Margin lending: dangerous practice or hard-nosed strategy?

From June 2001 to June 2002, outstanding loans to buy shares and managed funds on margin lending accounts increased by over $2 billion, or 25 per cent, pushing total borrowings out to $10.6 billion. Meanwhile, the number of margin lending clients rose almost as fast, by 23 per cent, to 116,126 people.

That’s an astonishing result for a year in which the stock market, while more buoyant than many expected, still managed to lose 4.5 per cent of its value on an accumulation basis and more on the straight index.

However, two other facts from the Reserve Bank of Australia’s (RBA) August Statement on Monetary Policy add another dimension to this apparently bullish margin lending scenario.

Leverage — the amount by which each client is geared — crept up to 50 per cent by the end of June, from 45 per cent in the previous quarter, while the value of the underlying securities rose only 13 per cent over the year.

These figures indicate that many borrowers have not experienced the wealth multiplier effect that is the justification of leveraging from an investment point of view.

By June, the sluggish market had started to take a toll on the ever higher levels of wealth geared into it.

However, as most advisers would agree, tax deductions provide at least as much impetus to margin lending as investment returns.

Predictably, reactions to the current scenario differ considerably according to who you speak to.

Banking products rating agency Cannex assesses the margin lenders twice a year, allocating star ratings weighted heavily towards two-year interest rate performance.

“Anecdotally, I think there’s been a bit of a scare among financial planners,” says Cannex managing director Andrew Willink.

“After strongly recommending that people go into margin lending, their clients have been hit by margin calls. There’s a question mark now over what debt instrument should be used to gear into the sharemarket.”

According to this theory, financial planners whose clients have been hit by margin calls may be considering the advantages of using home equity to buy into shares and managed funds.

Margin calls were down by 15 per cent over the year to June, but they nearly doubled over the quarter to June, according to the RBA data.

Talk to the margin lenders themselves, however, and there’s very little sense that anything could or should halt the margin lending juggernaut.

“Things did drop away after September last year,” says Stephen Mildred, chief manager of marketing with the Commonwealth Bank’s Premium Financial Services network. “But by January, demand for margin lending was at or above pre-September 11 levels.”

Two-thirds of the Commonwealth’s margin loan book comes through financial planners, both in-house and external.

That means the vast majority of loans are now over managed funds, which provide, says Mildred, “instant diversification”.

The loan book’s average loan to valuation ratio (LVR) was up to 51 per cent in mid-September, according to Mildred.

“It used to be that margin lending was for the well-heeled. Now it’s across all age bands,” says Andrew Black, head of margin lending at St George.

“Far more younger people are taking on margin lending. The workforce is far more mobile and house prices have risen so dramatically. They’re not buying their first home so young. But they do want to accumulate wealth.”

Scott Young, divisional director of Macquarie Margin Lending, agrees.

“When it comes to market trends it’s pretty obvious that the growth is coming from the 25 to 35 year age group. I think by far the majority of margin borrowers are still male. And lump sum margin lending is still mainly into shares, although managed funds are attractive because of instalment gearing.

“Financial planners have always been interested and they’re getting more interested,” Young says.

He suggested that the boom in master trust and wrap services, which reduce the adviser’s administrative load, had contributed to the popularity of margin lending among planners.

There are now five big names in margin lending: Colonial/ Commonwealth Securities, with a loan book of $2.8 billion, followed by BT, Macquarie and Leveraged Equities each with well over $1 billion, and St George at $830 million.

Following the Westpac purchase, BT has repositioned its margin lending business with the launch of Lifestages, which is designed to help advisers sell margin lending to a variety of clients at various stages of life (see box at left).

Margin lending has become a highly commoditised business, with most lenders charging an interest rate of about 7.6 per cent at present, and paying a trail to advisers that starts at 0.25 per cent over the loan, going up as far as 50 basis points for large amounts.

Innovations have been in the area of customer service, covering such things as daily downloads of individual gearing ratios to financial planners, and product development such as instalment gearing and various protected loans.

Macquarie’s Young says dealer groups put pressure on margin lenders to increase managed fund LVRs — thereby decreasing the chances of a margin call. Macquarie now has 87 funds with a 75 per cent LVR.

And in an interesting twist on the margin loan versus home equity argument, both Commonwealth Bank and Leveraged Equities have developed products that allow customers to combine the two.

The Commonwealth is marketing the Colonial Asset Linked Investment Accelerator (CALIA) to external advisers, although the in-house Premium dealer group can also use it.

It’s a total loan that can cover a home, an investment property, as well as equities and managed funds, and it is only available to clients through an adviser.

The CALIA is in direct competition with some of Commonwealth’s traditional home equity products like line of credit and redraw facilities.

Then there’s Leveraged Equities’ PowerHouse consolidated debt product.

Unlike the plain margin lending product from Leveraged Equities, PowerHouse provides a property-based loan facility, which charges the bill rate plus 1.95 per cent and can be used to buy shares and managed funds as well as property.

John Powell, general manager of business development for Leveraged Equities, points out that the loan’s interest is not competitive with a straight mortgage product, but it is very competitive with margin lending rates.

So far, PowerHouse only suits financial planners who rebate all commissions, as it pays a trail of only 10 basis points. That may change in the future.