In for a penny margin lending catches on

by Nick Stride

Thursday 8th April 2004

Perhaps because of an innate conservatism, perhaps because of memories of the 1987 share crash, margin lending using shares as a security to borrow against is still a tiny market here even though it's big business overseas.

ASB Securities' Jason Watson estimates margin lending accounts for less than 1% of average market turnover. In Australia it's a $A10 billion industry with a big slice of market activity.

Yet the idea is no more complicated than that other well-favoured leveraged investment, residential property.

ASB, for example, will lend approved clients up to 70% of the value of a share parcel and will charge interest on the loan. The investor gets dividends, and the value of any rise in the share price, from the entire parcel.

The idea is that investors with good cashflows can build up a diversified share portfolio, spreading risk, with only a fraction of the cash it would otherwise take in much the same way as landlords use the equity in one investment property as security to borrow for the next. There can also be tax advantages similar to property investment, if the interest paid to the lending broker is a larger amount than the dividends received from the shares bought with the loan.

There are also major differences between leveraged equity investment and property.

Property investors tend to value their holdings only occasionally say, once a year while share prices change daily and on occasion dramatically.

And unlike borrowers against property, leveraged equity investors face "margin calls" if the value of their holdings falls by more than the value of the equity they put in.

If that happens, Mr Watson says, the borrower has three options.

First, he can put in more cash to cover the difference between the value of the loan and the value of the shares. He can also sell shares to achieve the same effect. Or he can register additional securities into the account. These can either be fully owned shares in the same company or shares in another company on the broker's approved list.

The criteria margin lenders use to decide which companies they will lend against vary from broker to broker but generally include only stocks with high market capitalisations, good liquidity (trading volumes) and low volatility.

Lenders such as Forsyth Barr's leveraged equities unit also take into account company profitability and dividend payments.

Macquarie Equities lends only in Australian dollars, and only against a limited number of New Zealand stocks.

"We tend to do business only with people who are using the Australian market and are happy with Australian dollar exposure," says financial services group head John Rowley, although the broker is in the process of building up the list to include at least the top 30 listed companies.

Mr Rowley estimates the total New Zealand margin lending market is worth less than $100 million, whereas in Australia Macquarie's margin lending business is worth $A2 billion ($2.3 billion) and the total market maybe $A10 billion.

Brokers are developing new products in an effort to stimulate interest.

Macquarie has a capital-guaranteed product with a higher interest rate attaching to the loan than in its vanilla-flavoured accounts. Leveraged Equities lends on a range of fixed interest stocks as well as shares.

Goldman Sachs JB Were operates accounts that lend in both Australian dollars and Kiwi dollars, and lends on 250 Australian and New Zealand stocks and a selection of managed funds of "substantial" size and with an established history of at least three years.

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In for a penny ­ margin lending catches on

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