Margin lending collapses

The Reserve Bank of Australia (RBA) released the September 2011 margin lending statistics (D10) today (but have not released household finance data (B21), which was scheduled at the same time).

I’ve covered this data previously, as it is one of the sub-factors in my macro model for the Australian share market, as I explained then:

One of the key factors in a new bull market in stocks, just like property, is a propensity for investors to borrow more on expectation of higher earnings – alongside a move to higher price/earnings ratio premia, reversal from a lower interest rate environment and the “lazy balance sheet” theory.

Margin Lending totals
The September 2011 quarter nominal value of margin loans outstanding – $15.9 billion, is a significant reduction from the June quarter at just over $18 billion and is the lowest since the Dec 2004 quarter (approx. $18.5 billion), after rising to the heady heights of over $41.5 billion in the December 2007 quarter.

From the March 2009 share market lows, to the December 2009 quarter, margin lending increased slightly, but has been in outright de-leveraging ever since, averaging 4.2% quarterly or over 25% in the last year.

Notably, the market value of the security backing the lending (note: not the market itself, but the aggregate of the securities borrowed) has fallen to December 2008 levels.

Client Accounts and Margin Calls
This is also reflected in the number of client accounts, unadjusted for population increases, as shown below:

The number of client accounts – approx. 216,000 – is now below the March 2009 low, heading back to March 2007 levels and goes someway to explain the reduced returns on the major institutional retail and wholesale investment trading banks and wealth management houses.

Margin calls have almost doubled in the quarter, rising from 1 per day per 1000 clients to 1.82 per day, a level not seen since the volatility of 2008.

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  1. The other aspect is people that had borrowed against real estate to invest in equities, it is a shame those stats arent available as well

  2. Good article Prince. I consider a margin loan to be one of the most dangerous credit instruments available. I’m glad that it hasn’t been generally used by consumers, apart from notable exceptions such as Storm Financial clients.

    These are for professionals only.

    CFD’s also come to mind, as dangerous facilities. That doesn’t mean that I oppose them 100%, but users need to be well educated and very fast on their feet in volatile times.

    It’s the sudden unexpected share market falls that cause the damage.

    • But at least margin loan requires something like 30% deposit. Borrowing 95% for investment property is as risky in my opinion.

        • Is there no equivalent of a margin call when a property enters negative equity? But how do banks balance their books? They just pretend it is worth more?

          • I thought I read an article recently about a couple of households in negative equity who got a request for a top up?

            Do margin calls actually occur for housing in OZ? Or is it something we don’t mention? ala move along – nothing to see here….

          • Its when they go to refinance or adjust their housing ATM and the financier sends around the valuer, thats when they have to top up particularly if its an investment property

          • Banks can’t foreclose if payments are being made as per the terms of the loan contract. They can reduce or cancel a “line of credit”

            So the answer is “NO” there is no equilavent to a margin call on housing.

            Banks also have to make some concessions for “hardship” in consumer lending, that doesn’t exist in margin lending which is non-consumer lending. This type of lending is for investors, who are not covered by any “consumer legislation”

        • “Its not the LVR – its the margin calls that are dangerous.”

          Agreed in the short term, but there are a lot of people in many countries who have recently discovered that the leverage in their mortgage was extremely dangerous.

          • Mining BoganMEMBER

            My neighbour just learnt this the hard way. Young bloke blinded by the Rudd bonus and the media. Now the front window is filled with legal notices.

        • Hardly just the leverage. It’s the sheer size of the debt in an illiquid, and in most cases non-net income producing asset. But you can do the damage more quickly with a margin account.

          • Yeah, but it’s the leverage that allows the debt to be so large. Think of how smal mortgages would be if the maximum leverage was the same as for margin loans.

  3. divdends are higher than interest costs so i reckon its not a bad time to leverage up a bit.

    certainly not a lot of leverage in the stockmarket these days though. Another point i think the shorters dont appreciate.

  4. Also please note that since the new credit act came in the licencing of advisers to do this activity has been reduced.
    Yes the commentry re risky activity is somewhat true but it is less risky then say a 105% home loan from a few years back or a 100% lease on a depreciating MV ….
    The biggest problem was people using Margin loans on managed funds that then froze and could not be sold to cover the falls.

  5. “divdends are higher than interest costs so i reckon its not a bad time to leverage up a bit.”


    Last time I looked, the interest on margin loans was around 8.75%, if paid upfront. I can’t think of many stocks paying dividends greater than that.

    The basic point is, in the current market, the cost of capital is high and may be going even higher. If the cost of funding debt is around 8-9%, what should the cost of equity be? 15%…20%…25%??

    There is no doubt that borrowing on margin to buy stocks in a volatile market is very risky, so the possible returns need to be proportionately high. It is no surprise that investors are de-levering as a means of curtailing risk.

    • you got to look at gross not net yeilds breifly i.e add in the franking credits from the dividends and deduct the interest costs from your tax bill.

      you want to be leveraging up now while the market is low and deleveaging at the top when the market is high. this is the opposite of what most people do and then they turn around and say “margin lending is too risky” when in fact its their strategy thats to blame not margin lending. always easier to blame someone or something else than it is to blame yourself.

      • I get this, GB. But aside from the income risk, if you buy on margin you have a capital risk – that is, you can be forced to sell at time that is not of your own choosing and end up taking a loss on the total value of the stocks. So, when volatility is high, the chances that this could occur are by definition also high. Even if you could see a small income gain in the interest/dividend/tax equations, you are still buying risk. This is like entering the CDS market, in a sense, only instead of buying cover you are paying for the experience of playing naked.

