The Lombard Loan: concept and key points
What is the Lombard Loan?
The lombard loan is a type of collateralised legal transaction. Under it, the borrower offers the lender, as collateral, a security. This security may be enforceable in the event of non-compliance with the agreed repayment terms of the loan (or credit, because it can also be structured in this way).
Although it is a growing form of financing, especially among large estates (but not only), its origins date back to the 16th century. Specifically, it originated in the Italian region of Lombardy (with Milan as its capital), hence its name.
Characteristics of the Lombard Loan
The main feature of this type of loan is the security pledged as collateral (share, bond, fund share, etc.). Precisely the amount and financial quality of the security pledged as collateral will determine the amount that the lender (usually a financial institution) is willing to finance and the applicable interest rate. In this regard, it should be noted that:
- The standard percentage to be financed by the lender will be 50% of the listed value of the securities. However, depending on the risk assessed by the financier, it is often requested that the guarantee be extended to a larger number of securities.
- The applicable interest rate, although it will indeed be lower than other types of collateralised legal transactions such as mortgage loans (as the repayment term will also be lower than the latter), will also be subject to a risk analysis of the underlying security by the lender.
- The repayment schedule for the instalments under the Lombard loan is usually agreed between three and five years. However, it can be shorter or longer because the principle of party autonomy applies.
Advantages of the Lombard Loan
The lombard loan makes sense in cases where the borrower (the natural or legal person requesting the loan) has liquidity needs that it expects to cover in the short to medium term. In such cases, the borrower prefers not to dispose of the financial asset he or she is pledging as collateral, because he or she is confident that the asset will appreciate in value. Thus, its two main advantages are:
- The possibility of leveraging on the pledged securities and, consequently, of benefiting from their potential revaluation during the term of the Lombard loan. If we manage to ensure that the revaluation of the security is higher than the interest rate agreed with the bank, the deal is a great one.
- The non-accrual of taxes that would arise from a transfer of the securities to be pledged. In other words, liquidity is obtained without paying tax on any capital gains that would arise from a transfer of the securities.
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