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What if everyone capitalised their interest ?

Discussion in 'Finance & Banking' started by Glebe, 11th Jan, 2007.

  1. Glebe

    Glebe Well-Known Member

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    I've always wondered how margin lenders would pay their bills if everyone capitalised interest...
     
  2. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    They still get their money ... by capitalising you just pay the interest out of your loan account rather than out of your own pocket.

    One might argue that it's just their own money they are getting, but you do still have to pay back the loan one day (or your estate does at least) - and if you don't (or get a margin call), they will sell down your portfolio to redeem their cash. They will get it one way or another.

    They control their risk by maintaining lower LVRs on funds/shares which aren't considered to be as reliable ... and they can always lower the LVR of their funds if they become overexposed.
     
  3. Glebe

    Glebe Well-Known Member

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    Yeah but it still represents a cashflow issue to them surely.

    By capitalising, you are accruing a debt, and delaying the servicing of said debt. For most accounts the delay is a year probably so no problem, but what if everyone capitalised their interest, and what if the bull run lasts 15 years (yeah I wish).

    In the meantime, how do they pay their staff and building costs etc etc?

    Of course this is just a fun theoretical exercice...

    I suppose they have the right to suspend capitalisation, and they can drop their LVR's forcing repayments...
     
  4. Davidr

    Davidr Active Member

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    As Sim' said they are taking the capitalised interest adding it to your loan and paying themselves. Think of the assets and liabilities statement. Your loan is on your LIABILITIES ledger. For them it is an ASSET. They are in effect converting an asset to cashflow.

    Part of the lending model allows them to lend more money than they actually have. I don't know what it is for a margin lender but for resi for a bank I think it is in the order of 1:30.

    I suppose though if they were ONLY a margin lender, and absolutely every client capitalised their interest they would fall into a cashflow shortfall .....
     
    Last edited by a moderator: 11th Jan, 2007
  5. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    I'm sure a pure margin lender could borrow funds at institutional rates (ie a lot less than they charge us) to cover their cashflow requirements.
     
  6. Glebe

    Glebe Well-Known Member

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    Exactly. By capitalising you are choosing when they get their asset converted into cashflow. All Leveraged Equities does is sell margin loan debt (admittedly it's owned by the Bank of S.A. which has a diverse product range) but it'd be a fun enough exercise to find out how long they could last if every customer capitalised their debt.

    I would imagine they could capitalise the debt from the institution they're buying it from, but I assume their staff don't allow a capitalisation of their wages :D

    Anyway, this hypothetical point was all I was trying to make :p
     
  7. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Actually Leveq is owned by Adelaide Bank.

    St. George owns BankSA.

    Just thought I'd make sure people knew who was who.