Margin loans: what you need to know

What is “margin” or a “margin loan”?

Margin, or a margin loan, is when an investor borrows money from a brokerage firm to buy stocks.

Unlike a bank loan, a margin loan requires you to have some money in your brokerage account (used as margin collateral), and the brokerage firm lends to you based on that amount, at a certain percentage. The collateral for the loan is held in your brokerage account itself.

Margin lets you buy a large number of shares without needing much cash in your account. Example: VIC stock trades at VND 90,000 per share. You have VND 900 million in your brokerage account, so you can buy at most 10,000 shares. But if your brokerage firm lets you use margin with a 50% margin ratio, you can borrow up to another VND 900 million to buy more of the stock, so you can buy up to 20,000 VIC shares. Note that in this case you may only borrow from the brokerage firm to buy VIC stock, not for any other purpose.

Requirements for a margin loan

To take a margin loan, you first need to register with your brokerage firm. The firm will then give you a margin account (margin sub-account) under your brokerage account. You transfer money from your main account into this sub-account, where it serves as margin. Only the margin sub-account can be used for margin borrowing; a regular account cannot.

The amount you are allowed to borrow also depends on how much money is in this sub-account. Brokerage firms set a margin ratio and use it to determine your lending limit.

In addition, not every stock in the market can be used as collateral for a margin loan. Each brokerage firm has its own list of marginable stocks, with different margin ratios. This list is updated weekly, and the stocks on it and their margin ratios are adjusted with each update, according to the firm’s assessment of each stock’s risk.

The margin ratio

The margin ratio is an important measure for both investors and brokerage firms when using margin.

Note: brokerage firms do not use a single, consistent definition of the margin ratio in their official documents. So whichever brokerage firm you use margin with, read carefully how they calculate this ratio.

Account margin ratio

Under the CFA definition, as well as that of the State Securities Commission of Vietnam (SSC) (Decision 87/QĐ-UBCK), the account margin ratio is your net asset value divided by the total portfolio value in your margin sub-account.

Total portfolio value is the value of the cash and shares in your account, while net assets equal total portfolio value minus total debt. Roughly speaking, if you think of your account as a company’s financial statements, net assets are shareholders’ equity and total portfolio value is total assets.

For example, if your total portfolio value (cash + shares) is VND 1 billion and your outstanding margin debt is VND 300 million, your net assets are 1,000 – 300 = VND 700 million, and your account margin ratio is 700/1,000 = 70%.

Initial margin requirement

The initial margin requirement is the minimum margin ratio an investor must have at the time of buying the stock. It usually ranges from 50% to 100%. An initial margin requirement of 100% means you cannot use a margin loan to buy that stock.

Brokerage firms set the initial margin requirement for each stock. Generally, lower-risk stocks have lower initial margin requirements, while higher-risk stocks require higher margin ratios.

You can easily find the list of marginable securities on brokerage firms’ websites.

From the initial margin requirement, we can calculate the required margin value and the loan ratio.

In the example above, we see that the initial margin requirement for AGG stock is 70%. AGG trades at VND 40,000, and suppose you want to buy 25,000 shares. Without margin, you would need VND 1 billion in cash in your account. With margin, however, the required margin value to buy 25,000 AGG shares is VND 1 billion × 70% = VND 700 million, which is the minimum amount you need to deposit in your margin sub-account to buy that many shares.

In this case, you can borrow another VND 300 million from the brokerage firm, giving a loan ratio of 7:3.

Here, your account has borrowed the maximum VND 300 million and cannot borrow any more. Your account has then reached its margin limit, a state known as being fully margined (“full margin”).

Available margin value

Available margin value equals your net assets minus the required margin value of the stocks in your portfolio. It tells you whether you can keep borrowing on margin. When the account is fully margined, this value is zero.

Continuing the example above: your margin account has VND 700 million, and this time you buy only 20,000 AGG shares, worth VND 800 million. The brokerage firm lends you VND 100 million, and you buy the 20,000 AGG shares. However, for this number of shares, the required margin value is only 800 × 70% = VND 560 million, meaning you only needed to deposit VND 560 million in your margin account to buy 20,000 shares. Since you deposited VND 700 million, more than required, you can still use margin to buy other stocks. Your available margin value is 700 – 560 = VND 140 million, meaning you can buy other stocks as long as their required margin does not exceed VND 140 million.

You then buy 5,000 HPG shares at VND 56,000 per share, a total value of VND 280 million. With an initial margin requirement of 50%, the required margin value is 280 × 50% = VND 140 million, exactly equal to the available margin in your account. You can therefore use margin to buy the 5,000 HPG shares.

