- Margin lending, including this product, is best thought of as a ‘credit card’ for shares
- Using it long term, the risk is that the loan won’t be there when you really need it
- Other products offer ‘locked in’ funding at comparable rates
‘Borrowing to invest, or gearing, has long been a popular wealth creation strategy. By enabling you to invest more money, gearing has the potential to improve your investment returns and achieve your financial goals sooner’.
That’s the pitch behind NAB’s margin lending product, which has recently been expanded with a facility designed specifically for SMSFs—NAB Super Lever.
Super Lever is like a standard margin lending facility but to comply with SMSF borrowing rules, conducted through a security trust. With a current variable interest rate of 8.6%, it’s sure to generate interest from those that want to use leverage in their SMSF.
The question of gearing
But is gearing really a ‘wealth creation strategy’ that will help you ‘achieve your financial goals sooner’? That depends, but the arguments made in Understanding Gearing by NAB—diversification, tax advantages and capital gains potential—simply don’t stack up.
SMSFs will usually have a large enough balance to get sufficient diversification without gearing. And they pay a low tax rate of either 0% on everything (in pension mode), or 10% on capital gains and 15% on income. There’s little benefit in trying to shift income between the 15% and 10% brackets, especially when you have to pay a hefty margin to do so. Gearing does offer the potential for capital gains, but only through increasing the risk of capital loss.
Leverage works both ways, which is why it’s a high conviction strategy. If you’re going to use it, you need to be really confident about where you put it to work. Optimism isn’t enough.
If you’re investing through a SMSF, you’re already using a form of leverage—the lower tax rate—anyway. This amplifies the after-tax value of gains and losses. Economically, it’s the equivalent of an interest-free loan of roughly 10-15% of your investment amount (refer Chart 1).
Despite this quasi-leverage there will be ‘high conviction’ investors who want to take a swing. If you think the sharemarket (or a particular share) is cheap right now and have the stomach and time horizon to handle the greater volatility that leverage causes, borrowing to invest in your SMSF may be of interest.
But is NAB Super Lever the right product? Let’s take a look.
The key terms of Super Lever are as follows:
- Margin loan. Super Lever is a margin loan. You’re obliged to keep the loan to valuation ratio (LVR) within the prescribed limit by posting ‘margin’ (paying down the loan) to cover any shortfall. This is very different to, say, a home mortgage, where a changing LVR doesn’t matter so long as you make the repayments.
- Ownership. Super Lever requires shares or units to be held by an investment trustee on your behalf. You are entitled to dividends and distributions but NAB instructs the trustee on voting and other matters.
- Limits. Super Lever has an overall ‘facility limit’ (a cap on the total of all loans made) as well as placing a LVR (called the ‘security ratio’) on each individual loan. Each individual investment is made with a new loan and has its own security ratio (set out in the Approved Investment List, but generally between 40-60% of the market value of the relevant share or unit).
- Limited recourse. Each loan made under Super Lever is limited recourse. There is no requirement to provide directors guarantees or indemnities as might be the case with a property loan.
- Buffer. In addition to the security ratio a ‘buffer’—equal to 15% of the market value of the investment—applies before NAB will make a ‘margin call’ (ask you to pay down the loan). If you borrow $50,000 to buy a $100,000 investment in the SPDR ASX 200 Fund (STW), which has a 50% security ratio, you will only face a margin call if the investment falls below $77,000. In the normal course of events this makes it unlikely you will face a margin call (especially if you borrow less than the maximum) but this is not guaranteed (more below).
- Interest rate. Super Lever has the same interest rates as NAB’s standard margin lending products—currently 8.6%pa (variable) for amounts below $250,000, 8.35%pa for amounts from $250,000 to $1m and 8.1%pa above $1m. A range of fixed interest rates are also available.
- Term. It doesn’t have one. Either party is able to repay or recall the loan at any time. The loan is ‘at call’ with five days notice (refer Clause 11.4 of the Facility Terms). Good for the lender (NAB), but not so good for the borrower (you).
