Aggressive and misleading advertising
The Australian Securities and Investments Commission (ASIC) was concerned that much of the advertising for high yield debentures was aimed at retirees, and featured images of happy older couples. These advertisements used words like ‘secure’ or ‘secured’ and played on many older people’s need for a fixed, secure income.
They did not acknowledge that high yield debentures are high-risk investments, and there is no guarantee that investors will get their money back. ASIC’s review of property development debentures frequently revealed poor disclosure about high risk factors in a risky industry, with no reference to the consequences of the residential property sector weakening.
High yield and property development
Interest payments unsupported by real cash flows: ASIC was concerned that many investors were unknowingly entering into high-risk finance. In many cases, the debenture issuers examined by ASIC lent money to property developers on a capitalised interest or pre-paid interest basis.
In these circumstances, there is no flow back of cash from the developer to the debenture issuer until the development is completed. In the meantime, investors in these debentures are paid only from the cash raised from other investors. This is high-risk finance that can only be sustained if the development is completed successfully.
Inappropriate or over-optimistic valuations: Some debentures are marketed using the ‘value as if complete’ of a property development. There is no guarantee about the time and cost of a development, no guarantee of a profit, and no guarantee that it will be completed and sold.
ASIC considers best-practice debenture prospectuses should contain the market value at, or about, the date of the prospectus or, failing that, the most recently determined market value, and the purchase price of the property.
Inadequate detail about security over assets: In one case examined by ASIC, prospectus noted that first mortgages were preferred, yet the issuer did not hold a single first mortgage.
Without a first mortgage to secure the loan, the debenture investment is riskier, because someone else will get paid before the issuer if the borrower defaults.
Related party transactions
High yield debenture issuers often lend money to related companies or other entities associated with the directors of the issuer. This increases the risk that arms-length lending procedures may not be used, which in turn increases the credit risk associated with the debenture investment.
Investors may not get their money back if the related party defaults on its loan obligations.
Bad and doubtful debts
Some debenture issuers examined by ASIC did not disclose the extent of their bad and doubtful debts. Where borrowers don’t repay the debenture issuer, investors risk losing some of their debenture investment.
Source: ASIC surveillance report: High-yield debentures
