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Tuesday 14 October 2008
Margin Calls Prompt Sales, and Drive Shares Even Lower
One firm’s senior wealth management executive said it was seeing people with $30 million in their brokerage account being completely wiped out within days. Weekly margin call lists have started swelling, this executive added. PDF
Margin Calls Prompt Sales, and Drive Shares Even Lower
By ALEX BERENSON and GERALDINE FABRIKANT 14 October 2008
For some big investors and corporate executives, Mr. Margin is calling.
In the last week, as the value of stock portfolios has plunged, executives and fund managers who had bought shares on margin – that is, using borrowed money – have been forced to sell millions of dollars worth of stock to settle those loans with banks.
Professional investors say that the margin calls probably added to the pressure on stock prices last week, when the average stock plunged nearly 18 percent.
Some analysts and investors are concerned about a situation in which margin calls occur in larger numbers, causing an even bigger wave of selling, even though most analysts say that stock prices are already historically low.
Trading in Standard & Poor’s 500 index futures suggested Wall Street stocks would gain as much as 5.5 percent at the opening.
Banking stocks led equity markets higher Monday in Europe and Asia after European leaders announced plans to inject new capital into troubled financial institutions and guarantee interbank lending, and central banks announced new measures aimed at restarting frozen credit markets.
In morning trading, the FTSE 100 index in London rose 5.6 percent and the CAC-40 in Paris gained 7 percent. The DAX in Frankfurt rose 6.4 percent.
In Hong Kong, the Hang Seng index soared 9.6 percent. The S&P/ASX 200 index in Sydney closed up 5.6 percent.
Margin calls affect more than those with outsize portfolios. By flooding the markets with sell orders, they can send prices broadly lower, ensnaring ordinary investors as well. Because margin calls force investors to sell their shares at times when stock prices are already falling, they can push stocks down quickly and mercilessly.
On Friday, Aubrey K. McClendon, the chief executive of Chesapeake Energy, issued a statement saying he had been forced to sell all of his 33.5 million shares in Chesapeake because of a margin call.
Sumner M. Redstone, the chairman of Viacom and CBS, disclosed that he would sell $400 million in shares in those companies to pay down a loan. For shareholders, margin calls can be painful, forcing them to liquidate portfolios at exactly the worst moment, as stocks are near panic lows.
For example, in July, with Chesapeake trading above $60 a share, Mr. McClendon’s stake in the company was worth more than $2 billion — the vast majority of his net worth, which was reported at $2.1 billion in last year’s Forbes 400. But to meet last week’s margin call, Mr. McClendon sold his entire stake, at prices ranging from $15 to $22.
Other investors will face similar squeezes, said Seymour Zises, who runs Family Management Corporation, a firm that manages money for wealthy families. “I believe that the predominant selling will be among hedge funds themselves and executives who control their own companies,” Mr. Zises said.
Because margin loans are private transactions between banks and borrowers, it is difficult to know exactly how many executives or hedge funds may face margin calls as a result of the stock market’s plunge. Corporate executives must report stock sales within two days of making them. But hedge funds do not have to disclose margin calls — and in some cases the first sign that they face calls may be their abrupt collapse.
Hal Vogel of Vogel Capital Management said he was taken aback when he learned that Mr. Redstone and his privately held company, National Amusements, were so heavily leveraged.
“That suggests that there may be other cases where chief executives who are controlling shareholders or the company’s major shareholder with the same problem,” Mr. Vogel said. “These people present themselves as financially savvy and not subject to great risk associated with debt. But in fact it seems that that is not always the case.”
Knowing exactly how many firms used those strategies is all but impossible. But margin debt increased steadily from late 2002 to 2007, according to the New York Stock Exchange, which requires its member firms to report their margin loans outstanding. It peaked at $381 billion in July 2007, just before stocks peaked.
Since then, margin loans have fallen. In August, the most recent month for which data is available, they were $292 billion. But those figures do not fully account for loans made internationally, or for other strategies that funds use.
Banks and brokerages offer investors loans against stock portfolios. But because stock prices are so volatile, banks require investors to have a substantial cushion, or margin.
Federal Reserve rules require that investors put up half of an investment with their own money as “initial margin” when they first buy a stock. After that, they must maintain a cushion of at least one-third of the value of the loan. Some brokerage firms require an even bigger cushion.
A margin call occurs when a bank tells an investor who has borrowed money against his portfolio that because the value of the shares in the portfolio has fallen, the investor must put up more cash — or immediately sell his shares and pay back the loan.
Suppose, for example, that the investor owns stock worth $1 million and borrows another $1 million from a bank or brokerage to buy even more shares. The portfolio is now worth $2 million.
If the value of the portfolio falls by 40 percent, it will now be worth $1.2 million. But the equity in the account will have fallen much further, to only $200,000.
The brokerage may then tell the investor to add another $400,000 in cash to the account as additional protection. If the investor does not have the money available, the bank will seize the portfolio and sell $1 million of shares to pay back the loan.
For hedge funds, the process can occur on a much larger scale.
One firm’s senior wealth management executive said it was seeing people with $30 million in their brokerage account being completely wiped out within days. Weekly margin call lists have started swelling, this executive added.
Wall Street bankers have been particularly hard hit. Many were given large amounts of their company’s stock in annual bonuses, only to see it disappear. Making matters worse, the wealth management executive said, many of those bankers borrowed against those shares to buy stocks of other financial companies that they thought might rebound more quickly. Those shares have since plummeted.
