Citation: As first seen in FT Adviser by Hari Doull & Harry Webster
Carries an indicative 30 minutes of CPD
Lombard loans, a type of secured lending, have been around for hundreds of years.
In the UK such loans have usually been reserved for private banking clients. They are typically based on the collateral of liquid investment assets such as equities, bonds, funds or commodities.
Wealthy private banking clients have been able to make use of money already invested without necessarily having to move their investment. Lombard lending provides low interest access to cash and without affecting investment voting rights or potential returns.
To access these loans, an individual would traditionally need to be a private banking client and want to borrow at least £250,000, for example. But Lombard loans are also becoming available to clients of financial advisers.
Lombard lending is expanding from private banking into wealth management to enable borrowing against the value of a portfolio via an investment platform.
The flexibility of these loans makes them an attractive option for a broader range of clients, and they can be a valuable tool for strategic financial management.
In this CPD article, we will be focusing on Lombard lending via investment platforms. Lombard loans from private banks may be different in their characteristics such as processes and pricing.
How Lombard loans work
Lombard loans are flexible, interest-only credit facilities secured against a client’s investment portfolio, allowing the borrower to access cash without liquidating their assets.
The liquid assets pledged by the borrower as collateral could be an Isa, a general investment account or an offshore bond containing an investment portfolio.
Lombard lending providers want assets that are easy to sell, easy to value, and stable in price. This gives the lender confidence they can recover their loan quickly if the borrower defaults.
By contrast, private company shares, for example, might take months or years to sell, so they are not usually accepted. That is why bonds, equities and funds are favoured: they are liquid, and both the client and lender can easily track their value. Diversified portfolios are best suited.
Loan-to-values typically range from 50 per cent up to around 70 to 80 per cent, depending on the type of asset and volatility. Volatile, individual stocks tend to provide lower LTVs.
Similar to an overdraft, Lombard loans are often revolving: borrowers can draw down, repay, and redraw.
Repayments are typically interest-only, with borrowers paying interest on a monthly basis. Changes in interest rates could affect the cost of the loan, impacting the borrower’s repayment obligations. The principal is repaid at the end of the term, or rolled over.
The pros and cons of Lombard loans
Enabling clients to access liquidity without having to disrupt any long-term investment strategies or sell existing assets, and while continuing to make gains from investment returns, can be important when market conditions are less favourable.
For assets held within a tax wrapper, Lombard loans can allow a client to generate liquidity from the assets while also preserving the tax status of those wrappers. For example, a client could keep assets in an Isa to continue growing tax-free, or prevent the need to withdraw more than 5 per cent of their original investment from an offshore bond.
But if Isas or other tax wrappers are used as collateral, the tax benefits could be invalidated in the event of a margin call.
Margin calls are triggered if the collateral of the loan declines in value, requiring additional collateral or a partial loan repayment. For example, an early warning at around 65 per cent LTV, before a margin call at around 75 per cent LTV, and then a sell out at around 85 per cent. Borrowers may be obliged to sell assets in a down market or when they do not have liquidity.
Lombard loan providers do not accept every type of asset: eligibility can be restricted to liquid, easily valued investments such as listed shares, bonds and funds. Very illiquid securities can therefore be excluded.
But because the collateral consists of liquid, market-traded assets that are valued daily, Lombard loans enable faster credit decisions and can be available within hours, or under 72 hours.
Lombard loans versus other types of borrowing
Lombard loans are collateralised debt secured against a borrower’s investment portfolio. They sit between an unsecured loan and a mortgage in terms of their features.
As Lombard loans are a form of secured borrowing, the interest rate is usually lower than that of unsecured borrowing such as a personal loan or credit card: typically the Bank of England base rate plus 1.5 per cent to 3 per cent, depending on the facility size.
Lombard loans can be substantial, starting at £65,000 for example, and can run into millions of pounds depending on the client’s portfolio size. Mortgages are limited by the underlying property’s value and affordability assessments.
