Issue 28: 2014

Insights

Your Flexible Credit

Credit solutions allow investors to transfer assets, make large purchases and pursue other financial goals.

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During the recent credit crisis, it seemed a day didn’t go by without news of another too-big-to-fail financial firm plunging into financial trouble. “Some of the big brokerage firms had been funding themselves via short-term loans in the repo market,” says John Wayland, national structured credit sales executive at U.S. Trust.1 “And then when that market dried up, they didn’t have anywhere to turn for liquidity to rescue themselves.”

Some individuals, particularly wealthy ones, found themselves facing similar, if less dire, circumstances. In some cases, they had binged on short-term credit secured by their marketable securities. It was easy to set up and incredibly cheap, so they would access that short-term credit to purchase long-term assets. In other words, says Wayland: “They were using short-term debt not for short-term liquidity, but as permanent capital. When the stock markets tanked and the margin calls arrived, they didn’t have enough time to take out mortgages on their homes or loans against their yachts, and some had to sell their securities to meet their obligations.”

But that was then. Now, having learned a few hard lessons, financial firms and corporations are in generally good financial health overall, and particularly when it comes to the use of credit. “Individuals can benefit from taking a page from the corporate playbook,” says Wayland. “It can make good sense to examine your finances the way corporations do — in terms of using credit strategically, creating an efficient capital structure and preserving financial flexibility.”

Factors to consider when creating your credit strategy
Click to expand
Factors to consider when creating your credit strategy
  • What are your short- and long-term personal and business goals?
  • How do you plan to use the funds?
  • When do you plan to repay the loan?
  • Do you expect interest rates to rise or fall?
  • What cash flow do you anticipate receiving?
  • How should the loan be structured to best align with your estate plan?
  • How would you prioritize the following loan features?
    • Interest rates
    • Loan structure
    • Term of loan
    • Timing to close
    • Loan amount

Using credit strategically provides flexibility

A strategic approach to using credit can be helpful with pretty much anything that involves a large expense: maintaining control of existing assets; acquiring property for investment or lifestyle purposes; tax management for liquidity purposes; transferring wealth; and even settling things like divorce. “In the broadest sense,” says Wayland, “you can use credit in a thoughtful way to give yourself valuable flexibility when it comes to what you own, what you purchase, what you sell, and the timing involved.”

Sometimes, it’s all about the timing

Wayland points to a current U.S. Trust client, an owner of a large privately held business that will probably go public in the next few years. The client has a significant marketable securities portfolio as well as a large ranch property, but he also wants to purchase another company right now. “He doesn’t want to give up any ownership stake in his current company before an IPO, but the opportunity may not be around a year from now, so he’s leveraging his personal assets to make the acquisition,” Wayland says. “Rather than be subject to potential market volatility with financing against his marketable securities, he chose to pursue a personal capital structure in the same way he would structure his corporation’s capital — with longer term debt maturity for the business acquisition secured by his real estate holdings. He plans to repay the loan with marketable securities once his current company goes public. So he’s created longer term liquidity to match his repayment timing and limited market risk to his capital base.”

 

Using short-term debt for long-term assets

Purchasing long-term assets with short-term debt can sometimes make sense, at least temporarily. “Let’s say you need $10 million to purchase a house, and there’s no time to liquidate assets efficiently or to take out a mortgage,” Wayland says. “Tapping a line of credit to pay for the house could be worthwhile. Then you can restructure the debt. You could maybe take out a 10-year fixed-rate mortgage to finance, say, $7 million of the purchase, so you can repay that amount you drew. That way, you don’t maintain such large short-term exposure against that long-term asset.”

Using credit for wealth transfer

Rather than liquidating assets as a way to transfer wealth, and rather than transferring the assets themselves, you might consider borrowing against those assets and transferring the liquidity to your next generation now. Think of, say, an aging patriarch looking at his eventual death and the impact of estate taxes on his surviving family who might find it useful to establish a credit facility now in order to pay the taxes when the time comes, and then liquidate his assets in an orderly fashion to repay the loan.

