Long Positions

Say a customer bought 1,000 shares @40 and made the required Reg T deposit of half or $20,000. At that point, the customer's account looks like this:
LMV       -     Dr               =    Equity         Reg T Deposit
$40000      -     $20000           =   $20000        $20000    

LMV stands for "long market value." It could be referred to as "market value" or "current market value." The "Dr" stands for "debit register," which can also be called the "debit balance." This is the amount the customer borrowed and owes his broker-dealer, like the mortgage balance that the homeowner owes the lender.

So, the long market value of the stock he bought is $40,000. He made the required Reg T deposit of half, or $20,000. The broker-dealer advanced him the other half, so it's a debit to the client's account until he pays it off.

The customer now owns an asset worth 40K but he owes 20K to the lender. That's why his equity is $20,000. Just like if you owed $80,000 on your mortgage when your house was worth $100,000—the difference of $20,000 would be your equity.

Equity, Excess Equity
If the stock rises, to $50 a share, the account looks like this:

LMV       -            Dr             =    Equity         Reg T Deposit
$50000     -       $20000          =   $30000        $25000           

The amount owed to the broker-dealer didn't change the long market value of the stock went up, increasing the equity dollar-for-dollar. Now, let's compare the equity of $30,000 to Reg T, which is 50% of the market value. Half of 50K is $25,000. The customer has $30,000 of equity.
That's excess equity of $5,000:
LMV       -            Dr             =    Equity     -      Reg T Deposit   =   Excess Equity   
$50000     -      $20000           =    $30000    -       $25000              =    $5000               

Since this customer has excess equity of $5,000, $5,000 is credited to a special line item called "SMA." SMA, which stands for Special Memorandum Account, is a line of credit the customer can tap.

So, he can withdraw $5,000 of his cash, like in a savings account?
No. The $5,000 is just a number. But, if the customer wants to borrow that amount of money, he can. And whenever he borrows from SMA, that amount is added to the debit balance. The customer can just tell the broker-dealer to cut him a check for $5,000, which will be added to his tab, like this:
LMV       -            Dr             =    Equity        
$50000     -       $25000          =   $25000       

Borrowing the cash didn't affect the long market value of the securities. We added the amount borrowed to the debit balance, which reduced equity and wiped out the SMA.

SMA can be used as a cash advance that will be repaid with interest. Or, SMA can be used as an initial margin requirement for the purchase of more stock. So, instead of borrowing the cash, the customer could have used the $5,000 SMA credit to purchase $10,000 of stock.
If so, the account would have looked like this:
LMV    -            Dr           =    Equity           SMA       
$50000     -       $25000        =    $25000            $0   

If the customer buys more stock, that adds to the market value of securities held long in the account. Why did his debit balance go up by $10,000? Because the customer in our example used his line of credit as his margin deposit, and the broker-dealer fronted him the other half, or $5,000, which is also added to the Debit. So, he borrowed $5,000 from his line of credit (SMA), plus $5,000 that the broker-dealer fronted him for the additional stock purchase.

When dividends, interest, or capital gains distributions from mutual funds come into the account, that income is applied to the debit balance. Therefore, SMA is affected by such income being applied to the debit.

Reg T requires that a customer put up 50% of the long market value initially. After that, what happens if the customer's equity dips below 50%?
Not much. Even though the account is called "restricted," there really aren't many restrictions. The customer is required to put up 1/2 to buy more stock. If the customer sells stock, he can borrow 1/2 the proceeds. He can do that provided it doesn't bring him below the minimum equity of $2,000, that is.

Surprisingly, when the market value of a securities position drops, that does not affect SMA. It reduces the market value of the stock and, therefore, the equity, but SMA is just a line of credit. It does not get taken away. The customer can always use SMA so long as using it does not take him below the minimum maintenance requirement, which we're about to look at.

Minimum Maintenance
Reg T dictates what to put down on an initial transaction, and any excess above Reg T gives the customer excess equity. But excess equity is a term used when the market is cooperating with the margin customer.

What happens when the market goes the wrong way? Suddenly, the customer's equity is deficient, and he either must throw more cash on the fire or put the fire out by liquidating securities. Broker-dealers do not have to consult with customers before selling positions to pay down debit balances. Unlike a mortgage lender foreclosing on a property with notice, the broker-dealer just sells the depressed property if the market price is dropping fast.

Reg T requirements apply initially and then help us figure if the customer has excess equity or buying power. But, the customer's larger concern is the SRO minimum maintenance requirement. The regulators say that a customer's equity cannot go lower than 25% of the long market value. If it does, the customer gets a maintenance call to bring the equity up to the minimum 25%. If the customer can't deliver the cash, the firm sells securities equal to four times the amount of the maintenance call:

LMV             Dr             Equity           Minimum       Call        Liquidate       
$40000      $25000        $20000           $10000              $0             $0             

At this point, the customer has twice as much equity as the minimum (25% of long market value).
If the stock goes from 40K down to 30K, he i okay:

LMV             Dr             Equity           Minimum       Call        Liquidate       
$30000      $20000        $10000           $7500              $0             $0                

But, if the market value falls to 24K, he is in trouble:
LMV             Dr             Equity           Minimum       Call        Liquidate       
$24000      $20000        $4000           $6000              $2000        $8000             

The SROs demand $6,000 in equity, which is 1/4 of $24,000. The customer has only $4,000. So, the customer gets a maintenance call informing him that he must deliver $2,000. If the customer does that, the account looks like this:

LMV             Dr             Equity           Minimum       Call        Liquidate       
  $24000      $18000        $6000           $6000              $0        $0                   

He paid down the debit by $2,000 and now has $6,000 in equity, the bare minimum of 25% of market value.
If he didn't have the cash, the firm would have liquidated $8,000 worth of securities. If so, the account would have looked like this:
LMV             Dr             Equity           Minimum             
  $16000      $12000        $4000           $4000                    
Selling the $8,000 worth of securities reduced the market value and the debit by an equal amount, leaving the customer with exactly 25% equity.
Also, the 25% requirement is the minimum maintenance. Many broker-dealers require a higher minimum maintenance than just 25% to protect themselves. For example, 33% is often used, the difference between 114th and 1/3rd the stock's market value. The regulators are fine with that, so long as the firm does not let equity drop below 25%.

Account at Maintenance
In the example above the investor received a maintenance call when the market value dropped to $24,000. Luckily, he doesn't have to wait for such a drastic outcome before realizing the phone is about to ring. Back when he established the long position the market value was $40,000 and the debit balance $20,000.

At that point, we can calculate the account at maintenance by dividing the debit by .75.
When we divide $20,000 by .75, we see that the lowest account value allowed before a maintenance call is $26,667. To double check that, we can take the equity that would be in the account--$6,667--and see if that is 25% of $26,667. It is. But any further drops will lead to more calls.


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