Standing around the braai on Heritage Day, a friend mentioned that if he had spare cash, he would have definitely taken advantage of the almost 4% dip in the share market at that point.
At the same event a self-employed friend mentioned how he had battled to get a bank loan for a renovation project.
This made me realise that few people know that they can borrow against their share portfolios very quickly and easily.
What are share-based loans?
New age share-based loans are lending facilities that allow investors to utilise their share account like a bank account with an overdraft facility. The investor can access the funds as long as they stay within the limits of the loan agreement. When they require the loan their trading account goes into debit. As and when they receive dividends, sell shares or deposit cash, the loan on their trading account is credited. It doesn’t require all the administrative paperwork involved with a non-collateralised loan and can be arranged within one week. Lastly, there is no fixed loan amount or repayment period on these loans.
How does it work?
The investor has to cede or pledge their share portfolio as collateral with their stockbroker or the funding institution. This means that in case of a default the stockbroking firm has the right to sell shares in the investor’s portfolio in order to settle the loan amount. Importantly, the investor still has control of their account and can buy or sell shares within the limits of the share-based loan agreement. The reason for this multi-control structure is that any proceeds from a sale in the share portfolio first go towards repaying the loan.
What are the requirements?
Most stockbroking firms would have a minimum equity portfolio size they’d offer this service to (to ensure the admin and controlling of the account is worth the effort). The liquidity of the shares within the portfolio also plays a massive role. At Vista Wealth Management, for example, a client’s share account must have a minimum value of R1m worth of Top 100 shares. If the National Credit Act applies to the investor, the investor has to complete an asset and liability statement as well as an income and expense statement in order to determine affordability.
How much can I borrow?
The loan amount depends on the investor’s share portfolio. At Vista Wealth Management a client can borrow as much as 60% loan-to-value (LTV) against a well-diversified liquid portfolio. This LTV will vary and move up and down as the underlying shares’ values increases and decreases. Once an investor breaches the LTV, the investor would have to repay a portion of the loan, cede more shares or sell shares. On a portfolio that is not well-diversified and for example only consists of one share, the investor would only get about 10% LTV. It is not advised that investors borrow the maximum as a decline in the share market could cause the share portfolio to fall below the allowed LTV, which would therefore trigger a margin call.
What can I do with the money I borrow?
The investor can withdraw the cash or use it to buy more shares. Most stockbrokers would prefer the investor has this facility available to allow the investor to buy more shares should market opportunities present themselves. It is in reality a very efficient and easy way of obtaining bridging finance.
What interest rate do I pay?
The interest rate varies from stockbroker to stockbroker and often depends on the size of the loan. At Vista the default interest rate for most share-based loans is the prime interest rate. Interest is calculated monthly and investors can decide to pay interest monthly or allow it to be added to their loan account. But be cognisant of interest on interest.
What are the tax implications?
Before this facility was available, investors were required to liquidate their share portfolios in order to access their funds. The selling of shares could trigger income or capital gains tax. Investors used to only be able to gear their share portfolios through instruments like CFDs and SSFs. Trading activity in these derivatives would however always trigger income tax while investors utilising share-based loans to gear their portfolios would only trigger capital gains tax if they stay invested in the shares for longer than three years.
Magnus de Wet is a director at Vista Wealth Management, a representative under supervision of Accredinet Financial Solutions.
This article originally appeared in the 20 October edition of finweek. Buy and download the magazine here.