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Is it time to hock the art?

Amassing wealth is terrific—as long as you can tap into it when you need to.
But what if many of your assets are illiquid?

That is a common problem among some wealthier investors. When the perfect investment opportunity comes along—say, a real-estate project or private-equity fund—these investors are unable to redeploy funds quickly.

To combat the problem, investors increasingly are turning to low-interest-rate loans from private banks or wealth-management firms to tap anywhere from $75,000 to hundreds of millions of dollars. They use a pool of their own securities, artwork or even aircraft as collateral.

Corporate executives have borrowed against their stock holdings for years using such loans. Known as "structured lending" or "borrowing against holdings," the practice grew more popular among smaller investors in 2012, say executives at wealth-management firms and private banks.

At Raymond James Bank, a subsidiary of Raymond James Financial, a St. Petersburg, Fla.-based financial-services company, securities-based loans outstanding rose to $414 million at the end of 2012 from $41 million in March.
"People are feeling a lot more comfortable and want to re-enter business transactions," says Anne McCosker, co-head of credit products at the Wealth and Investment Management division of Barclays . "At the same time, banks are generally increasing their appetite for credit again."

Securities-based loans, or loans made against pools of securities, are increasingly attractive to clients because of their low interest rates and flexibility, says Jordan Waxman, a managing director and partner at HighTower's HSW Advisors, which has about $1 billion under management. Currently, annual interest rates fluctuate between 1% and 2%. He says loan liabilities comprise $60 million of assets under management at his practice.

Clients have been using the loans for opportunistic investments that should return more than the cost of borrowing the capital to invest, Mr. Waxman says. Depending on the loan, there might also be no set "due date" for when clients have to repay the loans.

The loans carry advantages and drawbacks.

On the positive side, the loans let people keep their portfolios intact, without having to forsake future profits in the market and having to incur capital gains, says Andrew Kaiser, chief operating officer of Goldman Sachs Bank USA, a unit of Goldman Sachs Group.

Borrowers should remember they must pay back the loan with interest—and might end up having to sell of a portion of their securities to do so if the value of the securities declines, warns Bill Geis, executive vice president of retail lending at Raymond James Bank. Typically, clients use the income generated by the investments made possible by the loan to pay it back. But if those investments sour, the borrower still is on the hook.

The interest rate on the loans tends to be floating, says Mike McPartland, head of investment finance for North America at Citi Private Bank, a unit of Citigroup . The rate is typically tied to the 30-day London interbank offered rate. If the interest rate is Libor plus one percentage point and the 30 day-Libor is 0.25%, then the interest rate on the loan would be 1.25%. Some firms offer fixed rates as well, says Ms. McCosker of Barclays.

Loans differ depending on the nature of the collateral, Mr. McPartland says. For example, securities that are less volatile, like municipal bonds and Treasurys, will on average command an "advance rate" of 85%. So, if you put up $50 million worth of securities, you would receive a loan worth $43 million. The advance rate would be lower if the securities were noninvestment grade.

Banks are more likely to lend against more liquid offerings, like securities, than against assets like interests in a hedge fund or private-equity fund that are harder to value, says Mindy Rosenthal, executive director of the Institute for Private Investors, a New York group for high-net-worth families.

Still, Stephen Brodie, a partner at law firm Herrick, Feinstein in New York who represents six different private banks in lending to high-net-worth individuals, says art loans are "far more common" today than they were three or four years ago.

Works of art can be tough to sell quickly, and usually have advance rates from 40% to 50% of a conservative value estimate, Mr. Brodie says. Interest rates on those loans might be Libor plus two or three percentage points, says Scott Milleisen, a capital adviser at J.P. Morgan Private Bank, a unit of J.P. Morgan Chase.

To use art as collateral, clients also must pay appraisal fees to the bank—but they usually get to keep the art on their walls.

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