How the banking system works... 2

Courtesy of todays Sunday Star Times we have yet another example of the BSC (Banking System Crisis, or is it really BS Crisis?) and the kind of operation being run by many of the banking institutions.

AN ELDERLY grandmother with no known assets or income was lent $4 million by a mortgage fund company chaired by former prime minister Jim Bolger a transaction now under investigation by the Serious Fraud Office.

Mortgage documents obtained by the Sunday Star-Times show that Trustees Executors, a trust company chaired by Bolger, advanced $4m to Maria de Magalhaes, a 73-year-old Portuguese speaker originally from Mozambique, who was only in the country on a visitor's visa.

After explaining that the $4M loan is part of a total of $33M lent to a “property developer”, SST comes up with this very brief paragraph.

Sources dealing with the fallout of the saga say it raises serious questions about the lending practices of Trustee Executors. The money was part of the $242m Tower MortgagePlus fund, administered by Trustees Executors and frozen last April. More than 5000 investors had savings tied up in the "low-risk" fund, of which about 40% has been returned.

For more on the Tower saga, you can read up here, but the primary statements are –

Tower said the NZ$242 million TOWER Mortgage Plus fund, which is owned and issued by Trustees Executors, will shut after a surge in redemption requests and a jump in the proportion of mortgages in arrears to 9.1 per cent.

The Trustees Executors-owned 1st Mortgage Fund, branded TOWER Mortgage Plus, was being wound up, Tower Investments Chief Executive Sam Stubbs said. The fund lent on a diversified portfolio of residential and commercial first mortgages and was no longer relevant given heavy competition from banks, Stubbs said.

“Given heavy competition from banks”? Given that it seems over 13% of their total assets have gone down just one drain, I would hold little hope for a good part of the remainder.

But that is not the major point...

The bulk of the investments in the Fund (in TMP) were in the “low risk fund”. Let’s just think about that for a moment.

I have my super (401k equivalent) in a “cash and low risk” category. From that I expect to earn no more than about 3% nett of tax in a good year. On the other side of the ledger, I don’t expect to earn less than 1% nett of tax in a bad year.

It seems that if the same expectations apply to TMP, we can start with a mortgage interest rate of (say) 7%. Take out “expenses and administration” at 0.5% (not unreasonable for keeping a computer account straight). Take out tax at 35% and we get 4.5% ROI. So the bank is paying me 3% for their “good year”. Who is getting the other 1.5%??

The same calculation from a savings bank interest rate of 5% (not too high for a good year) we get a ROI of 3.2%; very much in line with the actual return.

So, there is a matter of Trust involved here.

Personally, I do not think that the investment policies of TMP and many of the other superannuation and unit investment funds have ever been any different. What is going to emerge from the ashes of TMP will be some very questionable investment decisions by all manner of people from Board on downward. Investment decisions that are all driven by the pursuit of personal wealth, rather than the benefit of the investors for whom they are purportedly supposed to be acting. High returns for the Company, means high bonuses at the end of the year....

And, I most sincerely hope, there will be some very high heads in many of the other "investment funds" who will losing significant amounts of sleep over the next few months until they are sure that their own patchs are cleaned and seemingly kosher. The shredders will be running...