The levers of power

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Turning over a report, Anton Pil starts scribbling calculations. A managing director at JP Morgan Private Bank, he spends his days heading the global currency, fixed income and commodities desk, advising the bank’s private clients. But this morning he grows animated as he tries to convey not the beauty of some complicated derivative but the good sense of having a mortgage.

Next to Series E Treasury bonds – the present every American kid hates to get – the mortgage is something so many Americans wish they did not have. Instead of dreaming of the day it will be paid off, he says people should embrace it.

“A mortgage is some of the cheapest financial leverage you can get,” he says. “People like the comfortable feeling of not paying a mortgage. Economically it is one of those deductions you should look to create up to the $1m cap.”

At a 6.5 per cent mortgage rate, Mr Pil points out, a person in the top 35 per cent tax bracket would be paying closer to 4 per cent on the money.

His back of the envelope jottings, however, shed light on a wider phenomenon: the very rich are not only more comfortable living with debt but they seek it out for things they could pay for outright.

“They’re borrowing for an investment; when they double or triple their money they sell and buy something bigger,” says Jane Heller, senior vice-president in Bank of America’s family wealth advisors group. “They don’t live in a house for 30 years.”

Ms Heller, whose clients include Martha Stewart, makes a clear distinction between the entrepreneurs who have amassed a fortune themselves and everyone else: “They don’t get attached to their things,” she says. “They’re not ‘thing’ oriented; they’re money oriented.”

Borrowing against their assets has been something the very rich have always done. But Louis Chiavacci, a private wealth advisor at Merrill Lynch in Miami, says the desire to take on more debt during the low interest rate environment skyrocketed. Even though rates are rising again, he has not seen a drop in borrowing because asset prices are holding up.

Somewhat counter­intuitively, the technology entrepreneurs and venture capitalists he has seen are often his less leveraged clients, largely because they have such concentrated positions in their businesses. All private bankers agree that the clients who are most comfortable with debt are real estate investors.

“Real estate people love debt. They say: ‘Give us more, please,’” says Ray DiNunzio, head of the northwest region of UBS’s client relation group. “You meet people who are worth $250m and they have been bankrupt twice before and they want to keep rolling the dice.”

The reasons for taking on debt range from buying aircraft, works of art, or yachts to meeting capital calls from a private equity fund or starting your own such fund. A very rich person may easily be able to pay $30m cash for a yacht but he probably won’t do it: the opportunity cost of selling something else and paying tax on it is far higher than borrowing money from his private banker.

For these loans, speed is of the essence, and this is where the private bankers with a big balance sheet behind them have an advantage. They can get a loan in a day or over a weekend for a top client. (And all the incentives are aligned for them to do so: lending deepens the banker’s relationship with his client, allows him to know more about the person’s total net worth and is lucrative for the bank.)

Ms Heller says BofA can deliver a loan to an existing client in one day, regardless of the size. She says the private bank is particularly good at evaluating and financing aircraft and yachts.

Ms Heller, whose average loan size is $50m and runs upwards of $300m, says a lot of clients are increasing their cash positions and opening lines of credit, a harbinger that the economy may worsen to create bargains. “If you think things are going to get bad, you sit on lines of credit,” she says. “They are value investors.”

Merrill Lynch’s Loan Management Account is available to clients with more than $10m at the group and allows them access to capital at will. “It is a very user-friendly mechanism to draw down and pay back as cash needs and cash surpluses arise,” Mr Chiavacci says. “The assets here are collateral on the loan. Whether they buy a farm or a yacht it doesn’t matter to us.”

Of course, not every very rich person is highly leveraged. Mr DiNunzio recalls a client who had a net worth of nearly $600m in liquid assets. “He said 95 per cent of my wealth will be distributed to charity when I die. He didn’t care. It was a game to him.”

The guidelines for how much people get are not something private banks are keen to divulge but the nature of the client’s assets is what counts. “The capacity to take on debt of someone with a $50m muni bond portfolio is very different to a guy with $50m in one tech stock,” Mr Chiavacci says.

BofA and Citigroup say they both like to keep loans under seven years. “That’s a time frame when things will change,” says Marc Bean, managing director at Citigroup private bank. “Their balance sheet can change; terms in the market can change.” He notes private equity firms are now challenging private banks to lend to the wealthiest clients, which has lowered borrowing costs.

As for the basic mortgage, the very rich still take them out – up to the limit of the tax write-off. Mr Bean remembers a client who bought a Manhattan apartment by taking out a $1m mortgage and paying cash for the additional millions; when the deal closed he refinanced the cash part and invested it in taxable securities.

“These clients are more entrepreneurial,” he says. “They’ve always leveraged their holdings.”

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