Are cheap and no-collateral investors right?

Martynas Stankevičius, crowdsourced real estate financing platforms x-ray manager

In recent weeks, several bond issues have been publicly announced in Lithuania, where well-known real estate or production companies borrow at 8-10 percent. interest with a secondary mortgage or no collateral at all.

Hence, in today’s economic conditions, 8 percent looks attractive to investors. yield bonds without any collateral, when there are a number of high-quality investment opportunities in the market with 9-11 percent. interest and primary mortgage of completed, liquid housing.

Therefore, today we observe an interesting trend in the market – private debt with a primary mortgage offers higher returns to investors than debt (eg bonds) with lower guarantees.

And this is where we “diverge from the textbook” where, according to financial theory, an unsecured loan should offer higher return opportunities (and risk) than secured debt.

In terms of numbers, today the highest quality bank-financed projects borrow at 8-9 percent. interest (ie 3-5 percent + Euribor), average or less experienced developers with primary collateral in banks or crowdfunding platforms can borrow for 9-11 percent. Further, economic logic would dictate that a bank-level developer with a secondary mortgage or no collateral could borrow another 2-3 percent. more expensive (ie, let’s say 11-14 percent in the range), and I wouldn’t even dare to guess the risk premium of a business that doesn’t meet the banking criteria and doesn’t offer a primary mortgage.

So the risk premium to investors should be paid by those businesses that borrow without deposit Because pledged solid assets help prevent losses or at least significantly reduce them in the event that negative economic scenarios materialize in the market.

Perhaps unsecured bond investors consider that the larger unsecured businesses are too big to go through, ie “too big to fail“? Indeed, large businesses have a certain “right” to borrow cheaper, because their experience and volume of activity theoretically reduces the risk of malfunctions and increases confidence. However, major economic shocks would similarly affect both large and smaller businesses, and the experience of investors in the event of shocks can be radically different – those who invested with collateral would have the opportunity to recover all or at least part of their investment, in contrast to those who invested without collateral. Because in recent cases, the main creditor (bank or platform holding the primary mortgage) will often take all the assets.

Therefore, today the unanswered question remains, do some investors lend too cheaply for higher risk, or do others, investing with lower risk, earn too much?