Vikas Bajaj and Eric Dash contributed reporting from New York and David Jolly from Paris.
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Margin Calls Prompt Sales, and Drive Shares Even Lower
By ALEX BERENSON and GERALDINE FABRIKANT
14 October 2008
For some big investors and corporate executives, Mr. Margin is calling.
In the last week, as the value of stock portfolios has plunged, executives and fund managers who had bought shares on margin – that is, using borrowed money – have been forced to sell millions of dollars worth of stock to settle those loans with banks.
Professional investors say that the margin calls probably added to the pressure on stock prices last week, when the average stock plunged nearly 18 percent.
Some analysts and investors are concerned about a situation in which margin calls occur in larger numbers, causing an even bigger wave of selling, even though most analysts say that stock prices are already historically low.
Trading in Standard & Poor’s 500 index futures suggested Wall Street stocks would gain as much as 5.5 percent at the opening.
Banking stocks led equity markets higher Monday in Europe and Asia after European leaders announced plans to inject new capital into troubled financial institutions and guarantee interbank lending, and central banks announced new measures aimed at restarting frozen credit markets.
In morning trading, the FTSE 100 index in London rose 5.6 percent and the CAC-40 in Paris gained 7 percent. The DAX in Frankfurt rose 6.4 percent.
In Hong Kong, the Hang Seng index soared 9.6 percent. The S&P/ASX 200 index in Sydney closed up 5.6 percent.
Margin calls affect more than those with outsize portfolios. By flooding the markets with sell orders, they can send prices broadly lower, ensnaring ordinary investors as well. Because margin calls force investors to sell their shares at times when stock prices are already falling, they can push stocks down quickly and mercilessly.
On Friday, Aubrey K. McClendon, the chief executive of Chesapeake Energy, issued a statement saying he had been forced to sell all of his 33.5 million shares in Chesapeake because of a margin call.
Sumner M. Redstone, the chairman of Viacom and CBS, disclosed that he would sell $400 million in shares in those companies to pay down a loan. For shareholders, margin calls can be painful, forcing them to liquidate portfolios at exactly the worst moment, as stocks are near panic lows.
For example, in July, with Chesapeake trading above $60 a share, Mr. McClendon’s stake in the company was worth more than $2 billion — the vast majority of his net worth, which was reported at $2.1 billion in last year’s Forbes 400. But to meet last week’s margin call, Mr. McClendon sold his entire stake, at prices ranging from $15 to $22.
Other investors will face similar squeezes, said Seymour Zises, who runs Family Management Corporation, a firm that manages money for wealthy families. “I believe that the predominant selling will be among hedge funds themselves and executives who control their own companies,” Mr. Zises said.
Because margin loans are private transactions between banks and borrowers, it is difficult to know exactly how many executives or hedge funds may face margin calls as a result of the stock market’s plunge. Corporate executives must report stock sales within two days of making them. But hedge funds do not have to disclose margin calls — and in some cases the first sign that they face calls may be their abrupt collapse.
Hal Vogel of Vogel Capital Management said he was taken aback when he learned that Mr. Redstone and his privately held company, National Amusements, were so heavily leveraged.
“That suggests that there may be other cases where chief executives who are controlling shareholders or the company’s major shareholder with the same problem,” Mr. Vogel said. “These people present themselves as financially savvy and not subject to great risk associated with debt. But in fact it seems that that is not always the case.”
Knowing exactly how many firms used those strategies is all but impossible. But margin debt increased steadily from late 2002 to 2007, according to the New York Stock Exchange, which requires its member firms to report their margin loans outstanding. It peaked at $381 billion in July 2007, just before stocks peaked.
Since then, margin loans have fallen. In August, the most recent month for which data is available, they were $292 billion. But those figures do not fully account for loans made internationally, or for other strategies that funds use.
Banks and brokerages offer investors loans against stock portfolios. But because stock prices are so volatile, banks require investors to have a substantial cushion, or margin.
Federal Reserve rules require that investors put up half of an investment with their own money as “initial margin” when they first buy a stock. After that, they must maintain a cushion of at least one-third of the value of the loan. Some brokerage firms require an even bigger cushion.
A margin call occurs when a bank tells an investor who has borrowed money against his portfolio that because the value of the shares in the portfolio has fallen, the investor must put up more cash — or immediately sell his shares and pay back the loan.
Suppose, for example, that the investor owns stock worth $1 million and borrows another $1 million from a bank or brokerage to buy even more shares. The portfolio is now worth $2 million.
If the value of the portfolio falls by 40 percent, it will now be worth $1.2 million. But the equity in the account will have fallen much further, to only $200,000.
The brokerage may then tell the investor to add another $400,000 in cash to the account as additional protection. If the investor does not have the money available, the bank will seize the portfolio and sell $1 million of shares to pay back the loan.
For hedge funds, the process can occur on a much larger scale.
One firm’s senior wealth management executive said it was seeing people with $30 million in their brokerage account being completely wiped out within days. Weekly margin call lists have started swelling, this executive added.
Wall Street bankers have been particularly hard hit. Many were given large amounts of their company’s stock in annual bonuses, only to see it disappear. Making matters worse, the wealth management executive said, many of those bankers borrowed against those shares to buy stocks of other financial companies that they thought might rebound more quickly. Those shares have since plummeted.
Vikas Bajaj and Eric Dash contributed reporting from New York and David Jolly from Paris.
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