The sharp slump in the share price of some of Australia’s biggest household names – Commonwealth Bank of Australia (CBA), Brambles, AMP and the gaming house Aristocrat – has delivered more than just paper losses to some investors. More than 125,000 share owners have margin loans.

A small slip in a company’s share price can take those investors straight to a margin call.

"Margin loans are a very aggressive strategy," says Nick Economidis, a financial adviser with Godfrey Prembroke. "We do use them as part of an overall debt strategy, but not right now."

Economidis says market uncertainty makes it too difficult to put clients into margin loans.

After all, AMP is down more than 65 per cent from its peak, CBA is off 28 per cent, and Brambles and Aristocrat are down 71 and 73 per cent respectively.

Nevertheless, the Reserve Bank of Australia (RBA) says the number of Australians buying shares using debt increased by more than 1000 during the December quarter, and the debt also rose to $9.943 million from $9.890 million during the previous quarter.

Stuart Wilson, executive officer at the Australian Shareholders Association (ASA), says: "Every time you look at a share price on your computer screen, every time you see that share price drop a cent or more, it makes you more and more anxious.

"All of the risks of shareholding are amplified by taking out a margin loan."

In the September 2001 quarter, Australians faced an average of 768 margin calls a day as the sharemarket plummeted after the September 11 terrorist attacks.

The number dropped significantly to 220 the following quarter. But investors were facing 501 margin calls a day in the last September quarter and 441 in the December quarter.

"It does not matter why the share price is falling or how quickly it falls, your responsibility is to meet the margin call," says Wilson.

The head of distribution with St George, Craig Mowll, says serious investors are always prepared to meet those calls. Mowll says the average St George margin-lending customer has a gearing level of about 42 per cent, so the market must drop significantly before the client faces a call for extra funds.

"A lot of people know in advance how they are going to tackle that call when it comes," he says. "Most people have strategies in place."

This can include selling shares to lower the loan-to-value ratio or drawing on other savings to increase the security on offer.

Peter Duvall, deputy managing director at the broker TD Waterhouse, says the firm has seen an increase in the number of people applying for margin loans but not all of those loans are being drawn down.

"People are establishing loans to take advantage of the market when they think it’s appropriate," he says.

"They are also controlling their risk by not borrowing as much as they can. They have a buffer."

But, as Wilson says: "If a company’s share price falls off a cliff, as we have seen this reporting season, that will trigger a margin call.

"There is a place for them [margin loans] but sometimes these things are driven by people’s greed which is never good."

Heeding the call

"I watch the market very closely – every hour," Randall says. "And seeing the share price fall made me feel very anxious. I had to sell into a falling market. But I sold before the margin call came through."

Randall, a 33-year-old investor with an economics degree and an MBA, has held shares directly for about 10 years.

He built up a substantial holding in the ASX-listed Packer investment vehicle CPH Investment Corporation before taking out a margin loan to increase his shareholding.

Randall has used Leveraged Equities, Challenger and JB Were for margin loans at various times.

His shareholding grew so that he ranked as a top-20 shareholder in CPH when the company’s share price went into a slide. Randall thinks his loan-tovalue ratio was about 60 per cent, so he started selling to meet margin calls.

"I might have lost a substantial amount of money but I believe by managing your account properly you are then able to rebuild your position far quicker when conditions turn up," he says. When the share price was falling, Randall says, he sold before margin calls were made, staying just ahead of the pack.

"It enabled me to hold on to greater equity," he says. Further selling triggered by the margin calls pushed the share price down even further. "It is always a frustration when the share price falls. But this experience has strengthened my resolve to use a margin loan."

Randall believes that for the experienced investor, the upside of borrowing outweighs the risks.

He says he has rebuilt his shareholding in CPH and is back in the money but adds: "The three key elements for investing this way are: having a good relationship with your lender and being proactive in managing your account; investing in quality companies with strong prospects for growth; and, maintaining a medium to long-term outlook. "Only then will your investment bear fruit."

How it works

The investments purchased are used as security on the margin loan.

If the market value of the investments falls below the contracted lending ratio – the loan-to-value ratio – the investor may be obliged to deposit more cash, or worse still, sell shares to bring the margin back to the agreed level.

For this reason, an investor should use a margin loan only if he or she has substantial assets or plenty of cash reserves to meet margin calls. By using a margin loan, you can increase your exposure to the sharemarket more than would be possible otherwise, creating the opportunity for greater dividends and, in a rising market, larger capital gains.

But, in a falling market, investment losses are also magnified because investors risk being forced to sell investments at precisely the wrong time – when share prices are at the bottom – to meet margin calls.

Source: Karen Eley, Technical Research Manager, Guest McLeod Financial Planning. ‘‘They are also controlling their risk by not borrowing as much as they can.’’

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