Higher returns come with risk

By Andrew Goode, Mellor Olsson Lawyers

One of the principles of investment is that the higher the rate of investment return, the higher the risk of a loss. Like all principles it does not always apply, but sadly sometimes it does.

In October 2012 Banksia Securities Limited ("Banksia") ran into financial troubles. Receivers were appointed to Banksia in October 2012.

Banksia was a Victorian country based financier based in Kyabram that operated a mortgage financing business. Essentially, investors lent money to Banksia at a specified rate of interest. A trustee was appointed to protect the investors and the monies were then lent to borrowers. Investors received a security called a debenture and earned a higher interest rate than you would expect from our major Banks.

Looking at the website for Banksia I note that it is referred to as "your non bank alternative". That should sound a warning bell as to the risk, although I hasten to add that most if not all building societies and credit unions have similar protection to the banks under a Government Guarantee that I refer to below.

When the receivers were first appointed they noted that Banksia owed approximately $660,000,000.00 to investors and had advanced their funds to borrowers primarily to finance real property purchases. Banksia held first ranking real property mortgages to secure those advances.

Banksia was clearly a serious player in regional Victoria and elsewhere, and its collapse has been devastating to investors, employees and many others.

The receivers are working to sell off Banksia’s assets and repay the investors, although the amount that the investors will receive by way of total dividend still remains uncertain. In the meantime however investment returns are frozen.

Investors have now received an initial payment of 20 cents in the dollar but for many it will be a very tough time.

I can’t tell you what Banksia’s interest rates or offer terms were as that information cannot now be accessed through the website but I am confident the interest rate would have been more than you would expect to get from a financial institution such as the big four local banks which are regulated by the Australian Prudential Regulation Authority ("APRA").

While interest rates seem pretty low with our big banks, and the other financial institutions regulated by APRA, which are also known as Authorised Deposit-taking Institutions ("ADIs"), what you do get with a new deposit is a guarantee from the Federal Government of up to $250,000.00 if one of those ADIs became insolvent. There was no such guarantee when you lent money to Banksia nor to any similar financier of that kind which is not an ADI.

The ADIs include many financial institutions other than the big four banks, and they are also regulated by APRA. You can access the list on the APRA website and will see the ADls include other Australian banks, certain foreign subsidiary banks and branches of foreign banks, as well as building societies and credit unions. If in doubt ask the borrower to confirm they are an ADl with the government guarantee.

While ASIC have some regulatory powers in relation to Banksia and similar financiers it cannot be everywhere all the time, and also its power to regulate is less extensive than APRA’s power to regulate ADIs.

ASIC has announced an internal task force to look at the failure of Banksia and the general regulation of similar financiers operating in the Australian unlisted debenture sector.

In the meantime I think it is fair to say, (as a generalisation) that if you invest in an unlisted debenture company like Banksia, your money is at a higher risk than if you put it in one of the ADIs, for a number of reasons, including that the ADIs are regulated by APRA with its extensive powers, and they have a Federal government guarantee for up to $250,000.00.

I am not saying that you should necessarily ignore the unlisted debenture sector but you need to understand the higher level of risk.

If you want to sleep better at night and are prepared to accept a lower investment return, you might prefer to invest funds in an ADI. However, if you prefer to take a risk and go for a higher rate of return, and decide to look elsewhere, don’t say you have not been warned.

Details: Andrew Goode e: agoode@mellorolsson.com.au or Phone: 8414 3400

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