Even if you are not into investment and finance, keeping pace with some of the more significant trends in lending is a worthy way to spend a small chunk of time. The mortgage-backed securities and the bundled rating system which served as two of the primary causes of the recession which first rocked the global markets in 2007 taught us this.
But the latest trend in investment bank lending practices is not going to lead to the decimation of your bank account, the loss of your livelihood, or global market panics, fortunately. However, it is a trend that is interesting, a tale which involves foreign cars, high-priced art, and repossessed yachts.
In recent years, large investment banks including but not limited to Goldman Sachs and Morgan Stanley have begun allowing wealthy clients to put up their high-priced personal property as collateral for mortgages and loans. This relatively new practice- called a wealth loan- frequently sees collateral take the form of these clients’ stock portfolios, but they may instead offer up their weekend play-yacht or collection of Picassos and Warhols.
It is an arrangement that, when it works out as planned, benefits both the bank and the client. When default occurs, the client loses something that they have less emotional and financial stock in than other high-prized investments or even their homes. The bank, meanwhile, often receives a commodity that has more value than what they would have received otherwise. However, these banks have come to find that the market for these high-priced toys and adornments of the wealthy are not always in high demand, and converting those items into cash is not always as easy or profitable as they would like.
Take the case of Texas oilman William Kallop, whose net worth has been pegged at $1.2 billion. Kallop, one of Goldman’s top clients, took out a loan with the bank in 2014. Instead of risking any of his investment portfolio, Kallop put up his 217-foot, $52-million yacht ‘Natita,' outfitted with a movie theater, helipad, and room for 12 guests in its six cabins, as collateral should he default.
Default on the loan is precisely what Kallop did, according to Goldman. Last month, Goldman- having sued Kallop in an unsuccessful attempt to gain ownership of the yacht without force- employed the services of the U.S. Marshals, descending upon a marina in West Palm Beach, Florida to appropriate Natita for its new owner, Goldman Sachs. Before you shed any tears for Kallop, you should know that he also owns Honey Fitz, a yacht previously belonging to John F. Kennedy, and another yacht named ‘Bad Girl,' so he had one to spare.
That is exactly the point. Kallop had a yacht to spare, and even though he apparently did not give up ownership easily (who would?), he had already determined that the luxury vessel had less value to him than whatever he chose not to put up in the boat’s place. If not for Goldman and other banks’ new lending practice which allows it to diversify its abundance of stocks, bonds, and commodities with boats, art, and other seemingly strange yet high-priced items such as rare cars or violins, the investments may never have occurred. It is a way for Goldman to incentivize investment that appears less risky to its clients. This, in turn, fosters increased loyalty from highly-prized clientele.
And while this strategy has increased the banks’ number of assets with true value, they have found that sale of these commodities is not universal in ease. When Goldman repossessed Natita last month, it had already been on the market for two years. In light of this, the bank will either have to wait for the demand for yachts to rise- a precarious bet- or sell the boat at a reduced price. Either way, Natita does not represent a scenario where the commodity used as collateral is a hot-seller, even if its value ultimately outpaces the value of the loan.
Since increasingly using this practice of issuing wealth loans in 2012, Goldman has quadrupled its balance of money lent. Morgan Stanley, which also ramped up this practice in 2012, has seen its wealth-loan balances increase by 420%. Revenue earned by these banks on their wealth loans also carries fewer fees and commissions which must be shared with brokers, a pull-factor for the banks to increasingly issue such loans and mortgages. Because banks already know the ins and outs of these clients’ portfolios, they see little risk in the possibility of default.
The true examples of property lent against via wealth loans are reminiscent of the wanton way in which millionaires and billionaires can afford to spend their massive fortunes. Hedge-fund billionaire Steven Cohen took out a wealth loan with Deutsche Bank AG, using his art collection- including paintings by Pablo Picasso and Andy Warhol- as collateral. Aubrey McClendon, a natural-gas billionaire who died in a mysterious car accident one week after being indicted in 2015, once borrowed against his wine collection, deemed attractive due to an abundance of rare Bordeaux.
Wealthy men and women like McClendon, Cohen, and Kallop- who is known for owning three Gulfstream jets and eight luxury homes and residences– put little weight on their conscience when they risk only a luxury item, often fairly easily replaced.
While this lending practice is not particularly risky to either the bank, the client, or the American and global economies, it is noteworthy. Who knows, you may be in Cohen or Kallop’s position one day, and in that instance, you may just want to consider taking out a wealth loan.
What’s the risk?