Just like the financial planning industry, the compliance will get tougher, more expensive and there will be a massive reduction in the number of businesses. Many older brokers will refuse to jump through the hoops required and eventually sell out rather than complete formal qualifications and continue with ongoing CE points. Others will merge with similar broking businesses to create spread the compliance costs.

I’ve seen it with financial planning and now it’s starting with broking. I would not be surprised to see the number of broker businesses less than half in 10 years. The average business will be bigger, but there will be less of them.

With the scenario you present, I would be a fool to disagree with you. Clearly, this example shows how unsophisticated investors can be manipulated due to ignorance and that predatory types pervade all industries.

The key problem though, is that our legislators do not regard ‘credit’ as a financial product and by extension, it’s also about how do credit service providers apply the proposed disciplines required for appropriate credit advice and in what circumstances.

If credit is brought under the ‘financial product’ umbrella, then we could see that regulated advice models will follow i.e. providing advice with appropriate needs analysis and SOA like validation of any advice given.

I suppose that ultimately, the evolution of credit ‘advice’ will mirror the way the financial planning industry went, along the lines of CLERP and FSR.

However, the financial planning community got to where it got to after many years of regulatory amendment. The credit market (and service providers) will likely follow a similar path however it’s in it’s infancy now.

The next step will be national licencing and once in force and with the culture of ASIC ready to progress the credit industry, we will see tighter controls and codified methodologies for credit advice. Of course, this will be with the view that consumers are protected as best as they can.

The Financial Planning community (through the the FPA)also made many representations to ASIC to bring about short form SOA’s and other policy amendments, to bring about some commercial sense and more appropriate compliance mechanisms.

ASIC had a one size fits all compliance approach & that simply didn’t work.

Hopefully, the credit market will learn from the compliance developments learnt from the planning industry and hopefully, with sound industry leadership, we will develop the credit advice industry to a more professional standard.

Last month, someone was referred to me by one of my brokers. They were “sold” a property gearing plan that appears to breach the ATO ruling in Hart’s case. They are low income earners with a small business and it was promoted to them as being tax effective and positively geared. The owner occupied home was re-financed to a higher interest rate than their previous loan. This was funded via lo-doc loans against their primary residence and new purchase.

I was called in to confirm they had been misled and show it was negatively geared by some $13,000 per year and what the taxation consequences could be. Their taxable income has them in the 15% bracket, so tax deductions are not their primary need. Their hand-written notes from their discussions clearly note they were to be cashflow positive. This appealed as they were looking to supplement their income, rather than rely wholly on their small business which could be subject to economic fluctuations.

With additions to the family they were looking to restructure and move to a larger home. They were horrified to learn the investment property valued up $65k less than what they paid for it, making the move to a larger home unviable. It appears the value of the property has never been close to the purchase price. The fact the banks haven’t called the debt in does not make the loss smaller. Not having mark to market makes the losses easier to hide.

There is no written confirmation of the “advice” they received about the positive cashflow effects. This is another case of an unsophisticated investor getting sold a lemon. Don’t they need the safeguard of having written advice that can be independently reviewed? At least with an SOA, you get written confirmation of what the advice is and why it’s being given. You don’t get that when investing in property, so it’s your word against theirs.

Investing in anything has it’s risks and there are rogues in all industries. Not all planners use the Storm model and not all property sellers follow the Henry Kaye model. I’m happy with whatever regulation is put in place. However, I’ll always argue that anyone giving advice on how to “invest” or fund investments should be operating under the same set of rules and regulations regardless of the underlying asset.

At the moment, planners have much stricter requirements than brokers. With the new regulations coming in brokers are starting to catch up, but there’s still a discrepancy between what I can do and what my brokers can. When recommending a home loan, even owner occupied, I have to complete a full fact-find and full SOA. Although my brokers do a fact-find and short SOA, that is my requirement, there is no legal obligation for them to do one.

I probably didn’t make it as clear as perhaps I could have. The analogy I was trying to make, was that *guarantors* are obliged to seek independent legal sign off for the reasons I’ve previously noted.

*Borrowers* don’t necessarily need legal sign off (although in some circumstances with some lenders, it is required) which is why I was making this distinction.

The other point I was making, was that SOA’s involving gearing could also be required to have legal sign off (similar to the guarantor example).

The reason why would be due to the relative complexity of the SOA and the possible negative financial impact of the strategy of investing in mark to market investments, particularly when margin calls are involved.

Banks don’t make margin calls against the family home for diminishing property values. Margin loans do (if you on invest here)…..which is why so often, when unsophisticated borrowers get stung, they plead ignorance.

If they’ve had independant legal advice from the outset, then they should have either rejected the strategy in the first instance (as inappropriate advice) or they should cop it sweet, if the market goes arse up.

