Margin Buyer Beware

Sydney Morning Herald

Wednesday April 9, 2008

Annette Sampson

The strategy To ensure my margin loan is safe.

Is there such a thing as a safe margin loan? The problems of margin lenders such as Opes and Tricom have highlighted the big risks that were taken by investors using their products (many claim they took those risks unknowingly), as well as some gaping holes in regulations. The good news is that most mainstream margin lenders operate differently to Opes and Tricom.

But some margin lenders operate on similar models and investors should make sure they understand what can and cannot be done with their shares.

Can you tell me in plain English what the problem was? A margin loan is simply a loan to buy shares or other investments such as managed funds. The underlying investments are used as security or collateral for the loan and the lender sets a loan-to-valuation ratio for each security, based on its level of risk. Typically you might be able to borrow about 70percent for blue-chip shares and about 30 to 40percent for more volatile securities.

Just as your home loan lender will take a mortgage over your home, a margin lender will hold your investments as security for the loan. The main difference is that, if your investments fall in value so that you breach your loan-to-valuation ratio, you'll receive a margin call.

Generally this means your lender will ask you to lodge more cash or securities as collateral on your loan, to bring your borrowing levels within limits.

If you don't plan for margin calls, this makes margin loans a risky proposition as typically you have less than 24 hours to stump up that extra security or sell some of your shares to bring the loan back to where it should be. But these features are common to all margin loans.

CommSec's managing director, Matt Comyn, says the Opes loans had two features not generally included in mainstream lenders' contracts.

First, Opes borrowers apparently assigned legal title of their shares to the broker, instead of retaining it themselves (though this will almost inevitably be tested in the courts). Opes lodged their shares as collateral for loans from lenders such as ANZ and Merrill Lynch instead of merely holding them on behalf of borrowers. Unfortunately that also meant lenders to Opes started selling clients' shares when Opes got into trouble.

Comyn says standard margin loan contracts clearly allow borrowers to retain title to their shares. The lender can still sell them if you don't meet your commitments - such as not meeting a margin call or not making loan repayments - but the arrangement is more like a mortgage.

The second difference occurs where the margin lender passes your shares onto someone else - either as security for a loan as with Opes or by lending the stock to short sellers. In response to client queries, last week CommSec notified clients that it did not (and could not) engage in stock lending. St George's general manager of margin lending and direct shares, David Curry, says it holds clients' shares in a nominee account and will only access them in the event of a margin call.

But doesn't that still leave me exposed to the lender selling my stocks without my knowledge? Curry and Comyn say very few margin calls result in forced sales.

Usually, if they can't provide extra security, clients have the opportunity to sell stocks themselves.

Where the lender moves to sell the stock, Curry says, it will generally work with the client (or their adviser) in identifying which stocks to sell. Comyn says your stock would only be sold without your involvement if you were uncontactable and CommSec would probably sell the more liquid stocks first. Curry says St George sells the lowest-geared stocks first (as you need to sell fewer of them to get the loan back into order) but with a view to liquidity.

How do I know what my lender does? Margin loans are not covered by the Financial Services Regulation and so there is no standard disclosure statement. However, all margin lenders have a form of disclosure statement or contract which should set out the loan's terms and policies on stock lending. Borrowers should read the fine print carefully and be sure they understand what can be done with their shares.

© 2008 Sydney Morning Herald

Back to News Index | Back to Home