What is the loan to value ratio of a share?

Question:

What is the loan to value ratio of a share, and how does this change as the share price changes?

Response:

A loan to value ratio or Lending Value Ratio (LVR) is a percentage measurement of the amount that can be borrowed against a share or a managed fund, using a margin loan.

For example, if the Lending Value Ratio of a share or managed fund is 70%, a margin lender would be able to lend up to 70% of its equity value on the proviso that you provide the other 30%. So, if you wish to invest $10,000 worth of shares or managed funds, your minimum contribution would need to be $3,000. This can be in the form of cash, or you can use your existing shares or managed fund as collateral to the loan. Most investors that wish to use a margin loan use this option to invest in the market. When using this option , the total purchase that can be made is $7,000.00 on additional shares or managed funds. The LVR is the same, in this case, that is 70%.

Most margin lenders actively review all approved stocks and funds on regular basis, and from time to time may reduce or remove the LVR on particular stocks. This can be influenced by a number of factors, such as, if a company is removed from the ASX, if its market capitalisation falls, or if its stock value falls too low. A full list of approved shares or managed funds can be found via the margin lender’s approved list.

An LSR, or Loan Security Ratio, is the amount of the loan borrowed in proportion to the value of your portfolio’s lending value. As the market value of your portfolio rises and falls, so does its lending value. If the market falls far enough, your portfolio’s lending value may fall below your current loan balance – which is when a Margin Call is triggered.

Once you have utilised the Margin Loan, to purchase your shares or managed funds, the margin lender measures the daily fluctuations by the portfolio lending value. This value changes as the value of the shares or managed funds within the portfolio change with market movements.

In this case the amount borrowed is $7,000. If the value of the portfolio increases to $11,000 then the LVR would decrease from 70% to 63.64%. If the value of the portfolio decreases to $9,000.00 then the LVR would increase to 77.78%.

Margin lenders understand that markets can fluctuate. We allow for a “buffer” of up to 5% which allows you to restore the gearing level of your portfolio before a margin call is triggered.  A margin call is therefore triggered if your loan balance exceeds the lending value of your portfolio by more than 5%. That is, when the LVR increases to 75%, or above, the margin loan would then need to be brought back to a 70% LVR. This is achieved by either putting in more cash or adding appropriate shares or managed funds, or alternatively by selling an appropriate amount of shares or managed funds.

In the case where the LVR decreases, you would have additional equity on your loan , this would allow you to  make additional purchases of shares or managed funds utilising the equity on your loan .