Leverage can also be useful when it comes to liquid assets. Sometimes members of the older generation want to pass wealth to the younger generation but they want to retain an asset — such as stock — that will continue to appreciate. They may be able to borrow against their stock holding, and then pass the cash proceeds to heirs without having to immediately liquidate the asset and incur a tax liability or lessen control or future appreciation. When the patriarch or matriarch dies, the stock can then pass to heirs with a step-up in cost basis, so there are potential tax advantages for inheritors.

Taking advantage of arbitrage opportunities

“Much of the time, U.S. Trust clients are seeking leveraged return, or arbitrage, opportunities,” Wayland says. Often, they want to remain fully invested. Maybe they want to preserve future upside potential in an existing asset (such as real estate or fine art). Or maybe they want to maintain their current income (such as from dividends or commercial real estate), voting rights or management control. Or perhaps their goal is simply to avoid paying capital gains or other taxes that would result from selling assets.

The bottom line is that investors don’t want to sell their old investments to fund new opportunities. “What you can do is use existing assets as collateral to secure a loan,” he explains. “You can then use the proceeds of that loan to purchase something that, ideally, works within your overall wealth plan.”

But what if you want to purchase something lifestyle oriented — say, a residence or a yacht? The same thinking applies: “Rather than liquidating assets, you can take a loan and allow your current investments to continue working, while freeing up capital to make your purchase.”

Creating your credit strategy

When it comes to creating credit strategies, the permutations are as varied as the individuals themselves. “Here at U.S. Trust, our credit specialists take an individual and holistic approach to addressing the credit needs of our clients,” says Wayland. “We have extensive experience and resources in all areas of credit and banking. We have subject-matter experts in fields as varied as marine, aviation, fine art, derivative and real estate — including specialty assets, such as farm and timber land, as well as recreational properties like ranches and vineyards. Whether its liquidity, financing, lifestyle or wealth transfer, or even credit strategies to minimize the effect of rising interest rates on your balance sheet, we can tailor credit and banking solutions to help you make the most of what’s important to you.”

1A repo market is a market for very short-term, usually overnight, borrowing for dealers in government securities.

22014 U.S. Trust Insights on Wealth and Worth® survey

IMPORTANT INFORMATION

Always consult with your independent attorney, tax advisor, investment manager and insurance agent for final recommendations and before changing or implementing any financial, tax or estate planning strategy.

OTHER IMPORTANT INFORMATION

Credit facilities are provided by Bank of America, N.A., Member FDIC, its subsidiaries or other bank subsidiaries of Bank of America Corporation, each an Equal Opportunity Lender. All loans and collateral are subject to credit approval and may require the filing of financing statements or other lien notices in public records. Asset-based and securities-based financing involves special risks and is not for everyone. When considering an asset-based and/or securities-based loan, consideration should be given to individual requirements, asset portfolio composition and risk tolerance, as well as capital gains, portfolio performance expectations and investment time horizon. For any loan with securities collateral, the securities or other assets in any collateral account may be sold to meet a collateral call as provided in the definitive loan documents and the client is not entitled to choose which securities or other assets will be sold. A complete description of the loan terms will be found in the individual credit facility documentation and agreements. Clients should consult with their own independent tax and legal advisors.

Case studies are intended to illustrate products and services available through U.S. Trust. The case study presented is based on actual experiences. You should not consider this as an endorsement of U.S. Trust or as a testimonial about a client’s experiences with us. Case studies do not necessarily represent the experiences of other clients, nor do they indicate future performance. Investment results may vary. The investment strategies discussed are not appropriate for every investor and should be considered given a persons investment objectives, financial situation and particular needs. Client should review with their U.S. Trust advisor the terms, conditions and risks involved with specific products and services.

Bank of America, N.A., and U.S. Trust Company of Delaware (collectively the “Bank”) do not serve in a fiduciary capacity with respect to all products or services. Fiduciary standards or fiduciary duties do not apply, for example, when the Bank is offering or providing credit solutions, banking, custody or brokerage products/services or referrals to other affiliates of the Bank.

