A brief reminder on how margin calls work
As many of those who borrow to invest are aware, a specific risk of margin loans is the risk of a margin call – that request that a lender may make for additional funds to be added to the investment.
Under a margin loan arrangement, it is the investor’s portfolio of shares or managed funds itself that provides security for the loan. Generally that loan will be approved up to a certain loan-to-valuation ratio (LVR). If investment prices fall so much that the loan exceeds the LVR, it may trigger a margin call.
To bring the LVR back below the maximum level, the investor must either contribute additional cash funds or sell part of their investment, usually within 24 hours of the margin call being made.
What is the chance of receiving a margin call?
Somewhat reassuringly, the current odds of a margin call are relatively low. And the odds are significantly lower than during the height of the GFC, when there were a whopping 8.6 margin calls per day per 1,000 clients (RBA, 2008). Since then, margin calls in September 2016 have dropped by 93% compared to December 2008.
According to data from the Reserve Bank of Australia (RBA), the average number of margin calls was 0.57 calls per day per every 1,000 margin loan borrowers as of September 2016. Based on the current number of 132,000 margin loan clients across the country, this equates to just 75 margin calls per day in the September 2016 quarter.
But the risk of margin calls appears to have been in a state of flux over the past 2 years, varying from 1.11 margin calls per day per 1,000 borrowers on average down to just half that at 0.56 calls per day:
|Date||Average number of margin calls
per day per 1,000 borrowers
|Source: RBA data (D10, 2017) as analysed by Canstar.|
Investors have hardly known what to expect in the past couple of years, with shocks to the stock market in 2016 alone including the Chinese stock market continuing to fall, the surprise of Brexit, and now Trump. The customer base for margin loans appears to be steady or declining slightly due to this market volatility.
Of course, things are nowhere near as bad as they have been in the not-too-distant past. The chances of receiving a margin call peaked in the December 2008 quarter, at an average number of 8.60 margin calls per 1,000 clients per day. With 233,000 margin loan borrowers at the time, this meant a whopping 2,004 margin calls per day during that quarter.
How to avoid a margin call
As an investor, the closer your level of borrowing is to the maximum LVR, the higher your chance of receiving a margin call. So consequently, one way to reduce your risk of a margin call is to keep your borrowings at a conservative level.
As a hypothetical example, assume that an investor has available cash of $30,000. They wish to use this as the basis of a share portfolio, on which their lender may extend a loan at a maximum LVR of 65%. The following table illustrates how a greater drop in value of the share portfolio is required to trigger a margin call, as the amount borrowed compared to the value of the total portfolio drops.
|60% LVR||55% LVR||50% LVR|
|Total share portfolio||$75,000||$66,667||$60,000|
|% drop in value
to trigger margin call
|$ drop in value
to trigger margin call*
|Shows the amount the portfolio value would need to drop by before a margin call will be triggered, for three different LVR levels.
*Value rounded up to nearest full number.
The smaller the margin between your borrowings and the maximum LVR, the sooner and more likely it is that you may receive a margin call. If you don’t have spare cash available to meet the call – and don’t like the idea of selling investments in a falling market – then be conservative with the amount that you borrow.
The good news is that many investors seem to be following this advice. The number of investors using their full available credit limit has decreased by 33% in September 2016 compared to September 2008. This shows investors are exercising more caution against over-stretching their portfolios in today’s relatively volatile climate.
CANSTAR’s annual Margin Loans Star Ratings report looks at both the cost and the features on offer from a range of lenders. Those institutions offering an outstanding value combination of price and features are awarded with our 5-star rating. Read our report for more details, or compare margin loans on the website:
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