Written by Per Amundsen, Head of Research, Thinktank
The numbers around Limited Recourse Borrowing Arrangements (LRBAs), the borrowing instrument that took effect in 2006 to allow self-managed super funds (SMSFs) access to leverage, can easily – and sometimes deliberately – be misinterpreted.
Let us cite two examples. In December 2014, the Financial System Inquiry, chaired by AMP Chair David Murray, handed down its final report that included a recommendation to abolish LRBAs. To quote: “Remove the exception to the general prohibition on direct borrowing for limited recourse borrowing arrangements by superannuation funds”, noting that over the past five years, from June 2009 to June 2014, the amount of funds borrowed using LRBAs increased almost 18 times, from $497 million to $8.7 billion, based on ATO data. [The Federal Government chose to set aside this recommendation.]
This $8.7 billion figure is then measured against the December 2019 figure of $44.9 billion, with the specific intent to illustrate that this form of borrowing has continued to grow exponentially; to be precise, 416%.
But what happens if your starting point is June 2017? Since that date, LRBAs have only risen from $41.39 billion to $44.9 billion – a far more modest 8.5% over two and a half years. And if the June figure for 2018 is chosen, $45.96 billion, LRBA borrowings have dropped. It’s a trend that should not be ignored.
One can only speculate why the growth has slowed, but let us venture four possible contributing factors: the heat coming out of commercial and residential property, a maturing market for this type of debt, ASIC proving effective at shutting down non-compliant operators, and borrowers increasingly realising that this is a complex debt instrument and advice is required from specialist lenders and advisers which implies take up only where it is appropriate to the circumstances of the parties involved.
The other sobering point that the ATO figures highlight is how often the quarterly LRBA figure is cited in isolation and without reference to the value of the asset the debt has been used to acquire. Taking the June 2019 figure, LRBA borrowings stood at $43.50 billion or 6.2% of total net SMSF assets of $699.4 billion. But when the value of the assets is stripped out to reveal the actual borrowings, the debt figure falls to $24.79 billion or 3.5% of total SMSF assets.
Behind the vast majority of these LRBA figures lie numerous individual success stories, of businesses that have continued to flourish and the accelerated personal wealth creation because their owners have been able to access this debt alternative. At Thinktank we can cite any number of examples where small business owners have sensibly used LRBAs to underpin their commercial success and retirement income strategies. And the fact the anecdotal evidence to date suggests LRBAs have thus far withstood the vicissitudes of the COVID-19 pandemic as well as if not better than other forms of debt is further evidence as to why they have an important role to play in the market.
Indeed, what’s encouraging is the fact we are still seeing steady demand for LRBAs, and, as a percentage of our overall business, is more than holding its own. Although we suspect this is not the case for the entire LRBA market, it’s true to say our market share is growing, which now increasingly includes the refinancing of related-party LRBAs from other lending institutions.
At the same time the evidence to hand suggests the average size of an LRBA is growing slightly, as are the SMSFs’ funds under management in which the LRBAs reside, although the industry will need to wait for the official data from the ATO to confirm this. But if these trends are still only estimates, they are based on well-informed analysis and help explain what is happening in our industry and how this product is naturally evolving in positive ways.
Certainly, they reinforce what the ATO figures have shown since 2017 – that the sharp increase in LRBAs has tapered off into steady long-term growth, which is what we always expected would happen, and, as it did, investors and regulators would have a more sanguine, if not positive, view of LRBAs. [This growth pattern, incidentally, mirrors the growth of SMSFs, that have also adopted a steady growth path after increasing rapidly post the GFC.]
Post COVID, business owners will be looking for opportunities to use gearing on the back of low interest rates to invest in real property, and with SMSFs being the only superannuation vehicle where this option is available, we remain confident SMSFs and LRBAs will continue growing in a responsible and sustainable way.