7

If I have a loan from a bank and I know that they do not sell their loans or the administration of said loans, is investing in their stock concentrating my portfolio risk?

Is there any reason to believe that the equity returns will be greater than the interest that I am paying them?

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    Why do you think that would increase your portfolio risk? Your loan is not correlated with the risk of the banks equities. If the bank bankrupts you will lose your equity - but the debt will belong to the estate, which is going to be taken over by someone else. – ssn Feb 13 '18 at 16:13
  • @ssn I don't think it would increase my risk. I'm asking in case it does. Hmmm... I guess in the event of my default, I would probably have sold my position in their company, so that's irrelevant. I suppose that in taking a loan from them, I judged them to be inferior to another lender in underwriting or lending rate, thus I already think they are not as good of an investment as a different institution. – Kora Feb 13 '18 at 16:28
  • Downvoter, how can I improve the question or is the premise of the question itself the reason for the downvote? – Kora Feb 13 '18 at 16:30
  • "I suppose that in taking a loan from them, I judged them to be inferior to another lender in underwriting or lending rate" I don't follow this logic. You are saying that the institutions that can't compete on rates are superior? That seems backwards to me. – JimmyJames Feb 13 '18 at 21:05
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    One thing to keep in mind is that every dollar that they have loaned you, they have also loaned to others. That is, in a fractional banking system, every dollar they have on deposit can be loaned out multiple times. – JimmyJames Feb 13 '18 at 21:10
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If I have a loan from a bank and I know that they do not sell their loans or the administration of said loans, is investing in their stock concentrating my portfolio risk?

Only if:

  1. those shares are a significant percentage of your portfolio (which is concentrating your risk whether or not you have a loan with them), and
  2. your loan is a significant enough percentage of their loan assets that a default could jeopardize the bank's solvency, and
  3. you were planning on defaulting on the loan.

Unless you're a Large Corporate Borrower (in which case you wouldn't be asking us), item #2 means that your loan won't affect the bank's share price.

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    +1 for "in which case you wouldn't be asking us"... Plus it's a great answer. – Harper Feb 13 '18 at 20:54
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    On the other hand, if 1, 2, and 3 were all true, shorting the stock might make sense. – David Schwartz Feb 13 '18 at 21:18
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    @DavidSchwartz I have a feeling that taking out a loan for the purpose of defaulting on it so that the bank's shares would take a dive you knew you could short is probably illegal somewhere along the line. – Kevin Feb 13 '18 at 22:12
  • @Kevin maybe not in Russia... :) – RonJohn Feb 14 '18 at 2:55
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    "in which case you wouldn't be asking us" heh! It would be great if a question appeared on here, "I'm John Smith from Apple. We just don't know what to do with this particular $3B I have in BVI ..." – Fattie Feb 15 '18 at 13:56
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I don't see a measurable relationship between equity returns and your specific loan interest rates. You have to analyze them independent of each other.

Regarding equity returns, if you are talking about dividends, you can go check the trailing yield of the shares. But, dividend yield (if at all any) will be much lesser than the loan interests in general. If you consider capital gains, then you have to analyze the stock in-depth. And, never forget to factor in taxes.

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There are analogies in corporate finance which compare equity to a long call option, and debt to a short put.

If you a long an at the money call (long stock) and long an at the money put (debit), you create a synthetic position in the underlying assets called a "straddle". When a bank loans someone money, it is essentially short a put (no upside beside recurring interest; risk of principal loss).

In theory, a straddle is less risky than buying the stock outright because you have some downside protection in case things goes against you.

Therefore it should be less risky to buy the stock of your lender than to buy stock outright. You are exposed to the bank's upside, but it is exposed to your downside.

For example, no matter how the bank performs, your debt will be no better or worse off -- the interest payments are not likely to change. If you do well, then the bank is not able to participate in your upside aside from lowering its default risk (which should in theory already be reflect in your rates). If you do poorly while the banks does well, then it finances your losses with their equity capital appreciation.

This is, of course, an oversimplification. There are other risk factors not captured by this specious analogy — e.g., counterparty risks in the case your debt is “callable”.

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