        I have a somewhat Oriental attitude to risk, which is to say if there is risk, it better belong to someone else.

      • Tassie TomMEMBER

        There is no reason that the ASX 200 could not fall to 2000.

        It probably will not fall to 2000, but it could.

        It may be caused by a rapid and unforseen escalation of known events, or it may be precipitated by a complete black swan event.

        It may be brief. It may be caused by panic and not make any sense. And it may be a wonderful time to buy. It may bounce back and climb even higher than where it started – in fact it probably will, as the crash will force the problems to be sorted out properly.

        Suppose I go and conservatively leverage up to 20%. Market falls 500 points (to 3750), so I leverage up another 20% (now 43% LVR). Market quickly drops to 2000, my LVR is 80%, maximum allowable is 70%, I’m sold out. Gone. No rebound when equities bounce back – time to start again.

        If I had extra money sitting around to “tip in” to the account to save myself from a margin call, then I wouldn’t have had to borrow money in the first place, so this clearly isn’t an option.

        Margin lending isn’t just “magnifying your returns and also your losses”, it is also exposing yourself to a complete wipe-out. This is different to gearing into property or most other ventures.

        Is it impossible for the ASX200 to fall to 2000? In the Great Depression the Dow Jones fell 89%. What is 11% of 6828?

  6. The other big issue with the collapse of margin lending has been the repricing of risk.

    Interest rates for margin loans are at about 9.6% for amounts less than $250k.

    In 2008 when the RBA cash rate hit 7.25% the margin loan rate was 10.25.

    In other words the is a full 2% extra risk differential in this current environment making the risk return/cost a lot less attractive, apart perhaps if someone was prepaying interest to offset a capital gain etc.

    • Good point GG – I’m yet to find a reliable and auditable data source for CFD providers. I might ask the editor at Your Trading Edge, they may have some insight. I haven’t used a margin loan in years (advised or my own), I use CFD’s (for trading and super) and sometimes options.

      I’m still waiting on the RBA to release B21 table – household finances – they took it off the schedule about half hour before it was going to be released. I’ve contacted them, but no reply (and I know they visit MB)

      I’m hoping its just a delay in data composition, because its a very useful data series to be thrown away.

  7. The number of client accounts is ~10k lower just now. The clients of MF Global who’s ‘segregated’ bank accounts are frozen & might be looking at a haircut to pay for others losing positions. No moral hazard there though.

    Goes to show that you don’t even need a position in the markets for it to cost you money at the moment.

  8. Also the legislation has changed, from an advice point of view the door has been closed on margin lending. Also people are thinking now more than ever ‘why borrow to buy a market that has gone no where for near on 3 years’….

  9. Margin lending became a consumer product, requiring specific AFSL conditions to provide advice in January this year (it had been on the cards and 1 Jan 2011 was the date). So in the past 12 months, consumer credit requirements have changed, margin lending advice has become regulated and margin loan products must have a PDS.

    So as the screws tightened it stopped being a product that gullible “investors” could be channeled into to produce some nice fees, and became a bit of a PITA instead.

    Not surprising the take up has dropped. If the government ever decides that realtors should be regulated like fin advisors are, I would expect a similar drop (if not larger), simply because easy money is suddenly less so.

    • Great comment, thanks persnickety.

      Have you seen any alternatives in the industry to margin lending as a result? e.g more structured products (I used to be assaulted by BDM’s (Brochure Delivery Men) for structured products all the time when I was in the industry, and did a lot of double gearing via home equity (easier to arrange than margin lending,not sure if that has changed?)

      Agreed on realtors – not sure why the likes of Kohler et al haven’t gone up in arms for RE agents who charge over 2% on a transaction (regardless of underlying value) yet rail against FP’s who get a 0.55% trailing commission? (not that I’m saying the latter is excusable)

    • That surprises me, I did a margin loan some months ago – but after Jan 2011 and I wasn’t asked for any additional compliance?

      Nor has my accreditation been cancelled.

      Perhaps I’m in breach..

      • Definitely need to check your AFSL- authorisations to offer advice on margin loans are a new addition.

        I don’t know if there are alternative products springing up to replace this. I track new and current legislation & regs to make sure that my clients remain compliant- we went through a big kerfuffle to work out if any fell under the credit licence regime and margin lending was part of the general credit bundle.

        On the consumer credit side- interesting how some of the worst offenders in the credit industry- the stores offering 0 interst for 12 months etc – were exempted in the final round. Kind of makes a large part of that process a waste of time as they routinely offer terrible terms to people who can’t really afford it.

  10. Confirms what I suggested yesterday on the BHP thread. Anecdotally, I have heard also that retail brokers have large sums deposited by punters sitting in the cash management accounts linked to brokerage accounts. Like $2b+ with Comsec alone.

  11. Wile my experience is not recent during my years in commercial and corporate banking it was common for larger, secured ommercial property loans to require a loan to security ratio which if breached triggered either a requirement to top up security or pay down the loan or a default. Failure to get back into compliance with LVR within a specified time was an event of default. In a default, rights were reserved and the bet approach to recovery worked out, including whether the client could be trusted to handle any sale or the bank should appoint a receiver, or more time should be allowed as the client sold other assets or provided regular additional cash flow from other sources.

    This included loans to quite large SME’s as well as smaller investors.

    We did construction finance based on an Loan to Valuation Ratio (LVR) to estimated value to completion and deducted the cost to complete from the notional amount of the loan.

    While new valuations were generally required for new loans and on loan renewal after say 3 years, they were sometimes requested if there was a significant change in circumstances such as loss of substantial portion (by rental income) of tennants or big property donwnturn plastered across the papers.