During the recent credit crisis, it seemed a day didn’t go by without news of another too-big-to-fail financial firm plunging into financial trouble. “Some of the big brokerage firms had been funding themselves via short-term loans in the repo market,” says John Wayland, national structured credit sales executive at U.S. Trust.1 “And then when that market dried up, they didn’t have anywhere to turn for liquidity to rescue themselves.”

Some individuals, particularly wealthy ones, found themselves facing similar, if less dire, circumstances. In some cases, they had binged on short-term credit secured by their marketable securities. It was easy to set up and incredibly cheap, so they would access that short-term credit to purchase long-term assets. In other words, says Wayland: “They were using short-term debt not for short-term liquidity, but as permanent capital. When the stock markets tanked and the margin calls arrived, they didn’t have enough time to take out mortgages on their homes or loans against their yachts, and some had to sell their securities to meet their obligations.”

But that was then. Now, having learned a few hard lessons, financial firms and corporations are in generally good financial health overall, and particularly when it comes to the use of credit. “Individuals can benefit from taking a page from the corporate playbook,” says Wayland. “It can make good sense to examine your finances the way corporations do — in terms of using credit strategically, creating an efficient capital structure and preserving financial flexibility.”

Factors to consider when creating your credit strategy
Click to expand
Factors to consider when creating your credit strategy
  • What are your short- and long-term personal and business goals?
  • How do you plan to use the funds?
  • When do you plan to repay the loan?
  • Do you expect interest rates to rise or fall?
  • What cash flow do you anticipate receiving?
  • How should the loan be structured to best align with your estate plan?
  • How would you prioritize the following loan features?
    • Interest rates
    • Loan structure
    • Term of loan
    • Timing to close
    • Loan amount

Using credit strategically provides flexibility

A strategic approach to using credit can be helpful with pretty much anything that involves a large expense: maintaining control of existing assets; acquiring property for investment or lifestyle purposes; tax management for liquidity purposes; transferring wealth; and even settling things like divorce. “In the broadest sense,” says Wayland, “you can use credit in a thoughtful way to give yourself valuable flexibility when it comes to what you own, what you purchase, what you sell, and the timing involved.”

Sometimes, it’s all about the timing

Wayland points to a current U.S. Trust client, an owner of a large privately held business that will probably go public in the next few years. The client has a significant marketable securities portfolio as well as a large ranch property, but he also wants to purchase another company right now. “He doesn’t want to give up any ownership stake in his current company before an IPO, but the opportunity may not be around a year from now, so he’s leveraging his personal assets to make the acquisition,” Wayland says. “Rather than be subject to potential market volatility with financing against his marketable securities, he chose to pursue a personal capital structure in the same way he would structure his corporation’s capital — with longer term debt maturity for the business acquisition secured by his real estate holdings. He plans to repay the loan with marketable securities once his current company goes public. So he’s created longer term liquidity to match his repayment timing and limited market risk to his capital base.”

 

Using short-term debt for long-term assets

Purchasing long-term assets with short-term debt can sometimes make sense, at least temporarily. “Let’s say you need $10 million to purchase a house, and there’s no time to liquidate assets efficiently or to take out a mortgage,” Wayland says. “Tapping a line of credit to pay for the house could be worthwhile. Then you can restructure the debt. You could maybe take out a 10-year fixed-rate mortgage to finance, say, $7 million of the purchase, so you can repay that amount you drew. That way, you don’t maintain such large short-term exposure against that long-term asset.”

Using credit for wealth transfer

Rather than liquidating assets as a way to transfer wealth, and rather than transferring the assets themselves, you might consider borrowing against those assets and transferring the liquidity to your next generation now. Think of, say, an aging patriarch looking at his eventual death and the impact of estate taxes on his surviving family who might find it useful to establish a credit facility now in order to pay the taxes when the time comes, and then liquidate his assets in an orderly fashion to repay the loan.

