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Also available as podcast (Episode #159)
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Can I Offer Lending Solutions To Clients In The RIA Model?
TL;DR – If you are using lending solutions with your clients, it is understandable that you will need to replicate those solutions if you take a new path with your practice. In the RIA model, solutions like margin loans and non-purpose loans are not only available, but generally come at a significant advantage over your current options. Understanding what’s available and how the due diligence process works are common steps when exploring an RIA path.
Host:
Brad Wales founded Transition To RIA in 2020 after nearly 20 years of prior industry experience, including direct RIA related roles in Compliance, Finance and Business Development. He has an MBA and has held the 4, 7, 24, 63 & 65 licenses. He has been quoted or featured in 100+ industry articles including in the Wall Street Journal, Barron’s, and most every other major industry publication. He is well known for his RIA video explanatory series, and Kitces named his podcast as a “Top Podcast for Financial Advisors.”
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Full Transcription Of Video:
Can I offer lending solutions to clients in the RIA model? That is today’s question on the Transition To RIA question & answer series. It is episode #159.
Hi, I’m Brad Wales with Transition To RIA where we help you understand everything there is to know about why and how to transition your practice to the RIA model.
If you’re not already there, start by heading to TransitionToRIA.com where you’ll find this entire series in video format, podcast format. There are articles, there are whitepapers. There is a Vendor Profile Series. All kinds of things to help you better understand the model.
Again, TransitionToRIA.com.
On today’s episode we’re going to talk about if you were to transition your practice into the RIA model, would you be able to use lending solutions with clients?
That could be because you are currently doing that with your clients at your current firm and you need and want to be able to carry over that same service and value to clients going forward. And/or you desire to start doing lending with clients going forward.
That’s what we’re going to cover in this episode, how that works in the RIA model.
The very short answer is yes, you can help facilitate loans for your clients in the RIA model. And as I’m going to get into, it is arguably a better way to do it in the RIA model than it is perhaps at that captive wirehouse type firm or broker-dealer firm you might be at now for reasons that I’m going to go into here.
For starters, there are two main types of lending that I’m referring to here.
First, margin loans where a client is able to take a loan in their account, typically to perhaps buy additional equities, although it could be used for other purposes as well.
And then the other is often referred to as securities-based lending, SBL loans. Sometimes that’s also referred to as non-purpose loans.
For those not familiar how SBLs are different from margin, they act somewhat similar in that the positions in the account are the collateral for the loan. But with SBL loans, how the release rate is calculated – release rate meaning how much the client can borrow – and how the interest rate is calculated is a little different.
And so if you’re currently using lending for your clients now, it’s likely either margin loans and/or SBL loans. Again, some folks refer to the latter as non-purpose loans.
There are other loan types you might also use with very high net worth clients, such as aircraft loans or loans against artwork. So I want to acknowledge some of those other types of client lending exist as well. But primarily when this question comes up about lending, it’s referring to margin and/or SBL loans.
We’ll start with margin loans.
Typically in the RIA model you are getting margin loans through the custodian.
Just like how currently, if you are in that traditional broker-dealer world, if it’s a self-clearing broker-dealer, like a wirehouse firm, that is the firm you’re getting the loan through.
If it is non-self-clearing, it might be the clearing broker-dealer.
But in essence, you are having a client’s account coded as a margin account, and you’re taking a loan against that. And in the RIA world, again, that is facilitated by the custodians.
Now, this is a perfect example of where it can be more advantageous in the RIA model as far as client lending goes, than in perhaps a wirehouse model or even maybe an independent broker-dealer model.
An example of why it can be more advantageous is let’s say you are at a wirehouse firm and your client comes to you, and that client has a $2 million account, and they need to borrow $300,000 for whatever the reason is, and you’re going to do it on a margin loan.
Well, you go to your firm and say… “For a $300,00 margin loan in a $2 million account, what interest rate can I go back to my client with on this?”
By default, they’re probably going to point you to a rack rate table that exists and say… “Here are the rates. Based on how much the loan size is going to be, here’s the going rate as of today.”
Now, you might be able to push back a little and say… “Come on, can you give me a discount?” And there’s sometimes some mechanisms for that. But at the end of the day, you are at the mercy of one firm to give you an answer on that. It’s the firm you’re at.
Now imagine you are in the RIA model.
It’s beyond the scope of this episode, but most RIAs of size are what they call multi-custodial. I’ve done episodes on what single-custodial is versus multi-custodial. But in short, as the name implies, as an RIA, whether your own RIA or you joined an RIA, if you have multiple custodial arrangements, those are multiple options you can go to and ask about the margin rate.
As an example, let’s say you have your own RIA and you have two custodians.
Part of your value to your client in our $300k loan scenario is you can go to two different custodians and say… “What is the best rate you can give me?” And you can play them off each other if need be.
You can say… “Custodian A, if you can give me the best rate, I’m going to open this $2 million account with you and you get the $300,000 loan.” (Which that is a very good revenue source for custodians.)
Or… “Custodian B, what can you do for me?”
Again, part of your value to your client is being able to say… “We’re going out and shopping your loan to try to get you a better rate.”
The idea being you’re not captive to just one answer regarding an interest rate on a margin loan. You can potentially shop it to more than just one firm.
That’s one of the big advantages of the RIA space is you’re not captive to just one solution.
Now, if we extend that to the other type of loan, SBL loans, it’s the same thing.
