I started in financial services, most Canadian banks had a national bias in their operations. The four traditional pillars of financial institutions were: banking services, trust services, insurance and investment brokers. Traditionally, almost all of the major banks in Canada have been created to meet these four distinct pillars. Today these pillars are a little different; some got stronger and some got weaker. While Scotiabank’s business model still includes four pillars, or lines of business: Canadian Banking, International Banking, Global Wealth Management, and Global Banking and Markets, these pillars are now broader and structured for adapt to the global landscape.
Likewise, the financial services provided by financial institutions have also changed considerably over the years. For example, if a client needed money in the past, we would discuss options that are very different from the options available today. Below are a few examples comparing the past with the most commonly used loan options today.
Save until you have enough money
A few decades ago, many people would not venture into investing activities (financial and non-financial) without being able to shell out the full amount. It was in a generation where interest charges were very high and new opportunities were not as expensive. Today, any new business venture or real estate purchase usually involves some form of debt, as interest rates are considerably lower. We also find that our clients are comfortable taking on good debt so that they have the opportunity to reach their financial goals. By “good debt” we mean debt that can potentially increase your income, your net cash flow, and your overall wealth. Debt no longer has the same negative connotation as it once did.
Years ago, we had the option of setting up a pledge agreement on the investment account (s). If our clients needed a loan, they could sign a collateral agreement and basically assign the securities / investments in the investment accounts as collateral. We rarely do pledge agreements these days. Installation costs are high and better options are generally available.
When investors create a regular investment account, they have the option of adding a margin agreement to the account if it suits their investor profile. The margin allows the investor to borrow money from the investments in his account. The total amount they can borrow will fluctuate each day, depending on the value of holdings and cash balances in the margin account.
We do not recommend margin accounts to any of our clients for various reasons. During good times when the markets are doing well, the strategy can be useful. However, during adverse times when there is more volatility and downturn in the stock market, it can lead to serious financial setback. As markets shrink, the ability to use margin also shrinks.
Clients faced with a margin call must either deposit additional money quickly or be forced to sell securities at a lower cost. The interest rate on margin accounts is also considerably higher than other forms of structured debt. If clients want to use leverage to invest, having a structured debt facility with a financial institution will almost always guarantee a lower interest rate than a margin account.
When we set up a discretionary managed account under the Managed Portfolio Program (MPP), they will always be set up as regular accounts. Regulators have fortunately and rightly said that a portfolio manager cannot use his discretion to put clients in a marginal position.
Essentially, it is not allowed to buy more securities than the cash available in the account. In other words, a portfolio manager is not allowed to use leverage in a client’s discretionary account. If our clients have loan needs, we will present them with the best option that offers the most flexibility and the least setup fees and interest.
Unsecured lines of credit
I’m not generally a fan of unsecured lines of credit. First, the unsecured line of credit normally has a much smaller dollar amount than a secured line of credit. Second, interest rates are generally much higher with unsecured lines of credit than with a secured line of credit.
For people who need a line of credit, I would generally avoid unsecured lines of credit. I have heard people say that they do not want to put their property (that is, their house) as collateral. My response to this statement is that if you plan to pay off the line of credit, that’s really not a problem.
Often our clients only need short-term financing, usually to facilitate a real estate transaction. They may upgrade or downsize their primary residence, and the time they sell their home may not coincide with the time they buy their new home. The bridging loan is a short-term financing option for homebuyers who wish to complete the purchase of their new property before closing the sale of their current property. If the completion date of the property you are buying is earlier than the completion date of the property you are selling, then you will need to apply for short term financing. With the bridging loan, you can use the equity in the current property as collateral, borrow money, and apply it to the new purchase, legal fees, real estate commissions, property transfer taxes, and more.
If you’ve signed two agreements, getting bridge financing is a relatively straightforward process. The interest rate for bridge financing is generally the prime rate plus five percent. If the prime rate is currently 2.45 percent, the bridge financing would be 7.45 percent. This rate is significantly higher than a normal mortgage loan; However, if the deadline is short, the prorated costs are minimal within the scope of achieving your real estate goals. For example, let’s say you need to borrow $ 1,000,000 for three weeks. So a typical mortgage rate is 1.50 percent. The 7.45 percent bridging rate is 5.95 percent higher than that of a typical mortgage. If we multiply the 5.95% x $ 1,000,000 x 21 days / 365 days, then the additional interest charge is $ 3,423.29. In chatting with clients, I explain that it’s quite a job for the bank to help you for just 21 days, and the extra interest charges are basically the compensation they will receive. The advantage of the bridge financing option is that you will not have a registered mortgage on your property. This assumes that you also don’t need a mortgage on the new property, which can happen if you expand, for example.
Home equity loan
Going back to my early days in financial services, our clients who wanted to borrow money usually had to pass a more stringent “income” test. The idea at the time was that if you didn’t have enough income to pay off the borrowed money, that was usually a hindrance. While income is certainly a primary factor for banks to consider, this hurdle can be overcome more easily if you already have equity in your home. Home equity borrowing allows individuals to refinance their existing home (typically, the credit limit is up to 80 percent of your home’s appraised value minus any existing mortgage, if applicable).
For example, if you had a home valued at $ 1 million without a mortgage, you could refinance that home up to 80% and use that $ 800,000 (80% of $ 1 million) in capital for other purchases. I’ve had clients who have taken equity to buy a second home, to help kids buy a home, and for timing differences when upgrading or downsizing their primary residences when the schedule goes. mismatch (i.e. buy a new home before selling an existing home). This process works well as long as the underlying asset you are refinancing is your primary residence or real estate that is easy to appraise.
Many of our clients own a diverse set of assets including their primary residence and other assets, such as vacation property, rental real estate (duplex, triplex, etc.), commercial real estate, insurance policies, small business ownership, etc. These clients often have significant net worth but find it more difficult than they should to obtain credit facilities through traditional channels. They also have advanced loan needs every now and then and need a little more service.
Today, for these customers, private banking services are often the solution. This service can encompass many of the functionalities described above. For example, a private banker may take into account investments, the value of a life insurance policy, etc. when setting up a loan agreement. There is a set-up fee required for private banking, but this comes with considerable flexibility to repay or use when needed (within established limits), for customers with advanced lending needs.
The role of a portfolio manager is to be aware of the investment and lending needs of our clients. Managing cash flow is a key part of overall risk management. Although we do not directly assist on the loan side for our clients, we can point them in the right direction to whom they should go.
Kevin Greenard CPA CA FMA CFP CIM is Portfolio Manager and Director, Wealth Management, for The Greenard Group at Scotia Wealth Management in Victoria. His column appears weekly on timescolonist.com. Call 250-389-2138, email [email protected], or visit greenardgroup.com.