Note also that because you have no cash left, the brokerage firm lends you the full VND 280 million to buy the HPG shares.

At this point, your available margin is zero, meaning your account is fully margined, so you cannot buy any more stocks.

Buying power

Buying power is calculated as available margin value divided by the initial margin requirement of the stock you want to buy. It shows the maximum amount of that stock you can buy.

In the example above, when your account has VND 140 million of available margin and you want to buy HPG with an initial margin requirement of 50%, your buying power is 140/50% = VND 280 million. In other words, you can buy up to VND 280 million worth of HPG stock, or 5,000 shares at the current price of VND 56,000.

Margin interest rates

In the examples above, I assumed you could borrow for free and pay no trading fees (to keep things simple). In reality, when you borrow from a brokerage firm to buy stocks, just like any other loan, you have to repay the principal and interest when due. Margin interest rates at brokerage firms currently range from about 13% to 15%, with a typical loan term of 90 days. At maturity, you must repay the principal and interest to the brokerage firm, either by depositing more money into your margin account or by selling some of your shares to raise cash.

Some brokerage firms also offer terms to help investors, such as allowing early repayment or allowing loans to run past their due date (charged at a higher overdue rate than the original rate). Unpaid interest is added to the account’s total debt, which affects the account margin ratio and reduces buying power.

Maintenance margin ratio

If you trade in a regular account and the share price falls to zero, you lose all your money. In a margin account, however, because the brokerage firm has lent you money, if the share price falls to zero not only your money but also the firm’s money is lost, and in many cases the firm cannot recover its capital and is left with an unresolvable bad debt. Brokerage firms therefore set a safety level for your account, and the measure they use is the maintenance margin ratio.

The maintenance margin ratio (safety margin ratio, maintenance margin requirement) is the minimum margin ratio an investor must maintain in a margin account. The SSC requires this ratio to be no lower than 30%, but brokerage firms may require investors to keep a higher maintenance margin for extra safety.

The account margin ratio changes constantly as share prices change, because both net assets and total portfolio value change. If share prices rise, the account margin ratio rises; if they fall, it falls. If the margin ratio drops below the maintenance margin ratio, the brokerage firm will immediately contact you and require you to deposit more money into your margin account or sell some shares, to bring the account margin ratio back above the safe level. This action by the brokerage firm is known as a margin call.

Let’s return to the AGG portfolio example above. Suppose AGG’s share price falls to VND 20,000, and your brokerage firm requires a maintenance margin ratio of 45%.

Your ratio is now below the maintenance margin ratio, so you receive a margin call. You need to add cash to the account or sell some shares within the deadline set by the brokerage firm. If your account margin ratio is still below the maintenance level after that deadline, the firm will liquidate the collateral, i.e. your stock portfolio, selling it to bring the margin ratio back to a safe level.

Liquidation margin ratio

This ratio is lower than the maintenance margin ratio. If your account margin ratio falls below it, your account is in danger and the brokerage firm may lose money on the loan. At that point, the brokerage firm will immediately force-sell your stock portfolio to bring the margin ratio back to a safe level.

How does using margin affect your returns?

When share prices rise, your portfolio value rises while the amount you borrowed stays the same, so your net asset value increases. Using the example above, if AGG rises to VND 50,000, the value of 2 portfolios with the same initial capital of VND 700 million changes as follows (I still assume zero fees and interest for simplicity).

You can see that with the same initial investment of VND 700 million, using margin has increased your rate of return.

However, margin also magnifies your risk. Suppose AGG falls to VND 30,000; the portfolio values change as follows:

As you can see, margin magnifies both the returns and the risks of your portfolio. Your rate of return changes accordingly.

It is just like the DuPont formula you use when analysing financial statements:

ROE = ROA × Financial leverage

Using margin is a form of leverage: it increases profit, but it also increases risk.

How to use margin effectively

From the analysis above, we can see that margin is a tool that can increase your rate of return and help you economise on capital. However, it also multiplies your risk. The worst outcomes for traders using margin are probably forced selling and margin calls.

Using margin requires disciplined money management and accurate analysis. So if you lack experience, it is best not to use margin.

You should only use margin if you have about 3 years of market experience and have been profitable every year. Your risk appetite must also be high enough to allow you to use margin.

In addition, with margin interest rates currently around 13–15%, your portfolio’s rate of return needs to be higher than that to cover the interest cost.

One final piece of advice: you should not use margin for long-term investing, because the interest burden becomes much heavier, while very few stocks rise steadily over many years.

Happy trading!

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