With Australia’s biggest financial institutions ceasing lending for SMSFs, it’s worth considering what this means for the sector.
SMSF lending has been a contentious issue, particularly since the Financial System Inquiry recommended “[removing] the exception to the general prohibition on direct borrowing for limited recourse borrowing arrangements by superannuation funds.” While this recommendation was nixed by then-Treasurer Scott Morrison, increasingly strict capital adequacy rules have brought it back to the fore.
The SMSF Association has long supported the provision of limited recourse borrowing arrangements (LRBAs) in SMSFs, arguing that “there is little evidence that borrowing in superannuation is causing a build-up of excessive risk in superannuation,” and that “SMSF trustees seeking to use LRBAs should seek professional advice as to whether they are right for their circumstances.”
Regulatory concerns
Since the Productivity Commission’s draft report into the efficiency and competitiveness of the superannuation sector took at aim at borrowing in SMSFs, suggesting it may create “systemic risks in the future,” both the ATO and ASIC have been closely monitoring the sector.
In ASIC’s REP 575, the regulator said “the strategy of gearing through an SMSF to invest in property, which is being actively promoted by ‘property one-stop shops’, is high risk.”
“Our results suggest that in many cases,” ASIC continued, “this is likely to result in financial detriment to SMSF members. We are particularly concerned about the operation of one-stop shops because of conflicts of interest and, together with the ATO, we will have an increased focus on property one-stop shops in the future.
“This will include building and sharing data and intelligence, and ASIC taking enforcement action when we see unscrupulous behaviour.”
What’s the exposure?
According to the ATO’s quarterly SMSF statistics as at March 2018, there’s around $32 billion in LBRAs and $113 billion of SMSF money invested in residential and non-residential real property. Put another way, about 16% of the total SMSF sector is invested in property.
Obviously, the actual amount of risk being taken on by investing in property in any individual SMSF will vary depending on the assets being invested in and overall diversification. But given that borrowing to invest will typically magnify risk, it’s perhaps unsurprising why SMSF lending is on the regulatory radar.
How about the lenders?
SMSF borrowers will usually face stricter borrowing terms than non-SMSFs, often only being able to borrow up to a maximum of 70% of a property’s value, at higher rates. Given this, it may well be that the institutions pulling out of SMSF lending are justified in their concerns about the SMSF borrowing market cooling.
On top of this, given the greater scrutiny being placed on banks’ lending practices in the lead up to and following the Royal Commission, traditional LRBA providers may be focusing on simplifying their businesses.
Effects on the property market
It’s been suggested multiple times that the SMSF market is contributing to rising property prices; a Credit Suisse report from 2016 described “selfies” as being “part of the shadow banking system” for residential developers. However, the same report also said that in contrast to the 2008 housing crisis in the US, SMSFs typically have “almost no debt,” limiting the “systemic nature of a potential housing downturn.”
Given that Labor has taken direct aim at borrowing in SMSFs as a means of cooling the housing market, though, it remains to be seen what the overall reduced availability of LRBAs will have on property prices. Of course, the SMSF Association has countered that given the relatively small proportion of LRBA funds compared to the size of Australia’s residential housing market, this is “hardly a figure to shake the market.”
Ultimately, even if the SMSF borrowing market is tightening, it’s worth heeding the association’s suggestion and seeking specialist advice as to whether this approach is right for you.
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