Tricom’s Irresponsible Margin Lending Similar to Subprime Scandal

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What the heck is going on at Tricom in Australia?

It’s not a story we’ve been following. But it seems like a shocker. It’s also a sign that the credit crisis has finally taken root in the Australian financial sector-even though it does not have anything directly to do with subprime loans. The root cause-irresponsible use of credit-is absolutely the same.

In Tricom’s case, it appears many investors were buying a lot of shares on margin. Last week’s 5% decline in markets forced margin calls, notably in Allco. But something unusual about Tricom’s structure has caused its creditors to force it to reduce its margin lending from a total of $2.5 billion at the beginning of the year to $1.5 billion now, and probably $1 billion in the near future.

What Adele Ferguson writes in today’s Australian suggests that Tricom wasn’t that much different than a subprime lender in the States, extending credit to borrowers without doing a lot of background checks. “The most likely reason a client goes to Tricom is because Tricom does not require the documentation of other margin lenders, such as ability to prove financial worth or ability to pay.” Tricom told investors that it had come up with a “smarter way to invest,” namely using someone else’s money.

“One broker said Tricom did not require the documents demanded by other margin lenders, such as the ability to prove financial worth or the ability to pay,” she continues. But as we’ve seen in the last week, it’s not all roses and candy canes for Tricom’s clients. “When a client takes out a securities lending agreement, the shares the client buys are transferred to Tricom, which takes on the beneficial ownership of the shares. This means the client takes on Tricom’s credit risk.”

This is the problem investors now, they have all of the risk and none of the benefits of ownership. We’re not suggesting this particular problem may surface elsewhere. We’re saying this is the sort of thing that happens in an easy credit era. People get reckless with risk. That reckless behaviour is showing up all over the Australian financial sector. It’s what seems to be moving the Aussie market now, too. So how much worse can it get?

“RAMS, Centro, MFS, Allco, forced sellers of shares bought on margin, and now Tricom. The list grows. Is it all pointing to a bigger, broader implosion,” asks Terry McCrann in his Herald Sun column today.

“All the signs are that the individual problems are – broadly – contained to the individual entities. Apart from that qualification ‘broadly’, that they show no signs of triggering wider unravellings,” he answers.

Really?

He goes on to make the point that there is no crisis in the quality of assets at most Australian financial institutions (as in previous crises) and that this current crisis-at RAMS, Centro, MFS, Allco, and now Tricom-is “entity specific,” and not yet “systemic.”

But isn’t that a little like looking at an emergency ward full of influenza patients and saying that each incidence of pulmonary edema is “entity specific?”

“Hey, that guy’s lungs are filling with fluid. And so are his…and his…and his.”

A doctor seeing the same symptoms in so many patients-or even just a reasonably intelligent observer of what’s happening in front of his eyes-would conclude that there is a common cause to the outbreak.

In the case of Australian financial institutions the common cause is obvious: the use and abuse of credit. As positive as Australia’s underlying economic relationship with China is, there have been excesses in the credit market here too, notably in housing and apparently in margin lending. Those will have to be liquidated before the market can move higher with any conviction.

Dan Denning
The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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