Borrowing against securities holdings, generally known as "margin" credit, hasn't gotten a lot of attention lately.
That's hardly a surprise. Margin loans are most popular when stocks are going up and investors are looking for a way to up the ante in the hope of a bigger payoff. The market's performance in the past couple of years hasn't encouraged that kind of thinking.
But now one local bank is betting there are folks out there who, for a variety of reasons, would like to borrow in a margin-type transaction, using their mutual fund shares as security.
Bethesda-based Presidential Bank figures there are mutual fund holders who need money but don't want to sell their shares, either because they would have to recognize and pay taxes on a big capital gain or because they think the market is near its bottom and they want to remain fully invested when share prices start to rise.
Last month Presidential rolled out a program called FundCash, which is aimed at these investors, and the bank is now running an ad campaign for it.
But unlike typical margin lending, which is meant to enable investors to buy more shares, money borrowed from Presidential Bank's FundCash program can be used for anything but buying more securities. Putting that restriction on the loans allows Presidential to offer a greater loan-to-value ratio than would otherwise be permitted.
Margin lending, which ran wild during the 1920s and is widely thought to have contributed to the severity of the 1929 market crash, is now heavily regulated, primarily by the Federal Reserve but also in part by the Securities and Exchange Commission. The problem with buying stock on margin is that if the price of the shares declines, lenders demand more collateral, in the form of either cash or additional securities, and if the added collateral is not forthcoming the lenders can and will sell the borrower's shares to pay down the loan.
Not only does that wipe out the borrower's account, but in extreme circumstances -- where there is widespread selling -- margin calls and selling can worsen a market downturn.
Today loans secured by stock or other financial assets are divided into two types, "purpose" and "nonpurpose." Purpose loans are used to buy more stocks or bonds, and they are limited to 50 percent of the value of the assets used as security. Nonpurpose loans are used for anything else, and loan-to-value limits are higher.
Presidential is offering nonpurpose loans, and depending on which mutual funds a borrower owns, will lend up to 90 percent of the fund's value, said Susan Henry, trust custody manager at the bank. Borrowers retain ownership of their shares and can receive dividends and the like, but they must transfer the shares to the custody of the bank.
The loans carry an interest rate of 1 percentage point over the prime rate, with a floor of 5.75 percent, which is the current rate. There is also an activation fee, ranging from a point to around 13/4 points, depending on how much is borrowed. Interest is generally not tax-deductible.
Mechanically, the loans operate in ways similar to a home-equity line of credit: There is a "draw" period, during which borrowers can tap the account using special checks and repay interest only, then an eight-year repayment period during which the borrower has to pay the loan off.
But they remain margin loans, and if the value of the mutual fund shares falls too much, the borrower will be subject to a margin call and may be sold out if he or she does not meet that call.
Henry said the bank builds in a "cushion," meant to make margin calls less likely. For example, if the loan limit is 50 percent of the value of the shares, the share price would have to fall enough to raise the loan to 60 percent of the shares' value before the bank would issue a margin call, she said.
Although mutual funds are generally less volatile than individual stocks, margin calls are a very real risk that is not present in other kinds of loans, several local financial planners said. Borrowers, they said, should be very careful before taking on this kind of debt.
Presidential, though based in Bethesda, does much of its business over the Internet via its online subsidiary. It can be found at www.presidential.com.
The ingenuity that surfaces in the never-ending quest of the well-to-do and their heirs for ways around the estate tax is a source of considerable amazement to the general public and, presumably, to the Internal Revenue Service. But as clever as some of the ideas are, they don't always work.
For example, it is well established that the value of an asset in an estate can be reduced by the amount of obligations, such as debts, that are owed upon it. And it is also true that value can be reduced if an asset cannot readily be sold.
So consider the individual retirement account. If an account owner dies and money from the account is distributed to a beneficiary, such distributions are subject to income tax, right? Taxes are an obligation, right?
Further, transfer or assignment of an IRA can result in tax penalties, so as a practical matter you couldn't sell it.
So if the IRA is going to be subject to income tax in the hands of the heirs and if it can't readily be sold, its value should be discounted when calculating estate taxes, right?
Um, no, the IRS said last month.
Drawing an analogy to the sale of an installment note, the agency ruled in a recent technical advice memorandum (No. 200247001), the value is what a willing buyer would pay a willing seller. And in the case of an installment note, "the fact that the willing seller might incur income tax on the sale of the note does not impact on the sales price," the IRS said.
Further, the IRS pointed to a deduction allowed for "income in respect of a decedent" that allows heirs an income tax deduction for estate taxes paid on the note. An earlier court decision found that there was "no basis for supplementing this income tax relief with additional estate tax relief," the agency said.
As for the "marketability" discount, the IRS said that while there are indeed penalties for selling an IRA, "there are no restrictions preventing the distribution of assets to the beneficiaries after decedent's death . . . and the beneficiaries can then sell the assets to any willing buyer." Thus, an IRA is not entitled to this discount, either.
CPA Edward A. Slott of Rockville Centre, N.Y., said the ruling should lay to rest the suggestion -- which he said he has heard at conferences and other meetings of estate planners -- that these discount arguments will work for an IRA.
But Slott noted that the case should be a reminder to planners and heirs of the importance of the "income in respect of a decedent" deduction. IRAs present special tax problems in estates, and as they become larger and larger components of older people's assets, heirs and their advisers should be alert not to overlook the deduction, he said.
The number of credit cards carried by American adults was, on average, unchanged over the past year. The amount of debt charged on those cards, though, has risen 35 percent. The annual credit card survey by Myvesta, a debt-counseling and "financial health center" in Montgomery County, shows that the typical American has a balance of $3,250 on 2.5 cards, up from $2,411 last year.
Included among the findings:
* Male cardholders carry an average debt of $3,932; female, $2,584.
* Married individuals carry an average card debt of $4,436; singles, $1,651.
* People ages 18 to 24 have an average credit card debt of $849. Those 25 to 34 average $3,110; people 35 to 44 average $3,011; people 45 to 54 carry $5,276; those ages 55 to 64 average $6,911; and those 65 and older have an average card debt of $433.
* Cardholders in the Midwest maintain the largest balances -- an average of $5,140 each. Those in the West carry the smallest average balances: $2,077. Individuals in the South have an average balance of $2,795, and those in the Northeast carry an average of $3,333.