Why are margin maintenance requirements based on total account value and not just the margin debt?

Question

Just reading through Charles Schwab's margin brochure and saw this section...

The securities used as collateral must maintain a minimum value relative to the account’s margin debit balance. Schwab’s basic maintenance requirement for equity securities (“stock”) is 30% of the current market value of the security; however, this varies depending on the type of security.

So we see that the min. req. is based on the total value of the securities in the account that were purchased in any part on margin (I'm assuming this is the case meant to be illustrated here and not that that it's based on the total market value of the account (though my question would still make sense in both cases)), eg. 30% of $12k is $3.6k.

My question is: what is the logic of having the min. reqs. be based on the total equity value of the securities that have some margin money used in them and not just the value of the actual margin debt?

Because from this it seems like if you bought $100k worth of stock and $1k of that was bought on margin, then the min. req. is going to be $100k x 0.3 = $30k, which seems odd relative to the amount borrowed. Am I misinterpreting something here? Do let me know. Never used margin and don't know which way would be better or worse, just curious.

Answer 1

In your example( of Charles Schwab's margin brochure ) when the stock was purchased margin debt was $5000 and Client Equity was $5000 and required Min Equity was $2k, so at that time client can further borrow $5k-$2k= $3k.

When price of the stock rise( if it does ?) , per example, then $7000-$3600 = $3400 can be borrowed. That is additional $400 can be borrowed.

Be careful when borrowing money ...

Answer 2

Because from this it seems like if you bought $100k worth of stock and $1k of that was bought on margin, then the min. req. is going to be $100k x 0.3 = $30k, which seems odd relative to the amount borrowed. Am I misinterpreting something here?

Yes, you are misinterpreting this. If you buy $100k of stock with $99k, you are at a 99% margin coverage.

My question is: what is the logic of having the min. reqs. be based on the total equity value of the securities that have some margin money used in them and not just the value of the actual margin debt?

Schwab is simply telling you the minimum margin maintenance amount without displaying the details of the margin calculations. To calculate it:

1) Determine the amount borrowed:

• Subtract the margin requirement from 1 and multiply by the purchase price.

• If $10k on 50% margin then amount borrowed is $5k

2) Determine the maximum percent of borrowed money allowed:

• Subtract the maintenance margin requirement from 1.
• Using FINRA's 25%, it would be (1 minus 0.25) or .75

3) Determine the maintenance level:

• Divide (1) by (2).
• $5,000 / .75 equals $6.666.67

$6,666.67 Market Value

$1,666.67 Equity

Equity / Market Value = 25%

The short way to determine the 25% MMMR level is 4/3 times the loan balance.

• $5,000 x 4 / 3 = $6,666.67 (10/7 for 30% MMR)

To visualize this:

  MV    Loan  Equity    Marg %    Schwab 
                                 .30*MV

10,000  5,000  5,000     0.500     3,000

 7,143  5,000  2,143     0.300     2,143

 6,667  5,000  1,667     0.250     2,000


 6,000  5,000  1,000     0.167     1,800

$7,143 would be the MMMR at 30% $6,667 would be the MMMR at 25%

What Schwab is doing arrives at the same answer but from another direction. Further down in the example cited in their margin handbook, they demonstrated the position at a market value of $6,000 (the last line above). The equity is $1000 and the minimum is $1,800 (.30*MV) so an additional $800 is required to support the position. That then becomes the following which restores the position to 30% MMMR:

  MV    Loan  Equity    Marg %    

6,000  4,200  1,800     0.300

Answer 3

To address your last paragraph.

Because from this it seems like if you bought $100k worth of stock and $1k of that was bought on margin, then the min. req. is going to be $100k x 0.3 = $30k, which seems odd relative to the amount borrowed.[...]

You want to buy $100K worth of stock but only have $99K. I lend you $1000. I'm not worried about my loan to you, not unless the stock spirals into bankruptcy. In fact, I'm happy to lend you up to $30K cash total against that position.

If this was a one time deal, the $30K is not a concern. i.e. you see that you can borrow more, but don't need/want to. If, long term, you are comfortable with leverage, you can look at that number to see that you can borrow to buy more stock. What you are really looking for is $1000/.7 = $1428.57. This number $1.4K is the value the stock can drop to before the broker asks you to deposit more money. The $30K is a sign to you that you have little risk of a margin call.

(Note, my math was incorrect, editing that now) Look at it this way - to understand the maintenance requirement, if you owe $1000, and must have 30% equity, in effect, it's not unlike a mortgage where the bank offers a 70% LTV (loan to value). Therefore $1000 "is" 70%, and by dividing, you get the 100%, the value the stock can drop to before you get a margin call.