Hi Mike,
I don't know why it didn't link. Here's a copy of the article:
Banks tighten dot-com credit
by Andrew Willis - 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 |
