A warranty for your investments

What is an investment warranty and does it mean your money in a mortgage trust is safe?
 
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01.Guidelines needed

Eggs
  • Despite Equititrust’s ‘safe’ marketing pitch, mortgage and property backed investments, which comprise a multi-billion dollar sector, are relatively risky when compared to safer investments offering comparable returns, such as competitive bank deposits. There's information about the risks, taken from Equititrust's Product Disclosure Statement (PDS), in 'Buyer beware', below.
  • Whether the ‘warranty’ is paid out if an investment fails is "dependent on Equititrust Limited’s capacity to meet the warranty obligations as disclosed in the PDS", according to the company's advertisement. The PDS states that, "Despite the warranties provided by Equititrust, there can be no guarantee of a return of capital or income."

“You wouldn’t buy a telly without a warranty … so why would you invest without one?” That’s the question asked in advertisements from a company called Equititrust, which offers fixed income investments and the opportunity to “earn 9.5 percent pa warranted”. One advert depicts a man tearing his hair out as smoke billows from his TV. In another ad, a woman sprays a toaster that’s caught fire.

If you read the money supplements in newspapers such as The Age and the Sydney Morning Herald, you might have seen these prominent ads and, like us, wondered what they mean.

Equititrust’s marketing pitch for its mortgage trust is centred around its supposed safety. But is an investment ‘warranty’ real protection? Will it protect you if your investment blows up, just like the TV in the ad?

Please note: this information was current as of June 2008 but is still a useful guide to today's market.


The company

  • Equititrust is based on Queensland’s Gold Coast and says it’s never failed to repay investors their capital or interest. “Established in 1993, its origins trace to the law firm, McIvor Coghlan, servicing mortgage investment clients since 1982,” according to Equititrust’s Product Disclosure Statement (PDS).
  • Equititrust advertises fixed-interest returns to investors, generally lending their money out at higher interest rates than banks.
  • Equititrust isn’t an authorised deposit-taking institution (ADIs are banks, building societies and credit unions that are licensed to offer deposit accounts to consumers), so it’s not regulated by the Australian Prudential Regulation Authority.

The scheme

  • It’s a mortgage trust with about $419 million of investors’ money.
  • Sixty-three percent of the money Equititrust lends is for development loans to property developers to finance their projects. The property is put up as security for the loans. The remaining 37 percent is for other types of property loans.

The ‘warranty’

  • This word isn’t used by the mainstream financial services industry, and has a different legal meaning to terms like ‘guarantee’ or ‘instalment warrant’.
  • In this case, Equititrust puts $10 million aside as a ‘capital warranty’ to repay investors if the company or its loans get into trouble — for example, if the loans aren’t repaid.
  • However, that $10 million represents just 2.4 percent of funds invested.
  • Equititrust offers a further "income warranty" that’s “unlimited”. The company’s balance sheet, included in the PDS, indicates that it has about $55 million in assets. When $9 million of liabilities are subtracted, the company’s total equity is $46 million. This is "more than sufficient to satisfy the capital and income warranties," according to the company’s lawyers.
  • However, the PDS states, “Despite the warranties provided by Equititrust, there can be no guarantee of a return of capital or income.”

The risk and return

  • The PDS states, “There may be loss of income or principal invested and delays in repayment.”
  • Interest rates of 8.25 percent to 9.75 percent.

Buyer beware

The PDS (available online) details the risks of investing. For example:

  • Equititrust isn’t nearly as strict as a bank when assessing a borrower’s credentials. For example, the PDS says, “Borrowers’ prior loan history may be less relevant [than a bank would deem it], ability to service [repay the loan or interest] may not be demonstrated, for development loans less or no pre-sales or pre-leasing may be required, borrowers may not have a proven history, loans may be approved and settled in a shorter timeframe.”
  • Equititrust lends most of investors’ money to companies and developers at relatively high interest rates (about half the money is lent at 11.5 percent to 11.9 percent, and another third at more than 12 percent). Some of these borrowers would be unable to get loans at more reasonable mainstream bank rates — the PDS explains that banks may not accept the risk. “Equititrust operates in a specific lending niche as an alternative to traditional bank lending or when these sources are unable to assist … the risks of providing loans to such borrowers may be higher than those accepted by traditional banks.”
  • Seventy-seven percent of the loans have capitalised interest. This means that the future interest payments borrowers would have to pay are added to the size of the loan at the start. Equititrust says this is common in development lending and a practice often used by banks and other experienced financiers.
  • Some of the property or land valuations are done on an ‘on completion’ basis. This means that the security for loans is based on the property development being completed (and building or development may not have started yet). Equititrust’s PDS states that with development loans, there’s a risk of non-completion of the project.
  • The company doesn’t have a credit rating (for example, by an organisation like Standard & Poor’s). Its credentials haven’t been independently researched by a credit rating agency or investment research house, meaning it wouldn’t generally be on the lists of approved products used by professional fund managers and investors.

CHOICE verdict

If safety for a 6–24 month investment term is what you’re looking for, you’d be a lot safer with your money in a bank. Banks are prudentially regulated, and some of their term deposit rates are almost as good as Equititrust’s.

For example, at the time of writing, Bank of Queensland was paying a special 8.45 percent pa on six-month term deposits, just 0.05 percent less than Equititrust’s rate for a six month deposit of between $10,000 and $99,999. Even if you invested $100,000 for a year with Equititrust, the present rate you’d get (9.25 percent) is less than 1 percent better than the best bank deposit rates. A one percent difference on a $100,000 investment is only worth $1000 extra interest over a year.

Opinion: better advertising regulation needed

In April 2008, ASIC took action against Equititrust’s previous advertising and PDS. It ordered that adverts couldn’t imply that the investment is suitable for a particular class of investor such as retirees, or comparable to a bank deposit. ASIC also stipulated that Equititrust can’t advertise words like 'safety', 'secure', 'warranty' without stating the size of the warranty and the size of the income fund. Following the action, Equititrust’s advertising and PDS promptly complied with these new requirements.

We think that 'high-yield' fixed interest mortgage trusts, such as Equititrust's, should be subject to similar advertising requirements as recently introduced by ASIC for unrated and unlisted debentures. ASIC says it’s currently reviewing the extension of guidelines, similar to those for debentures, to other mortgage or property-based investments.

CHOICE would also like ASIC to take a stronger line about the use of terms such as 'warranty' in the context of investments. We believe this term is unhelpful, as it gives less experienced consumers an impression of safety and security that isn't nearly as reassuring when you closely examine the fine print. Most consumers understand warranties for toasters or other household products to involve the replacement of the entire product should it prove defective, but there are no promises of this sort made for this investment.

Update: 10 July 2008: ASIC has proposed stricter rules for the advertising of words like 'warranty' by unlisted mortgage schemes. It says words like 'secure', 'guaranteed' and 'warranted' convey an impression of a safe investment, which has a disproportionate effect on investors. The sector, which comprises about 200 schemes (including Equititrust), is worth $42 billion.

CHOICE supports the move to better advertising and disclosure by unrated and unlisted mortgage and property investment funds. This follows improvements in the regulation of debenture advertising.

 
 

 

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