7th November 2007
Debentures and Promissory Notes - are they secure after all?
The recent failure of four property investment groups has highlighted how frequently investors underestimate the risk attached to their fixed interest investment return. A large part of the problem appears to be the misconception of the meaning of the word "secured". Many investors misunderstand this to mean guaranteed and no or low risk.
Too often at creditors' meetings, confused and distressed investors have said that they thought their "secured" debentures or notes were tied to first mortgage security and therefore they must be first in line for any distribution of liquidated assets if the company fails. Unfortunately, many investors have discovered, too late, that the “first in line” prioritisation for payout through investing in "secured" debentures was far from reality.
Invariably they have found that their place in the payout queue is behind first mortgagees, overwhelmingly the banks, which move in quickly to get their money back. The banks not only get back what they lent but interest, fees, legal and sale expenses, and often penalty interest as well. Other investors have to fight over the remains. Even the promoters of "secured" investments have benefited, ensuring that they receive spotters' fees, consulting fees, commissions and other payments to reward them for their efforts, all adding to the cost of the projects.
Investors considering investment into "secured" debentures and notes must be more inquisitive, ask more questions and rely less on their perceptions of the security they are offered. Most people put more research into buying a $20,000 car than they do when they invest a large sum, or all, of their lifetime savings. The misunderstanding of the word “secured” is often the underlying reason behind this. "Secured against what?" or “What exactly is the security?” should be the first question asked of the salesperson selling the product.
Some other questions to consider asking are:
- Does “secured” mean that you rank first for asset sale proceeds if the company fails? Or are there other private investors or organisational investors ahead of you?;
- Does the security represent some access to assets of the holding company, which may not be worth much?;
- If the borrower is a property developer ask, "What is the project’s financial strength?";
- Does the developer have a development track record?;
- At what stage is the development and when will it yield a return?;
- Does it have a Development Authority approval or is it still at the application stage?; and
- If other investors, including corporate investors, are ahead of you, how much of the asset proceeds are you entitled to?
If the annual return is 10 per cent or higher, investors are, in reality, providing high risk mezzanine or second-mortgage finance, which tops up what a first mortgage bank is prepared to lend. The bank may lend two-thirds of the valuation, but the developer needs more money to get the project off the ground. Developers sometimes package an investment idea called secured and unsecured debentures or notes, which top up the bank loans. To compensate for the sort of risk investors are taking, a professional investor is likely to expect a return of closer to 25%.
Investors should be aware that although first mortgage holders will often consider the position of second-ranking mortgages, they are not required. Their primary concern and obligation is to their shareholders and investors and to get the capital back. One solution is for investors who want fixed interest returns with more security than that offered by the Fincorps of the investment world is to invest in funds that hold first mortgages in diversified property companies run by well-regarded managers.
What ‘security’ can you expect from La Trobe?
La Trobe Financial specialises only in mortgage lending and investment. We are not property developers, we do not permit lending to related entities or staff, we have a tightly managed approach to funding construction and development loans, and we have a 55 year track record.
The La Trobe Australian Mortgage Fund is predominately backed by first mortgages over Australian property. We do offer direct investment opportunities into second mortgages over Australian property through our Special Situation Mortgages Option, where investors enjoy an investment return which is relative to the risk.
La Trobe’s position in summary
La Trobe is committed to quality of service and mortgage products, which have been the foundation of the La Trobe Financial Group since inception and what our valuable customers have come to expect.
We aim to ensure that you as an investor know exactly what you are investing in and the relative risks involved in each investment, so that you can make an informed investment decision.
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Head of Funds Management
t +61 3 8610 2811
Chris Andrews is the Head of Funds Management for the La Trobe Group and has responsibility for the La Trobe Australian Mortgage Fund.
Read full profile here.
La Trobe is one of Australia's leading independent specialist mortgage Financiers. Its business includes residential mortgages, commercial mortgages, and investment services operating one of Australia's largest Mortgage Funds under AFSL 222213. It employs over 115 staff and has raised over AUD$10Billion to assist over 100,000 customers since inception in 1952.
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