Solictor’s mortgages at the end of the line

Just over 18 months ago, the Australian Securities and Invest-ments Commission (ASIC) announced it would be looking at the state of solicitor mortgage schemes in Australia.

At the end of July, the regulator released its findings, as well as detailing the actions it had taken to target investments in property which were being sourced through the schemes.

And the work was not inconsequential. In the 18 months it took ASIC to conduct its investigation, the number of schemes on offer fell from 6,000 to less than 400 and even these are operating under strict instructions to either wind-up or become compliant under the Managed Investments Act (MIA).

Other statistics released by ASIC reveal the extent to which these schemes were being used, with 20,000 investors involved in arrangements which were of concern to ASIC. That number has since fallen to about 2,800.

At the same time, the value of loans in solicitor’s mortgages was reduced from $1.34 billion to $135 million, and the number of operators has dropped from 186 to 32.

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But were solicitor’s mortgage schemes deserving of so much attention, including an independent review and a series of actions designed at radically changing this part of the investment market?

ASIC seems to think so, with its web site listing around 25 actions taken relating to operator or investment schemes since the announcement of the review in February last year.

Many of the actions have centred around corrective measures, such as closing schemes down, imposing restrictions or prosecuting some of the promoters involved.

Of the 6,000 schemes mentioned, ASIC also found that around half were in default, and the best course of action was to force operators to wind the schemes down because ASIC found most would not be able to perform better if left operational

These measures were not aimed at all mortgage investment schemes but at certain types, specifically those labelled as solicitor’s mortgages and usually administered by solicitors under the supervision of law societies or institutes in each state.

However, after the announcement of the review into mortgage schemes, they also came to be known as run-out schemes due to ASIC’s stated policy of having them brought to an end in their current form and moved under the more stringent requirements of the MIA by October 31 last year.

The other mortgage investment schemes are:

registered managed investment schemes, which are operated by public companies acting as the responsible entity and are licensed through ASIC.

small industry supervised schemes supervised by an industry body, in this case the state based law institutes or societies which, while operating under different guidelines, are also restricted by what they can offer investments in.

schemes with 20 investors or less, where the operator does not operate or is not an associate of someone who operates a mortgage business. These schemes fall outside the strictures of ASIC’s Policy Statement 144, which cover mortgage schemes, and the MIA, meaning investors have little legal recourse if things go wrong.

As part of its review of run out schemes, ASIC called on the services of insolvency practitioner Tony Hodgson to produce a report which in part stated that solicitor’s mortgage schemes were found to have a “chronic lack” of management expertise, as well as inexperienced or unqualified personnel involved along with completely inadequate loan assessment and approval processes.

The rest of the report is a litany of poor practice and failings in terms of dealing with scheme defaults, property valuations, loan to valuation ratios and disclosure to investors of information which was central to their investment in the schemes.

In fact, Knott himself says he was surprised how badly the schemes had been managed by elements of the legal fraternity and recalls that in the past, mortgage services were only a value added feature of a solicitor’s office and losses were rare.

“Even now I remain astounded that services provided under the licence of legal practice and the supervision of the legal profession’s governing bodies were able to mutate into such high-risk exposures,” Knott says.

“These findings provided all the incentive we needed to take a hard line about closing these schemes down.”

While the Hodgson report also went on to recommend a number of changes to do with the mechanics of the solicitor’s mortgages and run out schemes, Knott says the regulator sees relevance in extending those to schemes covered by the MIA.

These changes would deal with the supply of truly independent valuations, more specific lender conduct guidelines focusing on the area of a borrower’s credit assessment, tighter disclosure and reporting requirements, and improved loan and default management processes.

ASIC national director Ian Johnston says the regulator has made positive moves in this direction and will alter PS 144 to reflect the recommendations made by Hodgson.

However ASIC’s efforts have also resulted in the law societies of NSW and Queensland no longer covering mortgage schemes with the direct result being that they are no longer available through solicitors. Victoria will be the only state to still do so but ASIC says it was not too concerned with the state of the market there.

But are these the dying days of solicitor mortgages across most of Australia?

Johnston thinks so, but says there are still some loose ends to tie up.

“Action will still be run against some of those people who ran these schemes but we feel the moves should result in the total number of funds getting close to zero and for ASIC, the complete conclusion of the matter. But having said that we will remain ever vigilant.”