Eleven (11) years ago, Nigerian money deposit banks were heavily exposed to margin loans, leading to AMCON purchasing all the margin loans or facilities that the banks granted to stock broking firms to purchase shares in the capital market. These facilities included all the non-performing loans granted by all the five commercial banks taken over by CBN then, amounting to combined toxic assets in excess of N2.2 trillion. Prior to this period, for 10 years (1999 – 2008), the Nigerian stock market grew, soared and gained extreme strength. The market experienced a period of record expansion and boom. Investors, market operators, regulators and market analysts were all pleased with this development. The NSE-All-Share Index grew from 5,672.76 in January 1999 to 58,579.77 on January 2, 2008, a 90.3% increase. The market hit a new height when on March 5, 2008, the NSE-All-Share Index hit a record of 66,371.20 points or an increase of 1,070%. Then the Index started to head down. The Index dropped by 45.8% or 26,539.44 points to close at 31,450.78 on December 31, 2008. From March 5, 2008 to December 31, 2009 the Index dropped by 69%. Between 1999 and early 2008, total returns on most stocks were over 1,000%. The Nigerian stock market emerged as the world’s best performing stock market in 2007 with a return of 74.73%. However, as at December 31, 2008, it earned the enviable record of being one of the world’s worst performing stock markets in 2008 after losing about N5.7 trillion in market capitalization and 46% in the NSE-All share index.
One of the immediate causes that facilitated the crisis was that in the years leading to the market crisis, a significant portion of the funds that flowed into the market were facilities from banks. With the success recorded by most of the banks that raised funds from the capital market between 2005 and 2006 and the popular belief that the stock market was less risky, the banks decided to increase their exposure and focus more attention on the stock market. It became easy for every market operator and investor to take margin facility to play in the market. Then came the news of a new CBN policy and a directive to banks to suspend margin facility. All banks stopped further lending to the market. In no time, this policy dealt a huge blow to the market as investors and particularly market operators could not seize opportunities in the market. Suddenly, supply became greater than demand and prices started coming down and some of the stocks became overvalued, trading above their fair value.
Apparently worried by the continuous drop in share prices of quoted companies then, the Securities and Exchange Commission (SEC) constituted a committee charged with the responsibility of working out modalities for investing with margin funds by stock broking firms and investors and came out with new rules on margin trading as released by the Financial Services Regulation Coordinating Committee (FSRCC), which included the banning of banks shares for margin trading, aggregate banks’ margin loans not exceeding 10% of the banks’ loans and advances, etc.
Since then, there has been further disruption in the financial asset trading ecosystem, especially buoyed by Fintech and other institutional policy changes. One can now easily trade on stocks from the comfort of your offices, homes or anywhere with your mobile phones, laptop or desktop computer systems, even without the assistance of a broker. Financial assets, especially stocks, though a bit risky, offer good returns and are very liquid compared to other investment assets. There is always a trade-off between risk and return; the higher the return the higher the risk. The key important thing with financial assets is liquidity. You can easily sell it unlike other assets such as real estate, etc.
This liquidity aspect brings us to our discourse; margin trading and stock loan, which is one of the inherent advantages of trading and owning stocks.
A margin loan is a facility given to an investor for the purpose of buying securities. The loan is secured with the investors’ collateral, which is usually a portfolio of securities. When an investor borrows money to buy shares, the shares purchased with the loan are domiciled with the lender as collateral. In the event of default, the shares can be sold to repay the loans. Margin loans can be highly profitable. It also allows the investors to take advantage of market opportunities and expand their portfolios. However, it can be a very risky venture; investment used as collateral can be lost in the event of default and funds can be lost when there is decrease in share value.
In margin trading, investors usually borrow money from their brokers using cash and other securities as collateral. According to SEC rules, margin trading means the buying and selling of securities by the Broker for themselves or for their Clients through Margin Financing. This has the effect of magnifying any profit or loss made on the securities. The net value, i.e. the difference between the value of the securities and the loan, is initially equal to the amount of one’s own cash used. This difference has to stay above a minimum margin requirement, the purpose of which is to protect the broker against a fall in the value of the securities to the point that the investor can no longer cover the loan. SEC Rules 365, stipulates that ‘For margin loans and margin lending, the margin requirement shall be 50% of the total purchase price of the securities or group of securities or as may be stipulated by the Central Bank of Nigeria from time to time.
Typically there is an approved margin list released on a monthly basis by CBN/SEC for securities that may be bought or sold in a margin account.
For margin trading, a broker needs to open a margin account, which is different from a normal cash account.
On the other hand a stock loan is different from a margin loan. A stock loan is a liquidity solution that allows a holder of publicly-traded shares of stock to draw a portion of the cash value out of unrestricted stock without selling it. Typically, the shares are held by a custodian as collateral for the loan and returned to the borrower upon repayment of the principal balance of the loan. In many cases, the title to the shares does not pass to the lender. Usually, the loan is a non-recourse; that is only the collateral is exposed and no other assets of the borrower and the borrower is allowed to use the full principal balance of the loan for business or personal purposes with no restrictions or oversight from the lender.
To qualify, the shares to be used for the loan must be unrestricted and traded on a public exchange that does not impose regulatory restrictions or limitations that preclude a stock loan. They must also meet certain minimum daily trading volume thresholds, on a 30-day average. So the borrower’s creditworthiness is not necessarily a prerequisite, but the stock’s liquidity; the average trading volume and the value matter. The loan to value (LTV) is between 35% and 65%, but if the stock is of blue-chip quality, the LTV can be as high as 80%. Notwithstanding above, jurisdiction, market capitalization, earnings, dividend and stock exchange on which the shares are traded equally affect the amount of the loan principal balance. The evaluated collateral (shares) is deposited with an appointed and approved Custodian and the collateralized shares are held in the borrower’s country in electronic format. Some lenders offer both title transfer and non-title transfer loans, and the nature and extent of the legal and equitable title to the collateral shares will vary with each specific loan transaction. The borrower’s loan package may include a collateral management agreement that further designates the title aspects of a specific loan.
On loan single obligor, some lenders have the capacity to close and fund stock loans in the range of $2M to $500M USD, but in certain situations may consider and evaluate loans outside this range. The loans can be structured and funded in specific currency of the borrower’s choice and also can be funded in most major crypto currencies.
Most of the stock loans are for a term of one to five years. During the loan term, the borrower pays monthly simple interest at a rate of between 3% and 8%. At the end of the term, the borrower makes a single balloon payment to repay the principal. A borrower’s inability or failure to pay interest or to repay the principal balance when due will result in the borrower’s forfeiture of all right, title, and interest in the collateral.
Because collateralized stock loans are complex transactions that involve publicly-traded securities that expose a borrower to certain risks, borrowers are expected to be an “accredited or professional investor” under the securities laws of their jurisdictions in order to qualify for a stock loan. Most lenders expect the borrowers to work with one or more independent referral representatives that are under contract with the lender. The representative helps the borrower to determine if the stocks in his or her portfolio are appropriate for a stock loan and initiate the transaction with the lender for the initial term sheet that summarizes proposed terms and conditions. For more information, you may reach the writer.
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