- Flexibility. Super Lever is pitched as a flexible product but this is largely to NAB’s benefit. At any time, NAB can reduce the facility limit, change the security ratios, remove investments from the approved list or, as noted above, simply ask for the loan to be repaid. If you don’t or can’t repay, it has the right to sell your investments.
The potential impact of these last two points shouldn’t be underestimated. The GFC decimated the wealth of many margin lending clients, sold out by the lender at the bottom of the market when margin calls couldn’t be met.
NAB’s reaction to adverse market movements may exacerbate the problem. STW might suffer a rapid fall of 20% but if NAB reduces the security ratio to provide it with added security, the calculations above won’t hold. You would be required to post a margin call, or see some of your shares sold. If NAB’s reaction was to remove STW from the Approved Investment List, you might be forced to sell the whole parcel at exactly the time you think it’s cheap.
This is the fundamental problem with margin loans. You get margin called right at the time when it’s most damaging to you, when you least want to sell.
If you think of margin loans as a ‘credit card’ for shares to fund short-term purchases, there’s a more justifiable case. If, for example, you want to take advantage of an attractive buying opportunity now but are waiting on a post-1 July contribution to fund it, a margin loan can help close the funding gap.
Long-term use of margin lending, though, is a very different proposition.
Super Lever versus other forms of borrowing
Compared with a credit card, Super Lever offers an attractive rate of interest. The major flaw is its ‘at call’ nature. At any time, for whatever reason, NAB can pull the plug.
It also takes a ‘one size fits all’ approach to the interest rate. Whilst the security ratio changes slightly from stock to stock, you’ll pay 8.6%pa whether you’re buying low volatility STW units or a more volatile proposition like Newcrest.
Contrast this with a protected equity loan. Westpac quotes 8.3% and 9.6% respectively for a protected equity loan (with 50% gearing) on these shares. That includes the cost of hedging, which locks the loan in until maturity and avoids the prospect of margin calls. A self funded instalment, effectively a pre-packaged (ASX listed) share loan, is another option for those looking to lock in their funding for a term.
Depending on the share, NAB is charging you more than, or the bulk of, the hedging cost whilst reserving the right to pick and choose which parts of your portfolio it wishes to finance (if at all). NAB Super Lever is a ‘heads NAB wins, tails you lose’ proposition.
Ultimately, the risk posed by ‘at call’ borrowing depends on whether you have a way to refinance it. You could, for instance, reduce the impact of a margin call by drawing down on a home mortgage, then making a loan or contribution to your SMSF to pay back the Super Lever facility (although you’d need to act fast). But if you do have this option, why not simply drawdown on your mortgage, pay a lower rate of interest and avoid a margin facility altogether?
How to keep your SMSF debt-free and improve your returns explained why it’s often better to keep the gearing component of an investment outside your SMSF.
But, if that doesn’t suit, it’s also possible to shift borrowed money into your SMSF by either making a loan (with appropriate legal structure in place) or a contribution (subject to caps). Borrowing on, say, your home mortgage won’t be limited recourse, but there isn’t much benefit to a limited recourse margin loan, which allows the lender to sell the assets if they drop in value. Self funded instalments and protected equity loans are a different story—they contain useful limited recourse protection—so you need to decide how much it is worth to you.
The benefit of borrowing outside your SMSF is a much lower interest rate. If you draw down on your NAB Home Equity Line of Credit you’ll pay 6.3%pa. You may not be able to get a tax deduction but this is only worth 0.95%pa at most (15% x 6.3%)—much less than the 2.3% additional interest payable on NAB Super Lever. For a pension mode (0%) SMSF, the tax deduction is irrelevant.
In a nutshell
The merits of borrowing in SMSFs are unconvincing. There’s an argument to use a product like Super Lever as a ‘share credit card’ to cover gaps between the timing of purchases and the availability of funding but that’s no ‘wealth creation strategy’. If you’re looking for longer term share funding, consider alternative products or do your borrowing outside your SMSF.
 Based on indicative quote provided by Westpac 30 August 2012.