Warnings on ‘high-yield’ products reach fever pitch

The Australian

Tread carefully on how you navigate the current landscape given everything appears calm on the surface.

What exactly is a term deposit? It’s time to start distinguishing between government guaranteed bank term deposits and high yield deposits offered over a certain “term” by a range of promoters.

The issue is suddenly on the agenda as the hunt for yield gets ever more desperate after the recent cuts in bank dividends.

Just last week the market regulator, ASIC, went as far issuing a major warning about anything that presents as an “alternative” to bank-based term deposits.

As the regulator explained: “ASIC warns consumers about investment advertising that compares fixed-term investment products to bank term deposits. A surge in such marketing of fixed-term investment products in recent months has prompted ASIC to caution consumers to take care making investment decisions based on such advertising.”

The regulator then spelled out the problem: “ASIC views these investment products as riskier than term deposits because they may be issued by entities that are not well-capitalised, not protected by the government’s Financial Claims Scheme, and not supervised by the Australian Prudential Regulation Authority (APRA). Some are also backed by concentrated portfolios of higher risk unlisted and illiquid assets.”

One of the more prominent in advertisers in this sector is Mayfair101, which recently froze redemptions on two of their products. Now entangled in a lawsuit with ASIC over misleading and deceptive conduct, ASIC said 185 investors poured $73m into M+ fixed-income notes while another 96 invested $67.7m into M core fixed income notes. It has been made public that 12 investors have been unable to withdraw $4.4m due to the redemption freeze.

Mayfair is perhaps the most prominent and controversial operator in the sector but there are a range of firms, which offer “term” investments from 48-hour accounts up to four-year term accounts.

Investors can also earn from 6 per cent interest with peer-to-peer lending. In other words, you lend your money on a secured basis against a residential or commercial property that someone wishes to obtain finance over.

The issue for you – the potential depositor — is to check the fine print. Typically a product promoter website might present a disclaimer which says something like: “ … We have 12 months within which to honour your redemption request if there is insufficient liquidity in this account at the time of your request …”

Josh Dalton, certified financial planner with boutique advisory firm Dalton Financial Partners says: “We are not keen on residential backed security investments — often there are high management costs and even trailing commissions”.

Needless to say, with cash rates at about 1 per cent just now, investors are very attracted by rates at these levels.

In the private lending market, smaller banks and non-bank lenders have not been able to access the $100bn emergency funding facility offered by the Reserve Bank of Australia to keep lending and stay afloat during these difficult times. As such, these smaller players who are getting interest abatement requests from their borrowers, may start to eat into their cash reserves to keep paying investors the promised rates of returns.

Once their ability to continue paying interest diminishes, the likely course of action would be to reduce interest payments, which would likely see a rush to the exit from investors as they smell something is amiss, and potentially trigger a freeze on redemptions.

For anyone entering the non-bank market in search of high yield, Tom Sherston, head of sales at Balmain, a well-established player in the secured mortgage market which settles $4bn of commercial loans annually says: “Investors should look firstly at the financial capacity, track record and experience of the loan manager. Once satisfied, they should then look under the hood of the loan portfolio and assess the risks, just like the manager did when they lent the money out.”

Sherston notes the four main areas to review in the mortgage lending market are:

Are they experienced? Is the amount of funding they are seeking commensurate with their personal net worth? Are they contributing “hard cash equity” to the project? Can they fix an issue if something goes wrong? Have they completed similar projects in the past? What other borrowings or projects do they have on? Are the directors providing guarantees and are those guarantees strong?

Security Property
Is it well located? Are the borrower’s plans for the property sensible and supported by market evidence? Is the concept pioneering? Does the proposed feasibility make financial sense? Is there strong market evidence to support the purchase price? Is there a broad buyer market for the asset if we had to sell? What is the loan as a percentage of the real value of the property?

Does the borrower have the financial capacity to pay the interest? Do they have other borrowings that may affect their ability to service this loan? Are they prepaying the interest and what capacity do they have to meet payments if there is a delay and further interest is required to be paid?

How is the loan going to be repaid? Is it a refinance into a construction loan. Is it from the sale of the property? Is it from refinance to a bank once transitional improvements are completed? Will the borrower repay from cash and if so where is that cash coming from and do we have guarantees from that entity? Is the borrower’s exit strategy sound?

So for those who are looking for above cash rates of interest and are prepared to take a greater level of risk over where their money is invested, tread carefully on how you navigate the current landscape given everything appears calm on the surface, but has an undercurrent of uncertainty and fear.

About the author

James Gerrard is the principal and director of financial planning firm FinancialAdvisor.com.au