With Lombard loans clients can draw down, repay or increase borrowing without needing to sell assets and crystallise gains, or go through lengthy approvals and valuations. On the other hand, personal loans are for fixed amounts, with fixed terms and fixed repayment schedules.
Personal loans are also capped at lower levels, often under £50,000. So in practice, Lombard loans can provide clients with access to larger facilities than other forms of consumer borrowing.
Use cases for Lombard loans
Lombard loans enable clients to borrow against the value of their investment portfolios without selling assets or disrupting investment plans, while continuing to make gains from investment returns.
They can be used for a variety of purposes; their efficiency and flexibility are what make them attractive.
With initial decisions made in hours or days rather than weeks or months, and the ability to draw down large sums instantly once set up, Lombard lending can be a solution for short-term financing.
For example, to prevent being stuck in a property transaction chain, Lombard lending can finance the property acquisition, and then be repaid once the previous property is sold. Whether it is this or getting cash ahead of a bonus, business sale, tax rebate or other liquidity event, Lombard lending can provide that flexibility.
Using a Lombard loan has tax advantages as well, as no capital gains tax is incurred when you borrow against assets, rather than sell them. They can therefore be used to manage and defer CGT, while providing liquidity.
For some clients, tax benefits form a core reason as to why they utilise Lombard lending. By spreading asset disposals over tax years, advisers can use Lombard lending as part of sensible tax planning.
But not all users of Lombard lending focus on the short-term. Long-term gifting strategies to family members are another well-trodden use case.
Borrowers may want to support their children get on the property ladder, but may not want to disrupt their own investment plans. By using their portfolio as security they can give extra funds to their children to buy a property, and allow their children to repay some or all of the loan over a longer-term basis, reinventing the bank of mum and dad.
We see examples of clients who have leveraged their assets then make a gift to their children. The debt remains in the client’s name and thus reduces the value of their estate.
Subject to surviving seven years and addressing any ‘gift with reservation of benefit’ concerns, they can potentially reduce the amount of inheritance tax paid without the need to liquidate assets immediately and losing out on the income and/or growth of those assets.
These types of use cases are common regardless of the interest rate cycle. But when rates trend lower, it is often the case that borrowers will use Lombard loans for leveraging their assets. When used conservatively and by borrowers with the necessary sophistication, this can underpin long-term wealth building.
Lombard loans and regulation
Lombard loans are subject to the same regulation as any other consumer credit product. But due to the historic focus on higher value clients, they have historically been structured as agreements that are exempt from the Consumer Credit Act.
In order to qualify as an exempt agreement, the loan must be greater than £60,260 and made to someone who is certified by an appropriately qualified accountant as having at least £500,000 in net assets (excluding a primary residence and pensions) or an annual income of at least £150,000.
With the emergence of technology-driven solutions, we are seeing a greater demand for loans to mass affluent clients, and expect to see various solutions emerge that allow clients who do not meet the high net worth criteria, or wish to borrow less than the threshold; but these agreements would be regulated by the Consumer Credit Act.
Regardless of the regulatory status of the loan itself, if a financial adviser is offering Lombard loans to their clients, or introducing clients to a Lombard lending provider, they are likely to require credit broking permissions, as it falls under the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001.
Just because a credit agreement is exempt, this does not mean the credit broking activity is dispensed with, if they are introducing a client to a Lombard lending provider.
There are potentially ways in which clients of advisers can still access Lombard lending without credit broking permissions; but the adviser themselves cannot be involved in the process, cannot effect an introduction, and can only play a role limited to ensuring necessary operational standards are in place.
If the firm does have the necessary regulatory permissions then they can also, subject to having suitably qualified staff and strong processes, advise clients on whether a Lombard loan is suitable or not. But many may still treat this as a non-advised, execution-only solution available to the relevant clients.
As in all cases, regardless of the approach, the consumer duty will thread through this and the target market, target outcomes and the impact on any vulnerable customers should be thought through.