Leverage can also be useful when it comes to liquid assets. Sometimes members of the older generation want to pass wealth to the younger generation but they want to retain an asset — such as stock — that will continue to appreciate. They may be able to borrow against their stock holding, and then pass the cash proceeds to heirs without having to immediately liquidate the asset and incur a tax liability or lessen control or future appreciation. When the patriarch or matriarch dies, the stock can then pass to heirs with a step-up in cost basis, so there are potential tax advantages for inheritors.

Taking advantage of arbitrage opportunities

“Much of the time, U.S. Trust clients are seeking leveraged return, or arbitrage, opportunities,” Wayland says. Often, they want to remain fully invested. Maybe they want to preserve future upside potential in an existing asset (such as real estate or fine art). Or maybe they want to maintain their current income (such as from dividends or commercial real estate), voting rights or management control. Or perhaps their goal is simply to avoid paying capital gains or other taxes that would result from selling assets.

The bottom line is that investors don’t want to sell their old investments to fund new opportunities. “What you can do is use existing assets as collateral to secure a loan,” he explains. “You can then use the proceeds of that loan to purchase something that, ideally, works within your overall wealth plan.”

But what if you want to purchase something lifestyle oriented — say, a residence or a yacht? The same thinking applies: “Rather than liquidating assets, you can take a loan and allow your current investments to continue working, while freeing up capital to make your purchase.”

Creating your credit strategy

When it comes to creating credit strategies, the permutations are as varied as the individuals themselves. “Here at U.S. Trust, our credit specialists take an individual and holistic approach to addressing the credit needs of our clients,” says Wayland. “We have extensive experience and resources in all areas of credit and banking. We have subject-matter experts in fields as varied as marine, aviation, fine art, derivative and real estate — including specialty assets, such as farm and timber land, as well as recreational properties like ranches and vineyards. Whether its liquidity, financing, lifestyle or wealth transfer, or even credit strategies to minimize the effect of rising interest rates on your balance sheet, we can tailor credit and banking solutions to help you make the most of what’s important to you.”

1A repo market is a market for very short-term, usually overnight, borrowing for dealers in government securities.

22014 U.S. Trust Insights on Wealth and Worth® survey

IMPORTANT INFORMATION

Always consult with your independent attorney, tax advisor, investment manager and insurance agent for final recommendations and before changing or implementing any financial, tax or estate planning strategy.

OTHER IMPORTANT INFORMATION

Credit facilities are provided by Bank of America, N.A., Member FDIC, its subsidiaries or other bank subsidiaries of Bank of America Corporation, each an Equal Opportunity Lender. All loans and collateral are subject to credit approval and may require the filing of financing statements or other lien notices in public records. Asset-based and securities-based financing involves special risks and is not for everyone. When considering an asset-based and/or securities-based loan, consideration should be given to individual requirements, asset portfolio composition and risk tolerance, as well as capital gains, portfolio performance expectations and investment time horizon. For any loan with securities collateral, the securities or other assets in any collateral account may be sold to meet a collateral call as provided in the definitive loan documents and the client is not entitled to choose which securities or other assets will be sold. A complete description of the loan terms will be found in the individual credit facility documentation and agreements. Clients should consult with their own independent tax and legal advisors.

Case studies are intended to illustrate products and services available through U.S. Trust. The case study presented is based on actual experiences. You should not consider this as an endorsement of U.S. Trust or as a testimonial about a client’s experiences with us. Case studies do not necessarily represent the experiences of other clients, nor do they indicate future performance. Investment results may vary. The investment strategies discussed are not appropriate for every investor and should be considered given a persons investment objectives, financial situation and particular needs. Client should review with their U.S. Trust advisor the terms, conditions and risks involved with specific products and services.

Bank of America, N.A., and U.S. Trust Company of Delaware (collectively the “Bank”) do not serve in a fiduciary capacity with respect to all products or services. Fiduciary standards or fiduciary duties do not apply, for example, when the Bank is offering or providing credit solutions, banking, custody or brokerage products/services or referrals to other affiliates of the Bank.