Gear into the banks this reporting season with no risk of margin calls

In the past three months, since reaching a record peak in November, the Australian share market has fallen dramatically. Many investors have experienced losses in their share portfolios, which is especially tough considering how well the market has performed in recent years. Those investors under the most pressure are investors who have borrowed to invest or have full recourse gearing within their portfolios.

One of the main reasons people use gearing is that underlying movements in shares are magnified, which delivers enhanced returns when the market is going up, but is especially severe when the market is going down. If you had borrowing in your portfolio, this recent market downturn has not only delivered exaggerated falls, but if your loans were full-recourse, then you may also have been subject to margin calls.

In recent weeks, the media has focused heavily on the fallout of these full-recourse loans, and has highlighted that a record number of margin calls have been made since the start of the year. If investors are unable to meet the cash requirements of a margin call, typically the lender will sell a portion (if not all) of the investor’s shares to cover the cash requirement. Unfortunately, if the market then bounces or recovers, because you have been a forced-seller, you are no longer able to participate in this recovery. One way to mitigate this risk is to use Instalments. If you choose Instalments as a way to gear into these shares today, and the market takes longer than expected to recover, you will not receive ANY margin calls. In the current market environment, gearing through Instalments offers investors an easy way to gain exposure to a recovery in the market, without any short term risks of margin calls. And the best part is, you can even gear using Instalments in your super fund.

Bank reporting season approaching

If you are a long term investor, with many of the core, large, blue chips down 20% or more, particularly bank stocks such as CBA, ANZ, and WBC, current prices may be tempting you. Especially considering (1) that the bank reporting season is only a few weeks away, with record profits expected to once again be delivered, and (2) yields on these stocks as a result of the recent falls, have now increased to very attractive levels.

The bank stocks have been caught up in the wave of selling in recent months and are now approaching serious value territory, according to Macquarie Research Equities (MRE). MRE believe that the sell-down we’ve experienced is excessive and implies a significant overestimation of financial risk. In an environment where markets reward strong, consistent earnings, and low levels of gearing, the bank stocks, which are currently trading near 5 year PE lows, and have fallen considerably from their highs, offer stable, high dividends, and low earnings risk.

With reporting season just around the corner, it’s also interesting to note the following statistic. According to studies performed by Macquarie's Research analysts, over a 30-day period prior to an ex-dividend date, 62% of stocks outperform the market with the average and median excess return being 2.1% and 2.4% respectively*.

One neat way you can leverage into the banks and possibly enhance your yields and franking credit exposure is through using Instalments. The basic principle of leveraging into dividends is to buy an Instalment over a bank share before its ex-dividend date, hold the Instalment for 47 days (under the “45 day rule"#), and then sell it after the stock goes ex-dividend. The objective is to pick up the dividend, any franking credits attached to the dividend, and a potential capital gain at the same time.

The following table sets out the expected ex-dividend dates and forecast dividends for each of the five major banks about to report (according to MRE).

Tips for a successful strategy

1. Choose an Instalment that suits your view;
2. Calculate the break-even share price for your strategy;
3. Remember the “45 day rule”#; and
4. Remember the ex-date is not the "pay" date.

An example – Westpac (WBC)

James is an experienced investor looking to maximise the income from $10,000 of capital. James has a bullish view on WBC in the short term, and is keen to enhance his exposure to the upcoming dividend. WBC shares, trading at $26.50 per share and James expects to receive a $0.68 fully franked ordinary dividend.

Instead of purchasing $10,000 worth of WBC shares, James decides to purchase $10,000 worth of WBC Income Instalments at $6.50 (with a $23.00 Loan Amount, maturing in November). Assuming he is eligible, James could potentially be entitled to a full $0.68 dividend and franking credits.

The table below illustrates the comparative dividend yields and franking credits of WBC shares versus WBC Income Instalments.

The above is an illustrative example and figures only. Actual prices, dividends and franking credits may differ materially.

As the table indicates, potential forecasts dividends and franking credits are significantly greater from trading the Instalment as opposed to trading shares. In deciding between the ordinary shares and the Income Instalments, James must consider the risk of the additional share price exposure he would be taking on by purchasing the Instalments.

To find out more, talk to your adviser or ask Macquarie on 1800 803 010.

Visit: www.macquarie.com.au/instalments

* Macquarie Research Equities (MRE) Research, 16th January 2007
# This rule requires resident taxpayers to hold shares for a continuous period of at least
45 days (excluding the days of purchase and sale) to be eligible to receive franking benefits from dividends paid on shares. The “sufficiently at risk” condition means that the franking credit is denied if the resident taxpayer has eliminated 70 per cent or more of the ownership risk through other financial transactions during that period. That is, the rule also requires a 30 per cent minimum level of economic risk. There are some exceptions to the “45 day rule”. One of these is a small shareholder exemption which exempts shareholders from applying the “45 day rule” if they elect to limit the amount of total franking credits to which they are entitled. The exemption applies to all individual taxpayers with a total credit entitlement of $5000 or less.

Past performance is not a reliable indicator of future performance. Information is based on market conditions on the market conditions on the relevant table which may change without notice.

The above investment ideas and directional views are summaries based on research by Macquarie Research Equities (MRE), a wholly-owned subsidiary of Macquarie Group Limited. 

The research was based on market conditions at the time of writing which may change suddenly and without notice.  As the future matters described are of a predictive and variable nature, you should not rely them alone and discuss them with your adviser before making any investment decision. For example, they may be affected by assumptions that become inaccurate or by known or unknown risks and uncertainties.  Reports of the relevant research are available to your adviser from MRE on request. 

The investment ideas presented here are general and do not relate to you or Macquarie Instalments directly. MRE has not been involved in the creation of Macquarie Instalments and so does not endorse or recommend investing in it." 
This document is not an offer of securities or an invitation to apply for Macquarie Instalments. Macquarie Instalments are issued by Macquarie Bank Limited ABN 46 008 583 542 (“Macquarie”) and you should obtain a product disclosure statement (including the supplementary product disclosure statement (“PDS”) (if any) for the series of Macquarie Instalments you want to acquire) from www.macquarie.com.au and consider it before making any decision about whether to acquire, or to continue to hold, the product.

To acquire Macquarie Instalments, investors must complete the application form accompanying the PDS. This general advice has been prepared by Macquarie and does not take account your objectives, financial situation or needs. Before acting on this general advice, you should consider its appropriateness having regard to your situation. We recommend you obtain financial, legal and taxation advice before making any investment decision.

References to any entity (other than Macquarie) or security are included solely to identify the securities to which a hypothetical Macquarie Instalment relates. They should not be construed as  any express or implied endorsement by the entity of Macquarie Instalments or by Macquarie of the entity, its securities or products and services. Macquarie Group or its associates, officers or employees may have interests in the financial products referred to in this information by acting in various roles including as investment banker, underwriter or dealer, holder of principal positions, broker, lender or adviser. Macquarie Group or its associates may receive fees, brokerage or commissions for acting in those capacities. In addition, Macquarie Group or its associates, officers or employees may buy or sell the financial products as principal or agent and as such may effect transactions which are not consistent with any recommendations in the information.

To the extent permitted by law, Macquarie accepts no responsibility for errors, misstatements, negligent or otherwise, or for any direct, indirect, consequential or other loss arising from the use of any research information in this document. Information current as at 21 January 2008.