You could go to your current firm now and get that single answer on a rate. Over in the RIA space, some custodians offer SBLs, some custodians are aligned with third-party lenders they collaborate on with them, and you also have the option in the RIA space to use standalone third-party lenders that offer SBL loans.
And so again, you can go and essentially shop the rate. You can ask a custodian what rate you can get. You can ask a third-party lender what the rate would be
You have many more options, and some negotiating power.
Again, if you’re at that captive space, maybe a wirehouse, you don’t really have any negotiating power. They will give you a rate and you can complain about it, and attempt to push back. But if they give you a number and they say it’s final, you don’t really have any leverage at that point. Because when you’re captive in (for example) a wirehouse firm, you don’t have the option to go to another source to shop the rate.
And then to extend it back to what I said earlier, to the degree you have higher net worth clients, if you need more exotic type of loans like aircraft loans or loans against artwork, there are third party lenders you can go to in the marketplace. You can find the best solution to be able to bring back to your client to help facilitate those types of loans.
Part of your value proposition to your clients in the RIA space is to be able to say… “Not only can we help you facilitate loans where it makes sense for you, we are able to go to the marketplace for you. We’ve done the due diligence, we’ve located multiple different lending solutions.”
Again, you’re adding value. That’s one of the big advantages. It’s not just the optionality, but the value prop that you can add as well as part of that.
Next, let’s discuss how this works from a process standpoint, with the assumption you are currently using lending now, at perhaps a wirehouse firm. You have margin loans and/or SBL loans.
Part of your due diligence when selecting a custodian is while there’s a lot that goes into what custodian you might select – I’ve done different episodes on how best to choose a custodian – part of that is you are doing your due diligence on them, and they are doing due diligence on you, to make sure it’s going to be a good fit.
There are several reasons it may or may not be a fit. I recently did an episode on how some custodians have minimum AUM levels you must meet, so not all custodians are necessarily even available to you.
That’s a big part of what I help advisors and teams with, is to know which custodians might be a fit, which ones you should focus on, etc. I’m happy to have that conversation with you as well.
But as you’re going through that process and looking at all the different pieces that go into that decision of whether to work with a particular custodian, part of it is you would want to say (for example)… “We have 20 clients that currently have outstanding margin loans, and maybe another 10 clients on top of that have been approved for margin, but they haven’t drawn on them currently.”
The custodian will love to have that conversation because lending is a good revenue driver for custodians. I did an episode on how a custodian generates revenue. So, if you want to learn more about that, dive into that as well.
The custodian in response will say… “Great, walk us through each of those loans.”
Now, they don’t want you to, at this juncture, give them client names or anything like that, because at this point you’re still in the exploratory phase, you’re still in the due diligence phase.
But they’ll ask you to make a spreadsheet generically noting loan one, loan two, loan three, etc. And for each, here’s how much the client has been approved to borrow; here’s how much is currently being borrowed; here’s the interest rate currently on it.
The custodian’s objective is to be able to match whatever you have now, because understandably you’re not going to be able to go to your client and say… “I’ve started an RIA (or I’ve moved into an existing RIA) and I’d love to have you follow me, but by the way, that interest rate you’ve borrowed with, that’s going to go up.”
That’s a non-starter of a conversation.
So, in most all instances, a custodian will be able to match those rates because again, they are working to earn your business and they understand it’s going to be a deal killer if they can’t do that.
Now, if somehow along the way you got some crazy sweetheart loan terms, interest rates, whatnot for some of your clients, it’s not a guarantee that everything will be matched.
But if it’s generally rack rate, or maybe a little discounted off rack rate at your current firm, custodians are typically able to match most of that.
That is part of the due diligence process. That is something that needs to be conducted. They will walk you through that. They’ll ask you about it… “Do you do any margin loans? Do you do any SBL type loans?”
Because again, they want to learn about your business as well. And when it reaches an appropriate point in the due diligence phase, they will need those details. And again, generally that is all able to work out, but just know the devil’s in the details. You need to go through that exercise to confirm that that would all work out properly.
That’s a very normal part of the custodial exploration process, the due diligence process. Don’t worry about having to go through those steps. Just know that there is a process for that.
The main takeaway is if you are using lending with clients now, if you were to transition to the RIA model, not only is it not likely to change, if anything it’s going to be better for you.
You might even be able to get better rates for your clients as part of transitioning. To where you can go back to your client and not only say… “I’m moving into the RIA model, and here’s how that benefits you. But I’ve also negotiated down your current borrowing rate.”
Now, there’s no guarantee that will be able to happen. But that type of thing can happen at times. And obviously that’s you adding a lot of value. That’s a great conversation to go back to the client with.
So again, just know that generally this will not be an issue if you were to move into the RIA space. And if anything, it will be an advantage for you to go into the RIA space.
With that, like I said at the top, my name is Brad Wales with Transition To RIA. This is the type of conversation I have with advisors and teams all day long is to say… “How does your current practice look? In this case, are you doing lending with clients? How would that look in the RIA space. Is this a path, a transition that’s worth your consideration?”
I’m happy to have that conversation with you as well.
First things first, head to the website at TransitionToRIA.com where you’ll find this entire series in video format, podcast format. There are articles, there are whitepapers. There is a Vendor Profile Series.
And at the top of every page is a Contact link. Click on that and you can instantly and easily schedule time to have a one-on-one conversation with me, whether you want to talk about today’s topic or anything else RIA related. I’m happy to have that conversation with you.
Again, TransitionToRIA.com.
And with that, I hope you found value on today’s episode, and I’ll see you on the next one.
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