Pledge your assets instead of selling them. Lombard loans create liquidity.
Those urgently in need of cash generally sell a portion of their securities. Instead of doing that, investors can also take out a Lombard loan. This enables them to continue benefiting from the potential return of their portfolios. Below are some points to keep in mind.
A Lombard loan increases liquidity
If a person wishes to purchase some real estate or take advantage of an enticing investment opportunity, they will usually take out a mortgage or sell existing investments. However, Lombard loans can also be used to boost short-term liquidity or bridge gaps.
With a Lombard loan, easily negotiable assets like equities, bonds, and funds are ledged. They serve as collateral. In return, the bank gives the investor a line of credit that can be utilized at any time within the scope of the pledged assets' collateral value. The collateral value depends mainly on the type of securities, their quality, and the expected volatility. The currency and the marketability of the deposited assets affect their collateral value, as does diversification across the entire portfolio. The bank sets and regularly reviews the loan-to-value ratio.
Sample calculation of maximum Lombard loan amount
Source: Credit Suisse
Ways to use a Lombard loan
Lombard loans are versatile and suitable when the expected yield on the assets being pledged exceeds the cost of credit. A Lombard loan is typically taken out when additional liquidity is needed but no invested capital should be sold.
One example is buying or renovating a vacation home outside Switzerland which cannot be financed using a mortgage. Another case in which it might make sense to take out a Lombard loan is purchasing pension benefits or issuing an advancement. Lombard loans can also be used to buy additional securities in order to increase one's yield or further diversify the existing portfolio.
Lombard loans are subject to market risk
The benefits of a Lombard loan are obvious. Investors continue to profit from the potential returns on their invested capital and enjoy a favorable interest rate. This type of loan is also highly flexible and adjustable for meeting individual needs in terms of the amount and term. At the same time, investors still maintain control over their securities. As long as the loan is covered, the portfolio can be modified at any time despite the fact that the assets have been pledged.
Nevertheless, the collateral used for a Lombard loan is subject to market risk. If the portfolio loses value or individual investments are rated as riskier than before due to certain events, that will affect the loan-to-value ratio. If that ratio is exceeded, the borrower will have to provide additional collateral or reduce their credit utilization. However, if that is not possible, the bank will be allowed to sell the pledged securities in an emergency.
Lombard loan shortfalls in cases of falling market value
Source: Credit Suisse
Making money despite borrowing money
Lombard loans can be very attractive in spite of the risks. It is fundamentally worthwhile when the investor is convinced that his investment will produce higher returns than the loan will cost in interest. However, the chosen Lombard loan should always be adjusted to match an investor's personal risk profile or risk ability and risk tolerance. Proper advice is therefore recommended.
