Bonds as a collateral for loan

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Bonds as a collateral for loan

Maarten Stevens
Real Estate Professional · Currently Abroad, Currently Abroad · Member since 2014 · 12 posts · 4 votes

Hi Everybody,

I am currently working on pre-arranging financing for my first deals. As I am currently not living in the countries where I want to execute these deals (Eurozone and Turkey) , I am limited in conventional mortgage possibilities. I do have some cash (say, 500kEUR) to put into the deal.

I had a discussion yesterday with a financial advisor, who floated the following possibility:

- Use 500k cash to buy bonds, which render a ROI of 3-4%.
- Banks would be willing to provide a loan with the bonds as a collateral, up to ~70% of the value of this collateral.
- The interest on the loan could be as low as 1-1.5% currently (= Euribor + 1%).

Now, sounds interesting, but I am unfamiliar with this type of structure. My questions:

1. Is this something heard of in the industry?
2. What are the risks? I see that the value of the collateral (=bonds) could go down and then the bank will probably ask me to top up the collateral.
3. I don't fully understand how the received interest on the bonds could be higher than the paid interest on the loan. Even if there is currently a spread between the 3-month Euribor and Bonds, is this sustainable?
4. Would a deal like this be better than just putting up the cash directly for the property?
5. Any further matters to be aware of? and where can I find more info?

Thanks a lot!

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  • Maarten Stevens
    OP
    Real Estate Professional · Currently Abroad, Currently Abroad · Member since 2014 · 12 posts · 4 votes
    12y
    Nobody?
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  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    12y

    No comments on the interest rates you posed. US commercial banks will only take A rated or better muni/state bonds A+ commercial bonds.  They often take an assignment with the bond interest and offer a slightly lower loan rate or may take only a collateral assignment. Banks don't take stock as collateral as they may not hold stock except in qualified banking institutions of affiliates. I'd say the spread would be higher, you should locate your lender first, ask what bond portfolio they would be most comfortable with and go from there.

    Keep in mind that portfolio real estate loans are made within the lending area of that bank. Bank of America in New York won't be making the loan in Missouri, they will take that to a Missouri branch local to the property. That means that while BoA in NY may have an international portfolio, the one in MO won't and then inter banking difficulties may arise with assignments, and more costly, so it is better to deal with the bank local to the real estate. That means the securities need to fit that bank's requirements. 

    Sounds like your financial advisor is selling bonds or knows where to buy them, if he is a broker you might consider the agenda.

    You might ask the bank about CDs at that amount with a loan as the net cost may be less, at a half million the rate can be negotiated.

    Another option is buying the bank stock in the lending bank, that they can loan against.

    I'd suggest you not take advice on what a bank will or can do unless that advisor is with that bank and don't buy bonds on an advisor's spiel unless they are an institutional broker who deals with that lender. Banks can have different restrictions on their securities portfolio that an outside broker won't be aware of.

    Oh, another thing, pledging securities "against the box" you need to be aware that if a bond price falls, you'll need to pony up that difference to the collateral level required and they may not take into consideration the principal reduction of the loan, they may look to lower risk levels later on.

    Also, just see what your brokerage will loan on, you may not need a mortgage. That then opens the equity door to future mortgages, refinances, cross collateralization or blanket loans.

    Hope that helps you, good luck.  :)

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