Boom In Warrant Loans

Sun Herald

Sunday June 20, 1999

By GILLIAN BULLOCK

THOUSANDS of investors, particularly those with do-it-yourself super funds, are jumping on the instalment warrant bandwagon as a way to leverage into the sharemarket and enjoy yields of up to 23 per cent.

But financial advisers warn that while you can measure your level of exposure, the instalments still carry risk.

The key players in the market, BT, Salomon Smith Barney and Warburg Dillon Read, have been rushing out new instalment warrants to cash in before the end of the financial year so investors can make their tax-deductible interest payments.

Salomon Smith Barney issued 10 new "high yield securities" last week.

As the table shows, you eventually pay more for the warrants than if you bought the shares right now. For example, an ANZ Bank instalment warrant would cost $4.23 now and $10 later, compared with the underlying share price used by Salomon Smith Barney of $11.18.

But by the time of the second payment, you hope, the shares are worth, say, $15.

The appeal of instalment warrants is that although they still carry the risk of the market heading south, the amount you can lose is limited to your first instalment which can be as low as 20pc of the underlying share price.

When the final instalment falls due - usually in 18 months - you can just walk away. But you have, of course, lost the first payment and the interest paid in advance to get the tax deduction.

Alternatively, you can pay the final instalment and take delivery of the shares or roll the security over for another 18 months. The choice is yours, determined by what has happened to the share price.

Investors are punting on the market continuing to be bullish or at least have a positive view on the individual companies.

If you chose to neither pay the final instalment nor roll over the investment and the price had gone up you would receive the difference between the final instalment and the current price.

But if the shares had fallen, you'd lose your first instalment payment. Given the average investment is $10,000 this is not to be sneezed at.

That first instalment carries a reasonably hefty premium, says Charter Financial Services adviser Evan Davies.

"I wouldn't necessarily recommend them to individual investors, but rather to an aggressive high-growth superannuation fund," said Mr Davies.

Knowing your maximum exposure is much the same as if you were buying shares outright with cash.

The problems in gearing into the sharemarket really arise when you take up a margin lending product which lets you borrow up to 70pc of the value of the investment. If the share price - and your investment - falls and your equity drops below 70pc, then you have to make a margin payment to top up your equity.

This is compounded further if you have borrowed against the equity in your home to gear into the market.

In the worst-case scenario, a share price plunge on a margin loan means you could lose your family home.

This uncertainty with margin lending explains the growing appeal of instalment warrants, says Salomon Smith Barney's manager of structured equity sales Paul De Lange.

Warrants are issued by a third party and not the company whose shares you are buying.

Current warrants include ANZ Bank, Foster's, National Australia Bank and Pacific Dunlop.

The cost is determined by the underlying share price, with interest costs and a risk premium factored into the first instalment.

During the warrant's life you will receive dividends as if you fully owned the shares even though you've only paid the first instalment.

This makes the yield on your investment outlay significantly higher than had you paid cash for the actual shares.

Most companies represented by instalment warrants enjoy reasonably high levels of franking, so investors can also benefit from dividend imputation. And your interest payments on the investment are tax deductible.

You can also trade the instalment warrants before maturity although Mark Small, senior vice-president of BT structured equities, says a typical instalment investor has a medium to long-term investment time frame in mind.

HOW TO GET A HIGH YIELD
                              UPFRONT COST       YIELD (%)         FINAL COST
SHARE PRICE
ANZ                            $4.23                           19.8
           $10              $11.18
BankWest                   $1.24                           20.1
         $3                 $3.40
Boral                              99?                           23.7
               $2                  $2.41
Foster's                      $1.57                           14.9
             $4                  $4.40
NationalBank              $8.50                            19.3
       $25                 $25.87
Pacific Dunlop                97?                           14.4
     $2.50                 $25.87
TAB                           $1.16                             12.2
         $2.50                  $3.00
Telstra                        $2.65                             10.0
         $7.50                   $7.74
Westpac                     $3.57                             20.3
         $10                 $10.25
Woodside                   $3.65                             12.2
         $10                 $10.20
Source: Salomon Smith Barney

© 1999 Sun Herald

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