Loan to value ratios (LVRs) on shares and managed funds sound complicated but they’re not. Just think of this ratio as the amount the lender is willing to cough up. So if the LVR is 70 per cent, then the lender is willing to lend you 70 per cent of the total value of the share or fund. This means that you must fund the remaining 30 per cent.
Let’s say that you pledge $30,000 of your own shares and borrow a further $70,000 from a margin lender and invest the entire amount, $100,000, into a portfolio of shares. Your LVR in this example is 70%.
Every lender has an approved list of shares and managed funds with their own special LVRs that can be downloaded from their website. On speculative stocks, LVRs can vary as much as 20 per cent between lenders. LVRs on blue chip stocks such as the big banks and miners, however, are fairly uniform, generally sitting at a maximum of 80 per cent. The more “volatile” or “risky” (in the eyes of the lender) the share or fund, the lower its LVR.
Unfortunately shares have a habit of fluctuating over the course of time, occasionally falling sharply. Company analysts might downgrade the company’s earnings, the company might disappoint the market come reporting season, even a turn for the worst in the economy can send a company’s share price into a spin. If such a stock is held in your margin lending portfolio then you’re likely to feel the shockwaves from a fluctuating share price. And depending upon the LVR of the stock in question and your borrowing limit, then the margin lender could sell the shares from underneath you.
Using our example above, if the value of the portfolio falls from $100,000 to $90,000, the LVR of 70% will be exceeded and a margin call will be triggered. To calculate the LVR, simply divide the loan amount, $70,000, by the total value of the portfolio, or $90,000, giving an LVR of 78%. Since an LVR of 78% exceeds the permissable LVR of 70%, we’ve entered margin call territory.