MILLIONS OF dollars invested by New Zealanders in a huge frozen Australian mortgage fund look increasingly at risk as its loans slide into negative equity.
The $A580 million LM First Mortgage Income fund was sold in New Zealand by several financial advisers, including Money Managers, now known as MMG Advisory Partners, but in March last year it was frozen as investors rushed for the exits.
While LM's manager insists losses are "highly unlikely", the nine months to the end of January saw the average loan to value ratio soar to 83.6% from 73.6% as a result of the fund's high exposure to capitalising interest loans.
Those nine months also saw $A57.4m of its loans slip into negative equity, where the value of the loans exceeded the valuations of the property, compared to none at the end of April last year. A further $A213.6m of loans are lent on properties where the loan was between 90% and 100% of the property value.
The reason for the deterioration in the fund's security position is clear.
Despite being a fund designed to provide regular income to investors while allowing them to get their money out when they needed it, the fund had a high level of loans on which interest was capitalised – $A513m of its $A580m loans have at least some element of capitalised interest – and these swell the amount the borrower owes every month compared to the value of the security they have.
That was fine when there was a lot of money washing around in the Australian development mortgage sector, allowing borrowers to pay back their loans by simply taking out a loan from another lender.
But when the liquidity dried up, it left the fund stranded.
The fund's manager, LM Investment Management, told investors: "Lack of liquidity in the finance sector first saw a general slowdown in repayment of loans from those borrowers who were relying on refinances from other institutions to repay their loans to the scheme."
That was followed by a flight of funds as investors sought to put their money into safer places, and mounting pressure from its bank, Commonwealth Bank of Australia, which extended its line of credit to the fund to the end of June only on the proviso that it would be paid back "in priority to most investor redemptions", a mechanism banks use if they are worried about getting their money back.
The bank is currently being paid back $A5m a month, which is causing cashflow problems for the fund. If any of its big loans are suddenly repaid, CBA, owed about $A120m, has a right to 60% of the proceeds.
Such repayments are in short supply, with the number of clearly troubled loans in the fund's portfolios also dramatically increased. At the end of January, $A324.8m of its loans were overdue by 90 days or more, compared to $A135.7m at the end of April last year.
LM told the Sunday Star-Times: "LM is strongly of the belief that the economy and property markets in Australia will continue to improve, and that the forecast loan repayment line in our model will once again provide significant liquidity to the fund to enable it to resume its normal activities as a provider of first mortgage finance to the commercial and property sector within Australia.
"We believe that once the Australian banks begin lending again at normal levels to the commercial and business sector, this will assist the mortgage funds with liquidity and see normality once again return to the sector. In addition to this, as investors once again seek alternatives to bank deposits and see the strength of this industry, which has been operating for 30 years, investor inflows will once again flow into the sector."
The last financial statements appear to show that the fund does have enough to repay investors. Net asset backing was 99.7c, although what investors finally get back depends on the loans being repaid, and where they are, not the value of the security backing them.
But LM dismissed the likelihood of investor losses.
"LM has completed a detailed review of each first mortgage security in the portfolio and has, in difficult conditions over 12 months, repaid one third of its finance facility without impacting investor capital. Over the past 12 months and continually, a considerable amount of time and resources has been invested into ensuring all fund assets are protected. The assets have been put into the best possible position in order to realise their full value back into the fund. LM's focus has always been not to `firesale' assets at the expense of the unit price, and to ensure that the fund is managed in order to achieve the best outcome for all investors."
It said capital loss was "highly unlikely". "In each and every year of operation since inception 12 years ago, the unit price of the LM funds has remained at $A1. We continue to work through the various issues surrounding the funds management/mortgage trust sectors as outlined."