Saturday, October 24, 2009

Margin Expands Regardless of Rate

THE SEPTEMBER 2008 market crash not only wiped out a huge amount of wealth; it also provided a reality check for traders using margin debt to buy their shares. But even before the Dow cracked the 10,000 mark last week, margin debt had started to climb. And though the rates investors pay for margin borrowing haven’t changed much in recent months, they still vary by as much as six percentage points, depending on the broker you use. Such a huge gap can make a big difference to an investor’s trading costs.

What exactly is margin? The Securities and Exchange Commission defines it as “borrowing money from your broker to buy a stock and using your investment as collateral. Investors generally use margin to increase their purchasing power so that they can own more stock without fully paying for it. But margin exposes investors to the potential for higher losses.” There is a further description, including possible risks and rewards, at http://www.sec.gov/investor/pubs/margin.htm.

New York Stock Exchange members had a record $381.4 billion in margin debt in July 2007, when the stock market was still charging ahead, according to the bourse’s Nyxdata.com Factbook. The low since January 2005 occurred close to the market bottom, in February 2009, when NYSE members’ margin borrowing stood at just $173.3 billion. It had climbed to $206.7 billion by August 2009, the most recent month for which the stock exchange’s data are available. Obviously, shifts in the stock market will increase or decrease the value of this collateral.

THE RENEWED BULL MARKET has inspired an increase in margin trading, and with investor confidence on the rise, more retail traders are apparently willing to take a chance and borrow to accumulate more stock—so think virtually all of the 19 brokers in a survey we just conducted. (This is the same group we covered in our annual ranking of the best online brokerages, “Blue Chips,” March 16, 2009.)

Lightspeed’s CEO Stephen Ehrlich explains that “the perception of a stabilizing economy, along with the recent run-up in the market, has given investors some added comfort with holding larger overnight positions, which translates directly into an increased use of margin.”

Most of the brokers we surveyed haven’t changed the rate of interest they charge for margin debt in recent months, presumably because short-term rates have remained low.

But the rates charged vary from a low of just 1.63% on a $50,000 balance at Interactive Brokers (http://www.interactivebrokers.com) to a high of 8.75% on a balance of $10,000 at TD Ameritrade (http://www.tdameritrade.com). IB’s and TD Ameritrade’s margin rates haven’t changed since our last report, in February 2009.

The underlying rate that brokers arrange with banks in order to finance margin transactions, called the call rate, has stood at 2% throughout 2009. A handful of brokers mark that rate up by one to three percentage points, while most charge five percentage points or more than their call rate.

Besides IB, the firms with lower-than-average margin rates include Siebertnet (http://www.siebertnet.com), Just2Trade (http://www.just2trade.com), tradeMonster (http://www.trademonster.com), Lightspeed Trading (http://www.lightspeed.com) and OptionsHouse (http://www.optionshouse.com).

Firms with higher-than-average rates, besides TD, include Schwab, E*Trade, Fidelity, Firstrade, and Scottrade. Surprisingly, two firms that cater to frequent traders, MB Trading and TradeStation, also charge margin rates of more than 7%.

Andrew Wilkinson, director of media communications at Interactive Brokers, attributes “some of the growth in margin use by our clients to the low financing costs available at IB.” But he also allows that “some of the rise is clearly attributable to a restoration in investor confidence as risk-appetite returns.” He notes that the use of margin increased 81% between December 2008 and September 2009 among IB’s customers.

Despite her firm’s higher-than-average rates, TD Ameritrade spokesperson Kim Hillyer says more and more clients are tapping this debt to make transactions. The use of margin at TD Ameritrade increased nearly 50% from the end of March through the end of June of this year.

If you are a heavy user of margin, it makes sense to shop around for lower rates to keep your trading costs in check. It will cost you $13.58 to carry a $10,000 margin debt for a month at Interactive Brokers while the same-size debt at TD Ameritrade will run you $72.92 a month—a difference of almost $60 a month. With a $50,000 balance, the monthly bill will be $67.92 at IB and $312.50 at TD Ameritrade. That’s a difference of about $245.

Margin increases in 2009 have largely tracked the market gains on a percentage basis, notes Tom Sosnoff, TD Ameritrade’s senior vice president of trading. “The market rallies 50%, debit balances increase 50%,” Sosnoff says. Thinkorswim.com, which is now a subsidiary of TD Ameritrade, raised its margin interest rate the most of any broker between February and October, by 2.2 percentage points, to bring it up to 7.45% for balances of $50,000.

Though the use of margin is increasing pretty sharply, few brokers expect the totals to reach 2007 levels because huge stock-market losses are still a recent investor memory. As Muriel Siebert, president and CEO of Muriel Siebert & Co., told Barron’s: “Given the dramatic market volatility over the course of the last 18 months, we don’t anticipate, anytime soon, as much use of margin as there was a few years ago.”

It will take time to restore confidence to the levels seen in 2007. “The last 12 months were a great stress test for industry risk departments,” says George Ruhana, CEO of OptionsHouse. He adds, “We are going to see them try and adjust after realizing three-standard-deviation events can happen on occasion.”

William P. Cahill, president and chief operating officer at TradeStation, compares the current situation to earlier in the decade: “The rebuilding of wealth and risk-taking is similar to the post-dot-com meltdown, when the Nasdaq dropped 70%.” That means it’s going to take awhile.

(Table referenced can be viewed at http://online.barrons.com/article/SB125573858162291219.html?page=sp)

Published in Barron’s, October 19, 2009. 

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