Margin Loans, trading in the buffer zone
Those who have a margin loan and have been subject to a margin call, will be aware of how margin lenders apply the buffer. The buffer represents the amount by which a loan to valuation ratio (LVR) is exceeded before making the margin call, typically around 5%.
Those that like to gear to the maximum would be advised to check their margin lender’s policy if their geared portfolio were to exceed the allowed LVR but remain within the buffer margin ie. Yet to trigger a margin call. Depending upon the size of your loan and / or relationship with your margin lender you may be able to continue to draw down on your loan once you’re in the buffer zone. For example, your loan is 3% above the LVR and you wish to drawdown on your loan further which increases your loan to 4% above the LVR, assuming a 5% buffer.
If this practice is allowed then you also need to confirm with your margin lender what will be required if the buffer is exceeded and they come knocking for a margin call. Ie will they require that the buffer is restored to zero, which is generally the case, or will they be satisfied if the buffer is merely reduced. Depending upon the size of your loan, this difference could be substantial and force investors into selling securities that they would otherwise have held onto.
This scenario occurred recently where the investor who had a substantial geared portfolio, was allowed to drawdown funds whilst the portfolio was in the buffer zone and the margin lender called for the buffer to be restored to zero once the 5% limit was exceeded, leaving the investor with no choice but to sell shares to reduce the loan. While investors should always ensure they have access to available funds to meet margin calls they should also enquire of their margin lender to ascertain the amount they’ll need to come up with under varying scenarios.