Body Corporate Lending Asset Class Interview with Terence Tobin
Updated: May 21, 2019
Although my approach to investing is focused on shares in the form of ETF’s. The reality is that different people invest their money in different ways. Yes, they may have achieved better returns if they all just invested all their money into one global diversified ETF, but I have spoken to enough people and tried hard enough to punt a single strategy to understand that people want to invest in all sorts of things. Things they understand (this is why property is so popular), things they find interesting (cows, solar or blueberries) or things that they can be told exactly what returns they can get (this is why fixed deposits are so popular).
If there is an asset that checks out in terms of safety or to put it bluntly, turns out not to be a scam. I am never going to tell someone they shouldn't invest in it. I will, however, ask them plenty of questions to ensure they understand it and give suggestions to where I think their portfolio might be lacking something.
In this post, I am going to tell you a bit about something different, an asset class that I became aware of from a trustworthy source on twitter.
Terence Tobin is a financial adviser (a very good one I might add) who I have had contact with over the last few years. He assisted me in getting a life insurance policy which was a requirement for me getting a bond on my flat. At the end of 2018 when I was gloating that my emergency fund has been my best investment over the last year. Terence made me aware of an asset class I have never heard of before.
After some back and forth to find out a bit more I decided that it would be an interesting topic to share as an interview on this blog. Enjoy!
Thanks again Terence for agreeing to discuss this with me in a bit more detail than what we did on Twitter, maybe you could start by just telling me a bit more about yourself and the work that you do?
I started in the financial services industry over 15 years ago and became a financial planner and investment advisor 10 years ago. My passion is to ensure that I assist clients in creating financial plans to meet their financial objectives through savings & investments, tax reduction and personal protection plans within their affordability. This is to ensure that they reach financial wellness.
As each client is a unique individual with their own desires, needs and goals, I offer a multi-step financial planning process that is based on an international six-step process (often with a few extra steps). This is undertaken over a period of time and in line with ever-changing budgetary and family requirements of my clients.
I take great pride in offering holistic independent financial planning services, educating clients through the decision-making process and allowing them to make the ultimate decision without being pressured into products/services that you do not need or cannot afford. There are no high commissions, no hidden costs and I also make use of a fee model, to ensure that you never feel pressured into product sales. Sadly this is the norm in our profession.
Before I ever get to recommending products, I do a thorough fact find to ensure that I understand your individual circumstances and needs, as well as your objectives and aspirations for the future. Whether planning for retirement or passing wealth onto future generations, as I am not tied to any product provider, I provide solutions that are best of the market for my client’s needs.
One hour spent with me is worth tens of thousands of rands over the long term.
So when we last tweeted each other you were mentioning the lending asset class that you work with, which in terms of investment return looks quite appealing. Could you please explain what this asset class is and how it works?
Lending as an asset class is not new, it is available to institutions and obviously the banks. We are used to being the borrower, for buying a car, a home, perhaps funding a short term loan. This asset class is now available to all investors (lenders). Sectional Title Body Corporates (Community Schemes) are unique borrowers, as they legislatively cannot go bankrupt, members (residents) are legally obligated to pay levies and Sectional Title Body Corporates cannot lend from a bank – would you sign personal surety for your neighbour? That is where we offer a solution, in the 4 different life stage products with a Hollard Capital Guarantee on one of them and legislative protection for lenders and borrowers in this space. Since the Sectional Title’s Act came into effect and was first tested in court in 2001 (The Amine Case) – no lender has suffered a loss. What financial service provider can give proof and backed up data to show over 18 years of no losses – ever!
Yes, it certainly true that we are not familiar with being on the side of the borrower. You mentioned that the expected return was “Prime+5%”. The prime lending rate at the moment is 10.25%, does this mean that the Body Corporates are taking loans at around 15.25%?
