Dryblower on Opes Prime’s fatal flaws Monday, 7 April 2008 WHAT...

Dryblower on Opes Prime’s fatal flaws


Monday, 7 April 2008


WHAT did they do with the money, and why did they want it? Those are the two questions Dryblower would like answered as the Opes Prime margin call crisis rumbles through the Australian mining sector and threatens the careers of senior executives and stockbrokers alike.


So far, all interest has been on who’s caught, and what’s being sold. That’s understandable because Opes Prime is one of the best (or worst?) scandals to hit the small end of the mining industry.

Without getting too technical, what really happened is that a stockbroker had a bright idea about extending the coverage of margin loans to include small, and illiquid stocks – and then pooling them into a bigger bundle.

It was a fatally flawed plan from day one for two reasons. Small stocks are unsuited to margin lending. Pooling is no different to the way United States banks pooled sub-prime mortgages to hide the duds in the package.

To explain: margin lending is nothing more than an exotic, short-term, debt facility. The way it works is that a client offers his shares to a bank in return for a loan.

In the case of high-quality shares the loan might be up to 70% of the value of the underlying asset. The weaker the shares offered, the smaller the proportion of the loan.

In essence, margin lending is only as good as the quality of the underlying asset, and the relationship between the bank and the customers. That’s why big banks only lend to their best clients on premium quality stocks such as BHP Billiton, Rio Tinto, or other top 100 listed stocks.

The reason for being so fussy is that in a correction these are the stocks which can be sold quickly, and easily.

Opes Prime seems to have bent quite a few rules. It made loans on small and illiquid stocks, it pooled the shares offered as security, and someone in the brokerage appears to have made decisions to protect favoured customers from calls from the banks to put up more security when share prices fell.

In the end it was the pooling that caused most of the trouble.

So far, so good; that’s Opes Prime from the banking side of the story.

What Dryblower is now asking is what did the customers do with the money loaned to them, and why did they want it in the first place?

Was a loan from Opes Prime used to buy more shares in the company against which the loan was made?

For example, did investors borrow money from Merrill Lynch or the ANZ Bank via an Opes Prime facility to buy more shares in their own company?

Or, given that many of the victims of Opes Prime live in Perth did they use their loans to “keep up with the Jones’ ” – a polite way of saying the debt went on funding lifestyle.

This is a real possibility because when you’re a director or senior executive of a small company you cannot be seen to be selling shares in your own company.

But, if those shares represent your biggest single asset, and everyone else in town is driving a Porsche Cayenne, or a BMW X5 then you want one too.

The problem, as mentioned above, is that it would be unacceptable to sell some of your shares, and banks will not lend against your portfolio – making an Opes Prime margin loan a tempting way to raise money to fund a high lifestyle.

What now? Opes Prime has gone. The shares you once owned have been sold. You might get back a small dividend from the receiver – and you still have to service the debt on the Porsche and/or the Beemer.

And, sometime soon, you will be asked to explain how you lost your shares, and whether you really are sufficiently competent to continue managing other people’s money in a public listed company.