The security of an investor’s funds is largely determined by the recovery that the finance company achieves on its loans. This is essentially a function of underlying borrower quality and/or the strength of the security held.

As with most investments, an investment in the products offered by finance companies carries a level of risk that is generally reflected in the returns being offered. In the property market, the finance rate charged by lenders (ie: the true cost of borrowing including all interest costs, fees etc) varies depending on the type, size and risk profile attached to a specific loan. We all know the rule of thumb that says the higher the return the greater the level of risk.

When investing in mortgage-backed securities, for example through Equitable's mortgage-backed term investments, one factor investors need to take into consideration is whether the investment is supported by first or second-mortgage secured finance.

The cost of borrowing second-mortgage secured finance is usually considerably higher than on a first-mortgage basis, reflecting an increased risk premium. This is because when the First Mortgagee seeks to recover their debt through the sale of a security property, they have some significant advantages over the Second Mortgagee. These advantages are outlined in the table below:

First Mortgagee risk

• The First Mortgage holder is first in line for re-payment in a recovery situation.
• The level of debt recovery is dependant on the strength of the security held.
• In most cases 100% of the loan is recovered.

Second Mortgagee risk

• Only after the First Mortgagee has been paid in full will the Second Mortgagee have access to any remaining funds.
• Assessed asset values are usually significantly discounted in a mortgagee sale situation (often by 15-20% or more) prejudicing the Second Mortgagee’s position.
• First Mortgagee’s priority over sale proceeds will include payment of accrued interest (at penalty rates) together with recovery of costs incurred, further eroding the funds available for repayment of the Second Mortgagee.

This is not to say second-mortgage or higher risk lending is bad -– far from it. As long as the lender in question is not overly exposed to high risk transactions and has a spread of relatively modest loans compared to its capital base, a small number of defaulting loans are in themselves unlikely to put the company (and therefore the investor) at risk.

History has shown us however, that financial failures do occur. Lending is a risk based business and financial services companies can and do collapse – remember Securitibank, RSL, Equiticorp, and DFC to name but a few. Investors should therefore understand that in the event of a financial collapse (as unlikely it may seem at the time of making the investment), the level of capital that will be returned is likely to be directly related to the underlying lending risks assumed by the institution in question. When making higher risk investments, it is important that the return to the investor should adequately compensate for the increased risk being assumed. If a finance company is charging a significant interest rate for the risk that it is exposed to, an appropriate risk premium should be paid to the investor.

The majority of investors in fixed interest securities are not risk-takers. Many are at or near retirement, cannot afford the risk of capital loss, and invest in the expectation that capital return is assured. Equitable is therefore an excellent place for conservative investors to consider placing funds. It provides attractive rates of return and the peace of mind of knowing that investments are backed by first mortgage security.

To further protect the interests of the investor all mortgages and investments at Equitable are held by an independent statutory trustee, Tower Trust Limited. For a range of investment products that are tax-effective, flexible, offering excellent security and returns it is hard to go past Equitable.

Call us today for a copy of our latest Investment Statements and Rates on 0800 656 500.

This is an advertorial for Equitable, written by Stephen Wilson, chief executive officer, Equitable Group of Companies