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Written by Per Amundsen, Head of Research, Thinktank
With little fanfare, the Council of Financial Regulators (CFR) recently handed down its report into “Leverage and Risk in the Superannuation System” – a form of credit almost exclusively used by self-managed super funds (SMSFs). It concluded “that borrowing by SMSFs through Limited Recourse Borrowing Arrangements (LRBAs) has not posed a material risk to the superannuation system or the broader financial system since it was first permitted in 2007.”
Although the report added caveats that there was evidence that some “LRBAs are used in inappropriate ways by some individuals and can be a high risk to their retirement savings” and “that continued monitoring and reporting on a needs basis would be prudent”, the report essentially gave LRBAs a clean bill of health.
From Thinktank’s perspective, this is not surprising. As an active participant in this borrowing space, we have seen LRBAs assist many SMSF members in laying valuable foundations for their retirement income strategies whether in acquiring residential real property or business real property housing a related party business.
Just as importantly in terms of the CFR’s latest report, we can attest that among our clients those signing up for these debt arrangements only do so after getting specialist advice and that the loan-to-value ratios (LVRs) are conservative. At Thinktank, the maximum LVR is 80% while the average across the loan book is 62%. Consequently, and despite the financial toll inflicted on many small businesses because of the pandemic, our borrowers exhibited minimal debt distress.
During the past three years Thinktank has seen strong growth in its LRBA portfolio involving both residential and commercial properties but with a higher proportion of commercial than residential than across the sector. This is no doubt a result of the high proportion (more than 85%) of SME operators that make up Thinktank’s borrower base.
The CFR report also must be seen in the context of a growing appetite for LRBAs with the number of SMSFs with this debt instrument increasing since the 2019 report. But it needs to be emphasised that this growth has been steady – not exponential. As the report spells out, the proportion of SMSFs using LRBAs has grown from 2.9 per cent to 11.8 per cent by 2020, with more modest growth occurring since 2017 at 2.2 percentage points of this total growth.
The value of assets held under LRBAs increased from $8.8 billion in June 2013 to $45.8 billion in June 2018 and to $59.7 billion in June 2021. At 30 June 2021, LRBA assets represented 7.2 per cent of total SMSF assets, up from 6.6 per cent in June 2018, and 1.9 per cent in June 2013. The total borrowing amount outstanding for SMSFs was about $27.8 billion at 30 June 2021, while the leverage ratio (total LRBA borrowings divided by total LRBA assets) for SMSFs with LRBAs has fallen from 34.6 per cent in 2017 to 32 per cent in 2020 as asset prices have risen.
Other numbers in the report worthy of comment are that although 70.3 per cent of LRBA SMSFs held residential property, it represented only 51.8 per cent of the total value of LRBA assets in 2020. By contrast, although non-residential property is only held by 26.6 per cent of LRBA SMSFs, it represented 44 per cent of the total value of LRBA assets in 2020.
SMSFs with LRBAs are predominantly still in the accumulation phase – it has increased from 85.8 per cent in 2013 to 94.8 per cent in 2020 – with most members of working age and have total SMSF net assets below $500,000. This proportion is much higher than the overall SMSF population, where only 55.1 per cent were in the accumulation phase in 2020.
In Thinktank’s opinion, these numbers present a picture of relative stability. And several reforms introduced to enshrine the quality of financial advice in the wake of the Financial Services Royal Commission help explain why.
As the report states, most of these measures have been implemented, including reforms to professional standards of financial advisors, disclosure of independence by financial services licensees and the introduction of a new disciplinary regime for financial advisers. In addition, the Quality of Advice Review (another Royal Commission recommendation) into how the regulatory framework can better enable the provision of high quality, accessible and affordable financial advice is due to be handed to the Government on 16 December 2022.
Another important reform that took effect on 1 July 2018 was to include LRBAs as part of an individual’s total superannuation balance, reducing incentives to use LRBAs to circumvent contribution caps and accrue larger assets. Changes to tighten non-arm’s length expense (NALE) rules in 2019 may have increased the costs of utilising an LRBA for some SMSFs, and greater enforcement of diversification standards by the ATO may have contributed to a slight decrease in asset concentration among some SMSFs.
Thinktank supported all these measures – as well as the ASIC campaign against the rogue operators in this space. Being a first-hand witness to how this debt instrument can assist SMSFs achieve retirement income goals, having a sound regulatory environment and the availability of specialist advice to assist anyone contemplating an LRBA is in everyone’s interest.
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