Once in a while a bank does something that is so logical, most of the commentators are wondering why they didn’t think of it before.
In this case, it’s Westpac’s decision, announced on Monday, to cease offering new loans to Self-Managed Super Funds to invest in property, as from July 31.
The note went out directly to mortgage brokers rather than in any announcement to the ASX. That tells you a) who does most business in that area and b) that the decision won’t move the needle in terms of being material to Westpac’s earnings.
Why did they do it? There’s a laundry list of good reasons. One, it’s a small but risky part of the big bank’s lending program.
Westpac’s not saying that, but ASIC made it pretty clear in a report released two months ago that lending for property in SMSFs scores very badly in terms of whether advisers are acting in the client’s best interests.
And if the client’s being disadvantaged, clearly there’s an increase in risk.
ASIC reviewed 250 randomly selected SMSF client files based on ATO data and found that in 91% of files, the adviser did not comply with the Corporations Act’s ‘best interests’ duty.
Not all the files related to buying property but ASIC was clearly taking aim at the “one stop shop” spruikers luring financially uneducated punters into investment properties and then reverse engineering an SMSF structure round the single asset.
ASIC found that in 10% of cases the client was going to be “significantly worse off” from following the so called advice, and that in 19% of cases, clients were at an increased risk of financial detriment due to a lack of diversification.
That last group were almost certainly in the “single asset” property category, which breaks all the rules, logic and theories that superannuation is based on.
What’s frustrating is that the spruikers have been making hay for years based on the fact that property is not properly policed in the financial licensing world, because it is not classified as a financial product.
SMSFs are also not allowed to invest directly in property: there has to be a “bare trust” structure which puts the property asset at arm’s length from the rest of the SMSF in case the loan goes bad. The borrower has to set up a Limited Recourse Borrowing Arrangement (LRBA) which guarantees that if the loan defaults the lender has no recourse to the rest of the SMSF to recover its funds.
That has pushed the borrowing rates up, plus of course has added greatly to the paperwork.
We do know that the banks don’t do a lot of business in this area. It’s generally accepted there’s around $700 billion in SMSFs, of which only about 4 per cent or $28 billion is invested in property.
What we also know is that there are lots of advantages for small business owners in having their business property in their SMSF, most particularly the fact that they won’t have to pay capital gains tax on the asset when they retire.
It’s not clear how the new edict is going to affect those people, but then they also have other bank loans with banks and it wouldn’t be hard to devise a legitimate structure that would advantage the small business owner while also securing the bank’s exposure.
But in summary, it’s small bikkies for the banks: perhaps half of SMSF property lending, or $14 billion.
Which brings us to reputational risk. Westpac won’t enjoy seeing this trawled up but one of its most painful moments at the Banking Royal Commission was in April when Scottish born nurse Jacqueline McDowall appeared as a witness to describe how her dream of opening a bed and breakfast operation fell to pieces because of bad advice from Westpac/BT advisor Krish Mahadevan.
She explained how Mahadevan had told her she and her husband could put such an operation into an SMSF and also live in the house, which was completely against the rules. You can operate out of a business premises owned by your SMSF but you can’t live in it.
By that time, one of Mahadevan’s lender colleagues had told her the bank could lend the couple $2 million, on the basis of which they sold their house.
By the time the mistake was discovered, the couple were almost $100,000 out of pocket and they have since had to decamp from Gippsland to western Queensland to try to rebuild their savings.
I might as well throw in the fact that according to Monday’s AFR, Australia’s banks face a $70 billion funding gap caused by superannuation funds shifting out of cash into international assets, while indebted households draw down on their savings.
That came from a report by National Australia bank economists who calculated that the gap between loan and deposit growth had increased from $390 billion in the second quarter of 2017 to $457 billion by the first quarter of 2018, resulting in an additional need for funding of between $60 billion and $70 billion.
That sounds a bit scary on its face but is quite possibly a temporary state of affairs and for instance if the banks lifted their deposit rates by 25 basis points they would probably be able to reverse that trend.
It’s roundabouts and swings. Yesterday’s AFR noted that the big banks are now slashing honeymoon interest rates by as much as 55 basis points on new home loan products in a bid to stimulate growth while real estate markets are slowing down.
Indeed, one of the banks named was Westpac.