Understanding the risk of margin call

Following the global financial crisis (GFC) one of the most feared terms when gearing into equities has been the ‘margin call’.

A margin call occurs when the total amount owing exceeds the lending value by an amount greater than the buffer. The buffer is an allowance that accommodates for intraday market fluctuations and with Leveraged it is 10%. Once the buffer has been exceeded, investors are required to remedy the loan, usually within 24 hours.

Reality check

Courtesy of Leveraged’s 25 years in the industry, here’s a potentially surprising fact:

• In 2017, less than 3% of clients with a loan balance were issued a margin call – and only 7% have ever experienced a margin call.

What happens in a margin call situation?

Let’s assume an investor gears at the highest possible gearing ratio for Company A at 75%. A margin lender would usually provide a 10% buffer space in addition to the base LVR.

Should the security decline in value by 10% or more, the account will enter a margin call. Once a margin call has been triggered, the investor would need to clear the facility back out of buffer. In this example, the facility would need to, at a minimum, return to a 75% LVR.

There are a number of ways investors can remedy a margin call, including:

• Reducing the total amount owing by using other funds to repay borrowed money
• Adding to the secured portfolio to increase the lending value
• Selling part of the secured portfolio with the net sale proceed to reducing the total amount owing.

Reducing the risks

So, what’s the key to riding out the highs and lows of market movements and keeping margin call at bay?

1. Conservative gearing

If someone has a gearing ratio of 50% with a portfolio LVR of 75% (i.e. the maximum amount Leveraged will lend on the securities), there would need to be a drop in market value of approximately 41% to trigger a margin call once you include our 10% allowable buffer.

To put this theoretical 41% drop into in to perspective, from peak to trough during the GFC the fall was around 51% - and even then, over a time period of 13 months.

The table below shows the approximate fall in market values required to trigger a margin call at various gearing ratios and portfolio LVRs.

2. Diversification

Diversification involves holding shares/asset groups across multiple sectors so that exposure to any one type of asset is limited.

Those spread across multiple sectors of the market tend to see lower overall volatility. Leveraged further encourages diversification by offering a higher LVR for diversified portfolios.

3. Choosing the right tool to gear

Leveraged’s unique Investment Funds Multiplier margin loan features a controlled periodic repayment plan during a margin call that provides borrowers time and certainty to budget for such events. In addition, our Target Gearing feature alerts investors when their portfolio has moved outside the target LVR and how much cash/security is required to rebalance.

Gearing can be a great tool to create wealth in a long term timeframe – and risks of margin call can be managed with the right strategy or product.

To find out more about our range of margin loans to help your clients build wealth and achieve their financial goals, please contact your Relationship Manager or call Leveraged on 1300 307 807.

_{Issued by Leveraged Equities Limited (ABN 26 051 629 282 AFSL 360118) as Lender and as a subsidiary of Bendigo and Adelaide Bank Limited (ABN 11 068 049 178 AFSL 237879). This information is correct as at 27 August 2018 and is for general information purposes only. It is intended for AFS Licence Holders or authorised representatives of AFS Licence Holders only. It is not to be distributed or provided to any other person.}