It is also quite clear to even the most unsophisticated borrower, that when establishing a home/investment mortgage, if they don’t pay, they get sold up. If you’re suggesting legal advice for this, then I simply wouldn’t agree for the obvious reasons.

Cheers

I’m not trying to get into an argument. It appears we have similar outlooks. Gearing is good, but it doesn’t suit everyone and you should have safeguards in place to reduce the risk factors. There are bad things happening in the planning & broking world and just about every other industry as well.

However, you did say,

Burbs: “Interestly, I would think that it would make sense that all SOA’s involving gearing, should be signed off by an independent solicitor, much like loan guarantors have to seek independent legal advice on their contingent liabilities.”

And then,

Kev: “If using the home equity as a deposit to invest is such a risky strategy which requires independent legal advice, then why are brokers doing it daily for residential property?”

Burbs: That was not my suggestion.”

I could be wrong, but I believe I’m receiving mixed messages. Gearing by Financial Planners (SOA) should get independent legal advice, but gearing by brokers into residentail property investments shouldn’t.

I’m seeking clarification:-

Do you believe that ALL gearing requires independent sign-off by a solicitor?

To really even up the playing field, how about detailed SOA’s for every mortgage. Imagine mortgage brokers squirming over about that one, if it ever came to pass………. unless their brokers are already trained to do this.

And your last sentance is exactly what I’m on about! Storm (allegedly) would have seen every client as a gearing oppportunity. You don’t.

And..

Kev: “If using the home equity as a deposit to invest is such a risky strategy which requires independent legal advice, then why are brokers doing it daily for residential property?”

Burbs: That was not my suggestion. The scenario I suggested involved guarantors. Lenders (as a credit policy requirement) who provide facilities where family &/or non family members act as ‘guarantors’ (investment or otherwise), often demand independant legal advice, ostensibly for two reasons.

1. To ensure the guarantor is aware of their contingent liabilities and 2. To protect the lender in the event of any future litigation in the event of default.

Kevin, I’m not anti gearing. I’m just anti anyone who pushes inappropriate products or strategies on unsophisticated investors/borrowers that’s all. I worked in the Funds Management industry for 12 years or so & also managed a large dealership for 3 years myself & I can assure you, some of the practices that went on simply left me gobsmacked sometimes.

And when I speak to a few twenty somethings who have been inculcated with the hubris surrounding high risk investment strategies as practically fail safe, which invariably have been ’sold’ to the unsuspecting ‘punter’….then the alarm bells start to ring for me, that’s all.

After all, if the property market progressively tanks, the compounding effect of capital losses within a double geared portfolio is magnified considerably. Look at the US where around 30% of property owners have negative equity.

The issue is not the underlying asset, but usually the level of debt and affordability. When previously with an institutionally owned major dealer group, the practice was allowed, but the margin loan could not exceed 40% gearing at the start and regular gearing had to be stopped if the LVR hit 50%. The home loan had to be 80% or less. Total debt (including rental properties) could not exceed 4 x income (including rent). They also had to be able to have enough cash reserves to meet 3 months living expenses & loan repayments. Clients had to be reviewed and cash reserves confirmed every 6 months.

If Storm had similar criteria, the majority of their clients would not have suffered the huge losses due to margin calls. Imagine how few investment loans the average broker would write following those guidelines.

The key is to keep the client in a sound position so they can keep investing through the downturn and continue to accumulate at lower prices. Most of the 4 major banks are trading at double their March lows.

I operate under similar, yet more cautious criteria to that institutional dealer group. Many prospects take time to become gearing clients as they need time to either reduce their debt levels or increase their income before I will accept them. While they are waiting, we look after their super, insurance etc. It would be something like 1 out of every 50 mortgages by the broking team that get referred to me as suitable for a gearing plan.

What are these ’strict controls’ you speak of? Other than implementing an options strategy regularly or a regime of stop loss orders, if the market progressively tanks, the compounding effect of capital losses within a double geared portfolio is magnified considerably.

Also, it’s been my experience that most double gearing occurs using the family home as this asset usually finds itself with the largest chunk of equity available to leverage.

I would also suggest that most (if not all) institutionally owned dealer groups (which caters for the vast majority of financial planning outlets) do not allow double gearing. The risks associated with this strategy are self evident. PI insurers also would place heavy burdens on practices that do.

But right for the ‘get go’, I did say that gearing is a viable strategy for the right investor. It just comes down to whether it’s (gearing) is the appropriate strategy recommendation for every client.

You see, some planning firms start off with the strategy first (as the front line sales spiel) and then ’sell it’ to the client.

It should be the other way around.