Margin lending without margin calls - the new reality
Can you imagine a margin loan without a margin call? Janine Mace finds the sector has been busy innovating.
Say the word ‘margin lending’ and you think margin calls. Right?
Wrong.
How about a margin loan with no margin call? Or a margin loan that acts as a cash management tool?
Welcome to the new world of margin lending and geared solutions.
As every student of pop culture knows, today’s world is all about reinvention and after several years in the wilderness, the margin loan market is about to stage a comeback – complete with a whole new look.
“The past few years have been a challenging time for the margin lending industry, as it has been reinventing itself,” explains Peter Steel, general manager of margin loan provider Core Equity Services.
This fresh look is even taking negatives and turning them into positives.
Don’t think margin call, think risk management tool.
Don’t think leverage, think liquidity.
As Adrian Hanley, head of margin lending at NAB Equity Lending, explains: “Traditionally when you speak about margin lending it is talked about in terms of gearing and to improve the client’s footprint in the market, but it is also a liquidity tool – not just a leverage tool.”
He points out that in the US margin lending has a long history of being used for liquidity purposes as well as leverage.
“It is a way to take advantage of investment opportunities clients see without having to sell another investment,” Hanley explains. This avoids triggering a capital gains tax event or using existing funds.
“It can be used as a tool for cash flow purposes instead of using the client’s own cash balance.”
Steel agrees this is a whole new area for Australian margin loan providers.
“We are placing a big emphasis on cash flow management. A margin loan is about gearing, but it is also about cash flow management,” he explains.
“Core Equity Services is launching a product later this year that will offer a Commonwealth Bank-branded product like the Macquarie Bank cash management account (CMA). We think the uptake will be significant.”
The new product will offer a range of tools for financial advisers designed to streamline the process and provide better integration with desktop tools. According to Steel, it is about making the client’s cash perform.
“Cash is just another asset class that needs to be made to work harder.”
Marketing magic
Even margin calls are getting a makeover, with some providers rolling out vehicles being marketed as ‘no-margin-call’ products.
No-margin-call products fall into two general categories, according to Steel. “The first group is home equity type products where the underlying asset is not valued very often, so there is no margin call.”
CES’s CALIA+ product is an example of this, as it offers a portfolio-style credit facility for home, investment and personal loans in a single loan facility.
“CALIA+ has been getting a lot of traction. It is about using home equity and it provides a loan to invest in the market,” Steel explains.
“A house has a lot of equity in it and by using it, we can provide an umbrella lending facility that clients can use elsewhere. It provides flexibility as the underlying asset is not regularly re-valued.”
The other alternative being touted as a no-margin-call loan uses structured products.
“These can help clients place an upfront cap or collar on their investment and avoid a margin call, but the price is baked in upfront and they are usually costly. They tend to be three- to -five year products due to the cost for the provider,” Steel says.
According to Julie McKay, Bendigo Wealth and Leveraged Equities senior manager technical and research, no-margin-call products are simply a new name for an existing product.
“No-margin-call products are called capital-protected or limited recourse loans.”
She believes the idea of no margin calls is simply good marketing. “People borrow to buy assets all the time but the name used is only marketing – essentially it is only borrowing with different features.”
McKay is sceptical about the need for complex, capital-protected, no-margin-call products.
“For assets such as Australian equities and managed funds, I’m unsure why you would implement that level of complexity when there are cheaper ways to manage risk and the emotion attached to a margin call,” she says.
“This is an emotional response rather than a sensible response.”
McKay points out that capital protection does not eliminate risk, but simply pays someone else to take the risk instead. “I am wondering why you would pay someone to take away a risk that shouldn’t be there if you are doing gearing properly.”
Despite the doubts, no-margin-call products are likely to find fertile territory with financial advisers.
According to the Investment Trends December 2011 Margin Lending Financial Planner Report (which is based on responses from 731 financial advisers), 56 per cent of advisers do not currently have access to all the products they would like in this space.
“The top product they would like is a no-margin-call product or automatic rebalancing loan,” explains Investment Trends analyst Trent Hardy.
He says interest in these products has increased over the past three years, with 25 per cent of all financial advisers saying they would like access to no-margin-call products. Other desired products include geared superannuation (24 per cent) and limited recourse products (15 per cent).
Over at NAB, Hanley says they are keeping their options open and are considering launching a no-margin loan product. “If we believe there is sufficient demand and the product is viable, we will deliver it.”
However, he believes adding complexity to a product is not always the best approach. “Margin lending is a fairly simplistic product and is not financially engineered, which is one of its attractions.”
McKay also has doubts. “Innovation is needed in the way you use the product, not the margin lending product itself,” she says.
“It is all about how you use the tool called margin lending, not about tinkering with the product. It is like a hammer – it is about how you go about using it that matters.”
Cheaper alternatives
McKay believes there are “cheaper and easier ways” to avoid margin calls than using capital-protected products dressed up as a no-margin-call loan.
“For example, instalment warrants are an old but good product and the new ones capture the dividends. That makes them even more attractive,” she says.
“We are seeing a return to the basics with an increased interest in instalment gearing.”
McKay points to Leverage Equities’ Investment Funds Multiplier (IFX) product as an alternative for clients frightened of receiving a margin call.
“The biggest fear about margin lending is when you have a margin call and the size of it is unknown. Our IFX product has a slow margin call process. Repayment is set at
1 per cent of the loan amount, so you can budget for it if you get yourself into that situation,” McKay says.
While they sound great for nervous clients, Steel warns no-margin-call products do need to be handled carefully.
“They are appropriate for some clients, but any type of gearing without a margin call is an issue, as a margin call is a circuit breaker for the client and draws their attention back to their investment. You would not want a client to ignore the importance of careful risk management.”
While believing clients and planners need more education around margin calls, Steel argues they actually play a valuable role.
“Margin calls have a certain taint in the industry, but people need to understand they are a valuable tool. They are about helping you to manage your loan better,” he explains.
“Some financial advisers are very averse to receiving a margin loan call, but actually it is good, as it is a call to action and draws attention to the investment and the underlying assets.”
McKay agrees margin calls only become an issue if the loan is not monitored carefully.
“With no-margin-call products you are paying the provider for comfort about a bogey, but if you geared appropriately and monitored the position appropriately, it is not an issue,” she says.
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