Share margin financing (SMF) is like a dirty word in the stock broking world. Investors either love or hate it. They love it as SMF is a type of revolving credit facility that’s provided to investors, allowing them to finance their share trading and investment activities. But using this facility to buy securities can be very risky indeed.
If the stock prices fall substantially, those on margin loans will be required to provide additional cash in order to maintain a threshold of margin debt to equity ratio. This will be on top of the interest paid on the margin loan.
The inability to provide the additional cash will lead to forced selling of the collateralised securities.
On the other hand, the recent super run seen by glove counters has made many investors richer. But this has also caused some jitters among stock brokers, which have started to limit their exposures as a safeguard measure.
“Glove stocks could have surged near or past their single counter exposure limit (which is one of the SMF criteria) following their stunning gains in May 2020 with Supermax highest at +197.3% to Kossan lowest at +58.2%. Consequently, these brokers have to start limiting their exposures as a risk management measure,” said a fund manager.
“I would advise to take profit on the glove stocks right now as a potential unintended consequence of the price capping exercise created a technical danger sign,” he added.
He pointed out that the key point going forward is to see that the SMF price capping exercises does not extend to other sectors.
“Should this occur, it will likely send the market into a tailspin like the 2005 SMF mini crisis. The impact that a SMF cutback can have to the market can be devastating,” he added.
The move by stock brokerages to tighten margin financing recently has caused glove counters to see a heavy selldown with their share prices declined by more than 20% on June 3. This marked a break from the three-month rally in the sector.
However, the sharp decline was just temporary as glove stocks are back on Bursa Malaysia’s top gainers list as analysts are still bullish on the sector given selling prices of gloves will continue to soar in the next 12 months as lead time stretches up one year.
Analysts believe the glove manufacturers’ earnings will be further pushed by expanded margins as raw material prices remain low, selling prices continue to grow, the US dollar strengthening against the ringgit and expansion plans remain intact for the glove producers.
That said, tightening of margin financing by stock brokers may have a knee-jerk impact on glove counters as investors continue to ride on the positive sentiments on the sector amid these unprecedented times.
Will other sectors be as resilient as the glove sector? Probably not. Other sectors may be more susceptible should there be holding back of the SMF facilities and cause a crisis similar to what transpired in 2005.
Back then, there was panic in the market when news emerged that banks have stopped offering SMF facilities. But what really took place was that a number of stocks were sold down aggressively and this had prompted banks to impose stricter guidelines on SMF.
The stricter guidelines typically involved the imposition of price caps on certain shares where the value of a share is capped at a certain percentage of its market price, or the lowering of existing price caps on some shares, or disqualifying certain shares altogether from the list of stocks acceptable for financing purposes.
As such, some borrowers were required to top up their margin accounts, either with cash or additional marginable shares.
Some of the borrowers were forced to sell down some of the shares pledged to the bank as collateral to reduce their borrowings to the permitted level (permitted margin of finance). This had led to the impression that banks are withdrawing their SMF facilities.
It is also common for investors to opt for SMF to take advantage of promising trading opportunities and purchase stocks beyond their investment capacity.
But SMF works best only as shares boom. When markets go south, investors who bought their stocks on margin are likely to see higher losses, compared to the losses they would have made had they not used SMF.
Take for example a scholar-turned-entrepreneur Abu Hasan Ismail who was known for his success in building Prestariang Bhd, one of the largest information and communications technology (ICT) software and training service providers from scratch.
He lost his entire 24.3% stake in the company some two years ago due to margin calls. The counter saw a freefall since 2016 and he was forced to sell his entire 117 million shares on Nov 14, 2018 in order to rectify personal margin account position held by his investment vehicles.
Surely, Abu Hassan was not the only “victim” and there are many more. Although SMF helps to increase investors’ stock trading power, thus boosts the vibrancy in the stock market, investors have to tread with caution as they may end up with the shorter end of the stick. – June 5, 2020
