Investment loans, also known as leverage loans, are growing feverishly in Canada, particularly at financial institutions that work closely with independent financial advisors.
Leverage loans are when people borrow money to invest either in mutual funds or segregated funds. This investment strategy lets consumers expand their portfolio without having to touch capital invested elsewhere.
Manulife Bank saw this business segment soar by 61% between November 2003 and 2004. Investment loans skyrocketed from $713 million to $1.15 billion during this period, according to data compiled by the Office of the Superintendent of Financial Institutions (OSFI) (note: this data may include a small portion of loans other than leverage loans).
AGF Trust reported growth of 51% as leverage loans ballooned from $280 million to $423 million in the same one-year comparison period.
OSFI noted that B2B Trust, a Laurentian Bank subsidiary continued to dominate Canadian investment loans earmarked for mutual funds and segregated funds with a total of $1.2 billion at November 30. ING Bank lags far behind with $358 million, and MRS Trust with $190 million. Details from TD Canada Trust were not available at press time (see table).
Several factors stoked this sharp growth, explained Rock Dumais, regional vice-president sales at Manulife Investments to The Insurance Journal.
For one, the bullish performance of stock markets in 2004 powered an increase in investment loans, Mr. Dumais noted. Growing consumer awareness also aided this growth.
Mr. Dumais underscored the main increases in loans already in effect, notably in Manulife’s “Quick Loan” product line. These loans range from $10,000 to $50,000 with no margin calls, and only the interest is repaid monthly by clients.
“We saw growth in the volume of existing loans. The market performance was good and several clients wanted to tap into the growth by requesting that their loan amount be adjusted upward,” Mr. Dumais explained. Word of mouth also worked in Manulife’s favour, with spouses of clients applying for loans.
Manulife Financial’s acquisition of John Hancock Financial Services and its subsidiary, Maritime Life at the start of last year widened the pool of potential representatives. “Manulife became the largest insurer in Canada,” Mr. Dumais continued. “All this publicity had a ripple effect on Maritime Life representatives, and on the representatives affiliated with the competition. They began to place more business at Manulife.”
The growth of leverage loans at AGF is the culmination of three years of work, said John Bennett, vice-president, products and services. “AGF was not active in this market until three years ago. When you start with a base of zero, obviously you grow,” he explained.
Another winning strategy is the publicity blitz AGF aimed at its affiliated representatives, which highlighted its line of investment loans. Mr. Bennett said that “we’ve done a number of innovative products and approaches to the investment loan business vis-à-vis financial advisors. And we are gathering advisor clientele and they are bringing their business to AGF.”
The rise in popularity of leverage loans without margin calls has been instrumental to this business growth. Margin calls are made when the securities bought with the money from leverage loans plunge sharply. Borrowers are then asked to repay some or all of the loan.
Investors that borrow without margin calls are not obliged to place the assets acquired as collateral, as they do with margin-call loans, Mr. Bennett explained. At most, they have to pay the interest on the loan on a monthly basis. “We do both margin and no margin calls. The business as of late has been toward the no-margin options,” he said.
This stance was echoed by Gilles Sinclair, assistant vice-president at B2B Trust. “This sector has been fairly calm in 2004. We then saw a rebound when our new product without margin calls was marketed,” he said. Loans granted by B2B Trust remained stable at $1.2 billion between November 2003 and November 2004.
Mr. Dumais added that most of the Manulife leverage loans are contracted to buy segregated funds. Even if the amounts of these loans far exceed $50,000, the assets purchased are never required as a guarantee by the financial institution. “Segregated funds already offer a guarantee of principal at maturity. That’s the nature of the product.”
But will consumers continue to borrow to invest with projected stock market returns hovering below 10% for the next ten years? The forecasts are just that: predictions, the sources unanimously retorted.
Interest on leverage loans is still tax deductible, said John Bennett of AGF. Even if investors borrow at an interest rate of 6% (higher than the market rate, which ranges from 4% to 4.5%), after the deduction the interest rate is less than the lending rate. “One big advantage is that you don’t need that high of a return as you would otherwise for it to remain interesting,” Mr. Bennett commented.
No one can precisely predict market fluctuations, Mr. Dumais countered. “For 2003, the forecasts pointed to single-digit returns. In fact, we saw double digit returns. It is impossible to predict performance,” Mr. Dumais insisted. He pointed out that historically, over a 10-year period, the markets have never generated negative returns.
“In the 1980s, mortgages were at 20%. All the analysts predicted that we would never again pay rates of 8% like in our parents’ day. And now look, in 2005, mortgage rates stand at 6%.”