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Protected loans for the cautious

THE weakness in global share markets has created a fertile environment for promoters of capital guaranteed share investment loans.

Protected lending currently is a relatively small part of the market, amounting to just over $550 million, according to the Reserve Bank.

This compares with the $10.1 billion of loans outstanding in the traditional margin lending market.

However, the risk of pro-longed weakness in share values may prompt more investors to assess protected loans.

Protected loans, like margin loans, are used by investors to buy shares or managed funds.

With traditional margin loans, the debt is limited to 70-80 per cent of the total value of the investment.

With protected loans, there is no such limit. Lenders such as ANZ Bank, Commonwealth Bank, Leveraged Equities and Macquarie Bank advance 100 per cent of the cost of buying shares or managed funds.

In ordinary circumstances this would be a very risky pro-position, since any fall in share values would trigger a ‘margin call’.

But with a protected loan, the investor is fully protected from any capital losses, yet they retain any capital gains.

When the loan matures, if specific shares have fallen in value, they are simply handed back to the lender as full re-payment of that portion of the loan.

If any shares have risen in value, the profits are retained by the investor. In addition, all dividends and franking credits are retained by the investor.

The ‘price’ that investors pay for this seeming win-win situation is an unusually high interest rate, currently averaging about 15.5 per cent a year com-pared with 7-8 per cent a year for a normal margin loan.

The extra interest payments allow the lender to purchase options, which enables them to manage their own risk.

Protected loans are ideal for investors with high incomes and low savings who want to build a share portfolio in a risk-controlled manner.

The main lenders all have a minimum loan size of $50,000, which generally allows the investor to purchase four or five different shares.

Investors can select shares from an approved list, ranging from 38 stocks at ANZ to more than 85 at Macquarie.

The loans offer potential tax benefits, since most of the interest payments can be deducted.

Commonwealth and Macquarie offer substantially more flexibility than other lenders. Their loans can be fixed or variable and the term can be from one year to five years.

In contrast, ANZ only offers a three-year fixed rate loan, while Leveraged Equities offers just two choices – three-year fixed rate or five-year fixed rate.

The interest rates charged by each bank are similar, averaging about 15.5 per cent a year for a three-year fixed-rate loan.

The interest rate can vary substantially depending on the underlying shares chosen by each investor.

For instance, ANZ charges just 14.7 per cent a year if an investor buys a portfolio comprising the four major banks.

At the other end of the spectrum, investors buying stocks such as Computershare and Newcrest Mining could pay about 19 per cent a year.

Macquarie allows investors to reduce their interest costs if they share some of the potential capital gains with the bank.

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