Finance against Shares, also known as Margin Loan, is a Secured Facility that allows a borrower to mobilise Facility against the value of securities viz. listed shares, commodities, derivatives, structured products, and other financial products.

• The Facility allows the borrower to leverage the market value of the marketable securities.

• The value of the Facility that can be borrowed is determined by the securities in the portfolio, Loan to Value Ratio and a credit limit based on an assessment of borrower’s financial position.

• It is an interest-bearing loan that can be used to gain access to funds for a variety of reasons that cover both investment and non-investment requirements of a borrower.

• Buying securities against loan allows borrower to acquire more shares than on a cash-only basis.

 

 

Margin Loan Amount

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• Margin lenders allow the borrower to use the value of the shares that the borrower is buying (or own already) as security for the margin loan.

• Margin lenders specify which shares they are prepared to use for margin lending and the percentage of the share value that can be used as security. The borrower will need to provide cash or other shares to make up the difference between this lending value and the total loan.

• The amount that a margin lender is willing to lend is determined by the Loan-to-Value Ratio (LVR). For example, if a margin lender extends a loan based on LVR of say 75% and if the borrower wishes to purchase AED 40,000 worth of shares, the margin lenders will lend AED 30,000 to the borrower and the borrower will need to provide the balance of AED 10,000 or other shares.

• LVR is determined by the type of shares in the portfolio; LVR is set at a lower level if the shares are more speculative or risky.

• Margin lenders usually have categories of the all the listed shares/other financial securities; the category with the best shares/ financial securities attract the highest LTV and the group with risky shares attract the lowest LTV.

• The margin lenders also stipulate the diversity of shares within the share portfolio offered as security for the margin loan.

• This difference between the value of the loan and the current value of stocks offered as collateral is referred to as the "margin"; hence the term "margin lending". This difference must be maintained at a minimum level.

 

Why Loan against Shares/ Margin Loan

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• Access additional funds for investment which may help the borrower to reach the financial goals faster.

• Potentially increases the size of investment returns.

• Interest payable on a margin loan may be tax deductible.

• Margin Loan provides flexibility to the Borrower to purchase more securities, make a large purchase, or use as a bridge loan for short-term liquidity needs. Basically, Margin borrowing can be used to satisfy short-term liquidity.

• Margin Loan ensures that the Borrower can access cash without having to sell the investments. Allows the borrower to diversify the portfolio. A larger range of investment choices could increase borrower’s returns and reduce the risk that poor performance in any one investment will drag down the total return.

 

Margin Loan: Associated Risks

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Like any investment, a margin loan involves some risk. While borrowing to invest can potentially increase capital return over the long term, it can also prove to be very damaging when conditions change and if employed incorrectly. Some potential risks associated with margin loan are as below:

• Risk of a margin call due to share market volatility: Shares are the most volatile out of the main asset classes, rising and falling every day. If the shares offered as security to the margin lender were to suddenly nosedive, borrower could expect a margin call.

• Risk of having to crystallise losses by being forced to sell into a falling market: Having a margin loan means that the borrower is not as easily able to ride out periods of downturn. This is because when the value of the portfolio dropped which brings down  the LVR above the lenders maximum LVR and buffer, borrower will receive a margin call. If the borrower does not have the cash to meet the margin call, he may be forced into selling the shares at possibly the lowest point of the downturn.

• Potential to magnify losses: In the same way as a loan has the potential to magnify the gain in a rising share market, a loan also has the potential to magnify the losses in a falling share market.  

 

• Risk of LVR changes imposed by the lender: Lenders can adjust their acceptable maximum LVR which can put borrower at further risk of a margin call.

• Risk of interest rate rises affecting the ability of the borrower to service the debt: If the borrower has a variable rate on the margin loan, an interest rate rise will mean there is more interest to pay on the debt. 

 

Margin Call

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Once the borrower mobilises funds to invest; takes on a risk that if the investments fall in value; the borrower may not be able to repay the loan. As a measure to mitigate this risk, margin lenders take security with a stipulated margin. If required, these investments can be sold to repay the loan (if the borrower is unable to inject additional cash into the loan).

The share prices can move down quite quickly, exposing the portfolio to greater risk. If this happens the shares could be worth less than the loan, creating problems for the borrower and a shortfall of security for the lender. This is the reason why margin lenders limit the amount (LVR) that can borrowed against the shares – that is, to protect themselves against this possible shortfall.

If the value of investments offered as a security fall to a point where the value of the loan exceeds the maximum stipulated LVR by the margin lender; the borrower will be required to top up the security such that the actual LVR is within the stipulated maximum LVR.

Example:

If the borrower mobilises a margin loan of AED 30,000 to purchase shares worth AED 40,000 with a maximum LVR of 75% stipulated by the margin lender.

If the value of the above shares fall from AED 40,000 to AED 30,000, the actual LVR would become 100% (AED 30,000/AED30,000) – resulting in breaching the maximum stipulated LVR of 75%.

In the above scenario, a “Margin Call” will be issued immediately by the margin lender, and the borrower will generally only have limited period to correct the maximum LVR to 75%. The borrower’s options in this situation are:

• inject cash so that the loan balance is reduced

• lodge additional investments acceptable to the lender to reduce the LVR to 75%

• sell part of the portfolio and use the proceeds to repay part of the loan

If a margin call is not met the margin lender can sell the shares/investments, pay out the loan and seek payment of the difference between the proceeds of the sale and the margin loan.