Q: I have been considering taking out a margin loan to invest in more shares, as the market is going well at the moment. I have heard that this can be a risky loan if the market falls and there is a margin call. What is a margin call and how could this affect me?
A: A margin loan is a specific loan for investing in shares and managed funds. Trading on margin provides investors with more capital to invest but the margin loan does come with more risk than a standard loan as it secured against the shares or managed funds, which can be volatile.
Each margin loan may have a different loan to value ratio (LVR), which represents how much you can borrow against that security.
Craig Saunders, head of distribution at NAB equity lending says: “It is a very simple but powerful tool, the same as any sort of leverage. If it does what it says, then investors are able to buy more of a growth asset.”
CommSec uses the following example: “If BHP has an LVR of 80 per cent and you want to buy $10,000 worth of shares, the bank will lend $8,000 and you’ll need to fund the remaining $2000 yourself using cash or other shares.”
The latest Reserve Bank of Australia data reveals that margin lending is at its lowest level since 2003. The number of accounts plunged to just 98,000 accounts compared with 260,000 in its peak in December 2009.
Saunders says: “What we are seeing in our business is investors opening a smaller number of loans for larger balances.”
Marc Bineham national president of the Association of Financial Advisers says that this steady decline can be attributed to the losses that investors suffered back in the global financial crisis.
Bineham says: “It is not a pleasant experience to have a margin call on your loan and a lot of people were getting not just one margin call but a number of margin calls as share prices continued to drop.”
Margin loans typically have a buffer (around 5 per cent) to account for smaller market fluctuations and allows time to organise funds in the case of a margin call.
CommSec says: “The main way to reduce your chance a margin call is to borrow to a lower LVR. The less you borrow, the more the market needs to fall before you would reach a margin call.”
A margin call is made by the lender when the LVR exceeds the maximum allowed for security. The borrower needs to take action within 24 hours to avoid the lender selling the shares to bring the loan under LVR.
According to CommSec, if a margin call is triggered on your account, you can either deposit money into your margin loan to reduce your loan balance, transfer additional approved shares or managed funds to increase your portfolio value or even sell part of the portfolio to reduce the loan balance.
The number of margin calls peaked in December 2008 at 8.61 calls per 1000 clients per day. This was in line with a share market collapse that accompanied the global financial crisis.
Since then, there has been a recovery in the share market and very low volatility with margin calls. At June 2019 the number was just 0.15 margin calls per 1000 clients per day.
Saunders says there are still retail investors using margin loans but in NAB’s business there has been a shift to a new product called Equity Builder.
NAB’s Equity Builder has the same logic as a margin loan but without the risk of a margin call. It works similarly to a principal and interest investment property loan with a repayment plan built into it.
The main difference is that the equity has to be diversified and invested in a range of approved exchange traded funds, managed funds or separately managed accounts.
The investor pays loan interest and reduces the loan principal each month. If a monthly payment is missed, loan assets may be sold to correct the position or repay the loan.