The latest Reserve Bank of Australia (RBA) statement on monetary policy reported that margin lending for the purchase of shares and managed funds soared by 41 per cent to $28 billion in 2006.
Investment Trends director Mark Johnston has pronounced 2006 a watershed year for financial planners, with the use of margin lending and gearing growing broadly.
“Clients are more across the options available to them and planners have taken more of a role in educating clients to the benefits of gearing,” Johnston says.
“When we looked at barriers and limitations to using margin lending, it’s interesting that some of the traditional barriers, such as potential risks in the market falling or margin calls themselves, have gone away the longer the bull market has continued.”
In Investment Trends’ margin lending planner report in late 2005, 39 per cent of planners said clients’ main reason for not wanting to use margin lending was because it was too risky, with that figure dropping to 28 per cent by December 2006.
“To reinforce that point, in late 2005 we had 24 per cent of planners saying that margin lending is too risky for our clients, yet that dropped to 10 per cent in 2006,” Johnston says.
In the 2006 report, the two main barriers were a belief that margin lending interest rates were higher than those of a traditional line of credit for borrowing against property (43 per cent of respondents to a survey) and clients’ lack of understanding (36 per cent).
“There used to be a view that margin lending was really risky for the adviser . in the 2005 survey 45 per cent said this was the case. That is now down to 4 per cent and I think that is now because it is now easier and cheaper to get public indemnity insurance on margin lending,” Johnston says.
According to the RBA report, indicators of the riskiness of borrowers’ margin loan positions, such as the average gearing level and the proportion of available credit limits used, picked up slightly in 2006 but remain low by historical standards.
ANZ head of margin lending John Daley says the industry continues to battle against a common perception of the level of margin calls.
“We are frankly battling against a press that doesn’t understand the issues. I think the press make too much of it. That said, given they are not understood by many I think it is something as an industry that we have an obligation to explain,” Daley says.
“The first thing we’ve done is talk very publicly to anyone who will listen about the importance of diversification in a portfolio and the way you don’t have to use every dollar of leverage that you are allowed to use.”
While many portfolios allow investors to be leveraged to 70 per cent, Daley says the smart investor will only be leveraged to 50 per cent because that way it is very unlikely they will be forced to sell on the dips.
“Unless there is a 33 per cent market fall, and that is one hell of a fall, you won’t get a margin call, providing you have a diversified portfolio. If it isn’t diversified and the stock your holding does an Enron and falls out of bed, then you have a problem. Margin calls should be seen as a stoploss mechanism,” he says.
In September 2001, the average number of margin calls per day per 1000 clients was a little over eight, while the latest numbers released in December show that figure to be 0.25. In the same time, the total margin lending book has risen to $28 billion from $8.7 billion.
According to St George head of margin lending Andrew Black, further market corrections, like the ones we have seen in the last few weeks, could actually be of benefit to the margin lending sector.
“A couple of per cent in the day are not big changes and it could wake some people up and drive some of the day traders back to getting advice,” Black says.
“It’s not that they should be there, it’s that they need to be diversified and not so aggressive.”
Daley says things should be kept in perspective, with less than 1 per cent of the population still using some form of margin lending solution.
“I think there is no doubt we are starting to see a take off of the mainstream product. That said, it’s worth remembering there are still only 170,000 margin lending accounts and given that a significant number of investors have multiple accounts that means that there are probably something like 120,000 investors,” he says.
“I think this industry will increasingly develop as a retail product. We don’t think twice that there are a fact there are a vast number of Australians who are often 80 or 90 per cent leveraged against investment property and that’s become a mainstream product.”
There are around 20 margin lenders available currently after a number of consolidations in the past couple of years. These include HSBC, Challenger, Deutsche and JBWere selling their loan books to competitors, while Bank of Queensland took another approach and outsourced its margin lending to Macquarie Bank.
Black puts the down to the burden of infrastructure costs as a major problem facing new entrants to the market.
“In reality, when you start a business you need to get $400-500 million lent out before you can break even on your investment. It’s not surprising therefore there has been a consolidation in the space over time as a result,” he says.
Macquarie Investment Lending head of sales and marketing Peter van der Westhuyzen says the lack of choice in the marketplace means many mainstream institutions only offer vanilla products and therefore have to differentiate themselves with planners through other means.
“The thing that we are finding is that to differentiate yourself, product innovation is one angle, but margin lending is a very IT, cost and people-intensive industry. If you want to keep differentiating yourself you have to keep reinvesting in the product in not insignificant levels and that’s a way of staying ahead of the pack,” van der Westhuyzen says.
For Macquarie that meant spending a significant amount of money on its website to provide a front-end solution where advisers receive, among other things, real-time pricing and where transactions are updated every two hours.
“That takes a ton of money and people resources and smaller business which do not have large loan books are not going to have the ability to reinvest into their business to the levels required to differentiate themselves … it’s a business that requires scale,” van der Westhuyzen says.
According to Lift Capital managing director Jammal Bassem, size isn’t everything and independent players like it can carve a niche for themselves.
“The main reason it was necessary was that we could offer different features to the margin lending arena that the bigger banks wouldn’t,” Bassem says.
“Margin lending has become very much a commoditised product. It’s not difficult to provide lending on the ASX 200, or to the top-tier managed funds, but we wanted to look at individual tailored solutions.
“We decided to work closely with independent financial planners and stockbroking firms who have been increasingly concerned about doing business with the larger margin lenders, because those lenders are all owned by banks and those banks are providing wealth management services to and through their own channels and the independents want to work with someone that is not encroaching on their space.”
He acknowledges that there may be questions concerning risk, but says that in the end it comes down to the credentials of those running the business.
“Our people have extensive experience of working in this space. I’ve been in this business many years and have seen a number of stock market corrections. Also, many of our clients are very, very conservatively geared, so despite the recent volatility we have had very few margin calls,” he says.
He says while the major banks have reported some rises in margin calls, albeit comparatively small, Link’s have not increased. This is at least in part down to the lower level of gearing for Link’s clients.
“It would take a substantial drop in the market for our clients to go into margin call,” Bassem says.
