Risks of Margin Lending
The most common risks are outlined below.
Market volatility, margin calls and the risk of losing assets
If the market declines, so will the value of your portfolio. It may fall to a value where it no longer provides adequate security for your margin loan.
As the value of your security portfolio falls, this in turn reduces your borrowing limit. This in turn will cause a rise in your gearing level, as your loan balance has not changed. A margin call will occur when your loan balance exceeds the borrowing limit by more than the buffer.
You also need to be aware that a margin loan is a “full recourse” loan. This means that even if the value of your security portfolio falls to zero, you are still liable to repay the total loan balance outstanding. This means that you may need to sell other assets you have to clear the outstanding debt.
The LVRs which are applicable on your security portfolio are subject to change at any time and may also be reduced to zero. This will affect your borrowing limit and may result in a margin call depending on your gearing level.
Interest rate changes
Variable interest rates are subject to change at any time. In a rising interest rate market, your monthly interest costs will also increase. The interest expense on your loan balance may exceed the distributions/dividends you earn on your investments and unless you have an adequate alternate source of income to fund the interest costs, a margin call may occur.
Changes to dividend payments
The timing of dividend and distribution payments may not coincide with your interest payments. Also, these payments that you may be relying on to assist with servicing your interest costs, may reduce or not be paid at all. In these instances, you need to ensure that you have an alternate source of income that can assist with servicing your monthly interest.
If the equity you have provided on your margin loan has been borrowed from another source, your overall gearing level will be higher. The higher the overall gearing level, the greater the effect that any fall in the value of your securities will have on your financial situation.
Tax laws are complex and may change over time, possibly with retrospective application. You should seek the advice of an independent tax adviser on the tax consequences and impacts of entering into a Margin Loan Facility.