A margin loan is a facility given to an investor for the purpose of buying securities.  The loan is secured for the purpose of buying securities.  The loan is secured by investor’s collateral, which is usually a portfolio of securities.  An investor uses a margin loan when he or she does not have enough money to buy securities or otherwise take advantage of a potentially profitable rise in securities prices. 

Recent developments in the global financial system have not helped matters.  On August 4, 2009 the Central Bank of Nigeria in her effort to sanitize the Nigerian banking industry and rekindle investors interest, unilaterally sacked the Chief Executives and Executive Directors of 5 commercial banks based on unfavourable audit reports.  It was alleged that the audit exercise which is still ongoing by the apex bank i.e. Central Bank of Nigeria, found these 5 banks guilty of excessive reliance on life support for survival.  It was observed that some banks could at best be described as “insolvent”.  Indeed, there might not be a better description of their excessive reliance on the Central Bank of Nigeria for cash to meet investors’ need.  In a nutshell, they meet customers request for cash withdrawal through borrowings from the Central Bank.  These banks were cash-trapped as they were said to be highly geared. Indeed, the people they lent monies to for the purpose of purchasing shares, could not repay the loans as at when due.  The reason for non-repayment was obvious – the global financial meltdown affected the stock market negatively.  Investors were unable to sell their shares because doing so would be at a loss; and the banks could also not do so with the share certificates in their possession which was used as collateral.  Both parties were stuck between the devil and the sea.  What a dilemma!  Whether the action taken by the Central Bank of Nigeria was a democratic process or not and whether these banks were really guilty as pronounced, are not the issues for discussion now.  I am primarily concerned about the meaning of margin loan and its implication so as to advice borrowers appropriately.

It has also been observed that some investors sign off an agreement with partial understanding of the terms of the agreement.  They are usually over-shadowed by their ambitions and over look the necessary details at the start of a margin loan.  Before taking a margin loan, undertake the following exercise:

1.      Seek the advice of an expert on margin loans.

2.      Seek the advice of a lawyer to interpret the terms and conditions of the loan.

3.      Do not borrow an amount you cannot repay without selling the shares.

4.      Do not invest in any company without conducting financial appraisal of the company. See my article on http://hubpages.com/hub/How-to-analyze-the-financial-statements-of-a-company-before-taking-an-investment-decision

5.      Be careful what you use as collateral for loans.

Remember the first law of investment “Invest what you can afford to lose”.