Banks tighten dot-com credit
Investors in speculative Internet stocks face
tougher loan rules amid fears that bubble could burst
ANDREW WILLIS
The Globe and Mail; With a report from Angela Barnes
Saturday, March 11, 2000
Canada's big banks, fearing that the Internet bubble could soon blow up in their faces, are slapping new restrictions on the billions of dollars they're lending to investors speculating on dot-com frenzy.
The discount brokerage arms of the major banks are calling in some money and cutting back on lending, growing cautious after watching unproven technology companies soar in value and investors crank up the amount they borrow to buy stocks by at least 30 per cent over the past year.
Loans earmarked for high-tech plays have been cut to a fraction of what's allowed on other stocks, and brokerage houses are reining in lending for aggressive investing practices, such as betting against Internet stocks.
The brokerages have changed the rules on what is known as buying on margin. In cases such as these, an investor will put up only a portion of the cost of buying a stock and borrow the rest from a broker.
Some margin requirements are now being changed so that an investor has to pay back some of the borrowed money because the banks don't want their clients getting caught, unable to pay if the bubble bursts.
"We've seen an increased use of margin investing at the same time we've seen increased volatility in the market," said Bruce Dickson, senior vice-president at Bank of Nova Scotia's Discount Brokerage.
"Active markets and active trading mean we're going to clients more and more often over credit issues."
Mr. Dickson said that on volatile stocks such as tech plays, his brokerage has cut the amount it's willing to lend to 50 cents for every dollar worth of stock, down from 70 cents on each dollar invested in less speculative companies. Other discount brokerages have cut their lending limit to 25 per cent of a dot-com stock's value.
Other major discount brokerages have taken similar steps.
John See, vice-chairman of TD Waterhouse, said his discount brokerage firm has seen its so-called "margin lending" to Canadian clients double over the past year, to $2.2-billion. TD Waterhouse, the country's largest discount brokerage and an arm of Toronto-Dominion Bank, has $50-billion of assets spread across 760,000 accounts.
"We've been reducing the amount we'll advance to clients in about 25 stocks, the vast majority of which are technology and telecommunications-related," Mr. See said, adding: "Where clients do get out of step, we've been trying to help them get back on side gradually."
There's a growing list of stocks that dealers deem too risky, and won't lend against. U.S. stocks on Scotiabank's list of untouchables include China.com, Phone.com and Learn2.com.
The brokerage houses' conservative turn has caught some aggressive investors off guard.
One retired equity salesman who deals with Canadian Imperial Bank of Commerce's Investors' Edge service wagered $250,000 that seven dot-com companies were headed for a fall. He sold the stocks short, meaning he borrowed the stock from the brokerage and sold it, expecting the price to fall. Then, he would buy it back at the lower price, repay the brokerage and pocket the difference.
He also borrowed heavily to buy promising Internet plays.
Stocks that the investor predicted would drop included 1-800-Flowers.com, Stamps.com and Ashford.com, which sells expensive watches, pens and sunglasses over the Internet.
On Thursday, a CIBC representative called him to say the firm required an additional $1-million of security to maintain the dot-com investments. Because he did not have the money, he had to close some positions. He plans to transfer his account to Charles Schwab, which has more liberal margin rules.
A CIBC spokeswoman said the bank closely monitors and adjusts its lending on specific stocks and on portfolios dominated by speculative plays. Last week, the bank took steps to reduce some of its exposure to technology stocks "as part of a normal process to reduce our risks and our clients' risks."
These signs of caution appear as investors rack up impressive amounts of margin debt to bet on so-called "new economy" stocks. Between late October and January, debt extended by New York Stock Exchange members to their clients jumped by more than $60-billion (U.S.) to $243-billion, a level that echoes the record borrowing seen just before the 1987 stock market crash.
Joe Oliver, president of the Investment Dealers Association of Canada, estimates that the total amount of margin lending in Canada grew by 30 per cent over the past year. He said the increasing debt levels aren't seen as a problem for the industry, but every brokerage house is watching its exposure to clients.
"Margin rules in Canada are more stringent than in the U.S., so there's less leveraged exposure to the market in this country," Mr. Oliver said.
"One worry I have is the lending that's taking place outside the investment industry," he said. "You hear stories about people taking second mortgages on their homes to buy speculative stocks, and that's just not prudent."
The brokerage houses are cutting lending to small investors at the same time as a rising chorus of voices points out that speculative investing in technology stocks is overheating the market. For months, U.S. Federal Reserve chairman Alan Greenspan has been sounding a warning against what he sees as "irrational exuberance" in the market.
This week, Kees Storm, chairman of the Dutch insurance group Aegon, observed that "it is fascinating that people are prepared to pay the prices that are being talked about" for Internet stocks. He said: "We will see whether it is hype or not, but profitability is the only driver of a share price."
The surge in borrowing to finance stock purchases may spell danger down the road for stock markets, said Cl‚ment Gignac, chief economist and strategist of Montreal-based National Bank Financial. He is calling for a sharp downturn in the more speculative Internet stocks, and said that while some exposure to technology stocks is a good idea, "putting all eggs in the same basket is a one-way bet that we believe is a dangerous strategy."
TRADING ON THE MARGINS
If you have a margin account with a brokerage, it means you get to borrow money to pay for a certain percentage of the stock you want to buy. The broker lends you the money, charges interest on it and holds some of your securities as collateral. The "margin" is the proportion that you pay out of your own pocket.
This practice gives you leverage to buy much more stock than you would be able to purchase with your own money alone. If a stock rises, it means the profits are amplified.
For example, if you have a 50-per-cent margin limit, you could buy $10,000 worth of BCE Inc. shares, but pay for only $5,000 worth. The broker lends you the money for the rest. If the price of BCE shares rises by 10 per cent, to $11,000, you've earned $1,000. That's a whopping 20-per-cent gain on your actual $5,000 investment.
There will be interest charges though, and these eat into your profits.
But the really scary part comes if the stock drops. Not only do the losses multiply the same ways the gains do -- if the stock drops too much, you may be subject to a "margin call" from your broker. That means you'll have to put up more cash or some collateral, immediately, in order to maintain the margin at an acceptable percentage. Richard Blackwell |
