Bad News For Margin Traders
By MATTHEW GOLDSTEIN November 7, 2000
NEW YORK -- Buying stocks on margin just got a little more
expensive at E*Trade Group (EGRP).
The nation's third-largest online brokerage has broken
ranks with its main competitors and boosted the interest
rates it charges investors who buy stocks with borrowed
money. Now, E*Trade boasts some of the highest margin
interest rates in the online brokerage business for the
average investor.
An investor who borrows between $25,000 and $49,000 at
E*Trade, for instance, now pays 10.25% in interest on a
margin loan - a half-point more than before the Oct. 21
increase. The same investor would pay 8.75% at Datek
Online, 9% at TD Waterhouse (TWE) and 9.75% at both
Ameritrade Holding (AMTD) and Charles Schwab (SCH).
The rate hike at E*Trade took many in the brokerage
business by surprise because it wasn't preceded by a hike
in the broker call rate, or the interest rate brokerages
themselves pay to borrow money to lend to customers. The
broker call rate, in fact, hasn't changed since it rose to
8.25% in early May. Depending on the amount lent to their
customers, brokerages usually set their margin interest
rates a few percentage points above the broker rate, and
tend to change their margin rates only when the underlying
rate changes. (Other major online brokerages say they have
no plans to raise their margin rates at this time.)
E*Trade officials won't comment on their rationale for the
increase. The company's Web site says, tersely, "margin
rates change without notice."
It's possible, of course, that E*Trade made the move simply
to boost its bottom line. For most online brokers, the
interest paid by investors on margin accounts is an
important source of revenue, and E*Trade is no exception.
In its just-completed fiscal year, interest income
accounted for roughly 48% of the firm's $1.97 billion in
gross revenues.
But a more likely scenario is that E*Trade officials are
concerned about the steep losses incurred by its margin
customers this year. A recent survey by consulting firm
J.D. Power & Associates found that E*Trade customers are
far more likely to receive a margin call than investors at
other online brokerage firms. Roughly 27% of the E*Trade
customers surveyed reported that they'd gotten at least one
margin call during the first six months of this year -
compared with 17% of Charles Schwab customers, 13% of
Ameritrade customers and 7% of Datek customers.
Margin calls, of course, are designed to recoup the money a
brokerage has lent to investors to buy stocks. But because
markets are often volatile, calling in those loans isn't an
exact science. Sometimes the call is made too late, when
the customer's account has dwindled too low for the
brokerage to get all of its money back. The result: It must
eat the loss.
Brokerages must charge a high enough rate to cover
customers' unpaid debts. Perhaps E*Trade believed a rate
hike was necessary to insulate it from future margin
defaults resulting from customers' plummeting stock
positions. "The riskier you are, the higher interest rate
you are going to have to pay," says Nancy Salk, director of
research for J.D. Power. Commenting on the higher incidents
of margin calls for E*Trade investors, Salk says "E*Trade
investors are a higher risk than customers of other online
brokerages."
In increasing its margin rates, however, E*Trade has to be
concerned that it doesn't start driving away customers to
competitors offering cheaper lending rates. Wall Street
analysts say most investors haven't paid much attention to
the cost of investing on margin so far - they tend to focus
more on commission costs. But with investors no longer able
to count on double-digit gains in their portfolios, other
trading expenses, like margin interest, could begin to make
an impact on investing decisions.
"One of the fears with margin interest is that it gets to
be like a price increase," says Richard Repetto, a senior
vice president and brokerage analyst with Putnam Lovell
Securities. "Ameritrade officials, at a recent analyst
meeting, said they didn't intend to raise [margin] rates
and they were quite happy to see E*Trade doing it. It left
an opportunity for them."
We've already seen commission and advertising wars in the
online brokerage business. Could margin interest-rate wars
be next? Given the legions of investors buying stock on
margin these days, that would be a game of Russian roulette.
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