Is the fine print being pledged to investors?

Kristina Kairyte-Pypliene, Head of Financing at “Rontgen”

A large part of the recent popularity of bonds and crowdfunding in Lithuania can be linked to collateral, which sounds attractive to residents as a means of securing investments. In many cases, this is indeed an advantage, but investors should familiarize themselves with the types of pledged assets, conditions, and occasional nuances hidden in the “fine print.”

Through crowdfunding platforms alone, Lithuanian residents invested about EUR 400 million last year, while the bond market, based on older data from declared interest to the State Tax Inspectorate, may be almost twice as large.

Both directions are attractive to residents because of annual returns that exceed deposit interest rates several times, and investments are often (but certainly not always!) secured by pledging certain assets. Investors are reassured by the idea that in case of difficulties, the pledged assets would be liquidated for their benefit, helping them avoid losses. This may be true, but reality is much more complex.

The image of bonds
Let’s start with bonds. When talking to investors, it is often heard that they automatically consider this instrument “safe.” This perception may have been shaped by decades of media references to government-issued bonds. Although they have no collateral – except for the state’s reputation and economy – investors reasonably trust that countries like the United States, Germany, or Lithuania will fulfill their financial obligations.

However, in recent years, it is not government but corporate bonds – issued by companies or funds – that have become popular. These offer significantly higher returns and often attract investors with collateral such as shares, financial flows, real estate, or other assets.

The first lesson is that a government bond is not the same as a corporate bond. In the case of giants like “Microsoft,” investors may reasonably trust the company’s experience, economic strength, and reputation. But smaller issuers that pledge nothing should raise far more questions – especially if their communication tries to associate itself with the “safe” image of government bonds.

Even when bond issuers provide collateral, nuances increase. Investors must examine what is being pledged: for example, company shares or financial inflows may become worthless in case of bankruptcy. Both professional and retail investors tend to prefer real estate as collateral. But even here, it is important to understand whether the pledge is “primary” or “secondary.”

A secondary mortgage means that in case of financial distress and forced debt recovery, investors stand later in the creditor queue – usually after banks or other primary mortgage holders, but before the company and its shareholders. In cases of high debt, investors with secondary collateral may fail to recover their funds.

It is confusing that investments with secondary mortgages are sometimes publicly presented as “bank-level” projects. Banks may indeed be involved, but they benefit from primary mortgage priority. In the case of sustainable business and favorable economic conditions, such investments can still be successful, but investors should clearly understand what remains for them in case of trouble and whether the risk-return ratio is acceptable.

There are also hybrid scenarios in the bond market: for example, an attractive primary real estate mortgage may later turn into a secondary one. Overall, marketing and communication of bond issuers do not always make the situation clear at first glance.

For instance, unfavorable details about collateral may be buried deep within investment documents, while marketing creates a strong sense of security. Interest in bonds as a concept often exceeds attention to their terms and details. While bonds can be a good instrument, investors must remain cautious and carefully review all project information.

A standard with nuances
Crowdfunding, which attracts nearly as much investor attention as bonds, has over the past decade established a tradition in Lithuania of offering primary real estate collateral as a standard in projects. This is a valuable advantage, placing investors first in the creditor queue and effectively providing “bank-level” security.

This is also demonstrated by large and institutional investors participating in the crowdfunding ecosystem, often holding portfolios worth millions and, unlike many bond investments, benefiting from primary mortgages.

However, in Lithuania this is more of an “unwritten rule” than a guarantee. Therefore, investors should always verify in project descriptions or documents whether a primary mortgage is actually applied.

Even when assets are pledged with a primary mortgage, investors must assess their value, who determined it, and its ratio to the total loan. This is also relevant for bond investors. Non-professional and conservative investors should look for a loan-to-value (LTV) ratio not exceeding 70%, as such a buffer is considered significant in case of asset liquidation.

Even with a conservative ratio, it is important to understand the type of asset: completed apartments usually find buyers quickly, whereas industrial buildings or land plots in remote areas may not.

Finally, even if all investment conditions and collateral meet best practices, trust remains crucial. Key information about the investment, collateral, and terms should be provided in project descriptions and loan agreements, but independently verifying everything is not always easy.

For example, for a small fee, investors can check the existence of a real estate mortgage in the state register, but not all detailed information. Therefore, it is most practical to evaluate the experience and reputation of the financial partner, past loan performance, delay rates, and available information from the central bank, public sources, or other investors.

In summary, investing itself is an excellent choice. Since the beginning of this decade, both interest in and actual investment in Lithuania have grown many times over. All the considerations about collateral and pledged assets may seem irrelevant when borrowing businesses are sustainable and the economy is growing rapidly. However, experienced and wise investors understand that markets are cyclical, and all safeguards are designed to function precisely in more challenging business or economic conditions.