It may initially seem paradoxical that as the rich get richer, an increasing number of wealth managers are offering credit services to high net worth individuals.

It may initially seem paradoxical that as the rich get richer, an increasing number of wealth managers are offering credit services to high net worth individuals. In fact, the wealthy use credit for many reasons. Active entrepreneurial clients borrow to leverage their assets; those with inherited wealth are often asset rich and income poor; and City high earners can have high income, but few assets. Jeremy White, head of credit product for Barclays Wealth identifies four key reasons why wealthy clients use borrowing. The first is liquidity: “They might have a sudden need for cash when they receive an unexpected tax bill or write a cheque for the new Bentley. This might be funded through an overdraft against their advisory portfolio and be cleared when an offshore deposit bond matures. Another example is where a portfolio has embedded capital gains. A particular shareholding might have risen by 30-40 per cent and it makes sense to draw down the CGT liability gradually, and not break the whole investment.” A second common reason that wealthy clients use borrowing is investment leverage: “This sort of financing makes sense when there is a lower interest rate on borrowing than the projected potential return available from a particular investment”, says Mr White. “Carry trades have been popular where an individual borrows in Yen and invests in other currencies.” Larry Black, head of structured lending for Citi Global Wealth Management EMEA says credit can be used to diversify a portfolio: “Margin lending helps clients leverage their portfolios or even a single stock or hedge fund positions. We try hard to be creative to help clients meet their financial objectives.” He believes that lower interest rates have helped lending providers across the board: "Clients always look for the best possible financing for themselves. We offer high end real estate loans for residential properties in London and Europe, as well as assisting our real estate entrepreneurial clients to borrow to expand their business interests in commercial property. One asset class that has really taken off is private equity." A third area of credit identified by Mr White is wealthy individuals borrowing to fund their lifestyle: “Like the rest of us, HNWs might not want to wait until next year’s bonus or dividend to buy luxury or lifestyle assets. They will weigh up the potential enjoyment or convenience of a yacht, jet or holiday home, against the cost of a loan. They may also want to fund luxury items using the bank’s money, drawing on current income generation to service the loan rather than break long-term assets that are being preserved for future generations.” Coutts offers an asset reserve product as a way of creating a capital pot for clients who are asset rich and capital poor: “It all started five or six years ago in a meeting with a client who had a large and valuable estate”, says Peregrine Banbury, client group head for Coutts landowners division. “He happened to mention that he could not afford to take his children on holiday as the money that his estate generated had to be ploughed back into managing it. Although he was fabulously wealthy on paper, he had very little cash to spend.” “This prompted us to devise the asset reserve product where clients use outlying land or property as security for borrowing and then invest in Coutts in-house basket of hedge funds. All interest and management charges are rolled up into the fund. Of course, the assumption you make is that the fund grows at more than the cost of borrowing and taking into account capital gains tax.” According to Mr Banbury, the fund has achieved positive returns every year, averaging about 10-15 per cent where breakeven is about 8 per cent. As returns are reinvested, there is also the added benefit of compounding, which will hopefully enable clients to release their secured land or property in the future. Mr White believes that the final important reason why wealthy individuals use borrowing is tax. If used with supporting professional tax advice, borrowing can potentially help reduce exposure to income, capital gains, inheritance and wealth taxes. Whereas the average person is forced to borrow to mortgage a property or buy a new car, Mr White says HNWs have a choice and tend to borrow more strategically: “For example, a resident non-domiciled investment banker might choose to borrow to leverage investment income, rather than pay off debts with their bonus, or may choose to pay the bonus into a pension and borrow short-term because of the long term tax benefits.” Mr Black concurs: "The balance sheets of ultra high net worth individuals can be stronger than those of corporate clients. They borrow to get to the next level." So what are the benefits to wealth managers of lending to their clients? "The great thing about credit is that it provides a whole picture of a client’s financial holding, both assets and liabilities”, says Mr Black. "The trust that we can bring about by providing a loan, might mean that the same client brings assets to our investment management business for example." Mr White goes one step further to state that if an organisation is not providing credit it is a dilution of its offering and relationship with clients: “Loans are a useful hook product and ensure you have greater share of the client’s wallet. What better way to gain a client’s trust than for you to lend them some money before they entrust you with theirs?”