The return is not expected but rather a pre-determined contractual rate. If the loan is voted in, the body corporates and those residents are charged prime plus a factor as well as a raising fee and admin fee. Exactly the same as when we apply from the banks for a home loan. We get a rate linked to prime, pay a raising (or activation fee in thousands) and a monthly admin fee for the bond. (The body corporate can alternatively be charged a flat monthly fee in line with the Ombuds recommendations that cover these three costs.) I must stress that each resident in the body corporate is not forced to partake in the loan.
Also note that a loan will only be granted after a full due diligence process of the body corporate is followed and a majority vote at an AGM or SGM.
From what I have seen it is often likely that a body corporate who is in need of funds for a certain project may charge the residents a special levy. I am thinking that this loan would be a good option for those body corporates who still have a good cash flow over time but are looking for short-term funding on a specific project?
You are correct, a special levy is an option. One of the snags of a special levy is it could take months if not years to build up the capital required for a project unless this special levy is a large lump sum. Now if the resident doesn’t have the lump sum to pay in, they need to fund it somehow. This could be from a personal loan, credit card, increases on their overdrafts or even increasing their home loan (their bond). Should they opt not to use these lending options from banks (traditionally) with some interest rates being Prime + 15%, they can make use of a lending facility via Body Corporate Funding Solutions (BCFS) which is how we as lenders get Prime + 5% (upper limit) for the lender, not the borrower. There is actually no maximum but BCFS adheres to the maximum that the NCA recommends. There are many complexes that have special projects, such as solar installations. These complexes do have the means to service a loan and do not need the funds for arrear levies. This type of lending is at Prime + 3% via an amortised loan. All body corporates are encouraged and without fee or penalty to repay their loans as quickly as possible – to ensure responsible lending principles are applied. It is important to note that no one in the complex is forced to partake in this lending environment. If they have the money for the special levy, they simply pay it in and their participation is zero.
I know you have mentioned that Body Corporates cannot go bankrupt and no lender has ever suffered a loss, but are there any scenarios where losses could happen, and what would the process be if the body corporate cannot continue to repay its debt?
I need to break my answer up into a few parts:
To assist with aligning our thoughts with Sectional Titles legislation, I have included the “EY Stuart legal opinion” (endorsed by Webber Wentzel) as it is quite user-friendly:
Part A. 1.h. – Perpetual Succession
Part A. 2 – Every unit owner automatically a member
Part A 3.1 – Cannot be destroyed
Part A 3.2 – Cannot be placed in liquidation
Firstly, making reference to the Part A points above, we can understand that a Sectional Title Body Corporate (BC) cannot die, cannot be destroyed or go insolvent. I.e. it has to continue and it has to seek financial assistance where cash flow issues exist (arrear levies) or where the Body Corporate does not want burden its members with a potential large special levy (special projects).
Part B 10 – Creditors stand first ranking
Secondly, we also understand that creditors (our clients), regardless of whether they are individuals, corporates or trusts stand first ranking with respect to the recovery of capital. This point is key to the long-standing security afforded to our clients (This point in various versions has been tested right up to the Appellate division of the Supreme Court on 4x separate occasions, where the creditor has been protected).
Another critical point that often gets overlooked is the due diligence process in vetting the borrowers. In summary, it’s extensive and the conditions of loans are strict. Furthermore, no more than 20% of the developments municipal valuation will ever be made available to a Body Corporate. I.e. technically a loan would have to go beyond 500% interest before the point below would be considered.
Part C. 1. – All unit holders can be joined
Thirdly, this is an extension of the point above in that if recovery cannot be secured directly through the arrear levy units, the balance of the community can be held jointly liable in their PQ (participation quota) share. I’m not aware of any cases where this element of the legislation has been implemented as the point above has to date always been successful. I.e. this provision is a back-up plan.
Having considered pertinent points that are material to the questions, let’s consider the questions:
“but are there any scenarios where losses could happen”
As we know, there haven’t been any circumstances where loss has occurred. This also as a result of the continued examination of potential threats to our clients capital in our environment. In the past 3 odd years, two legal items have raised their heads and have been dealt with:
Prescription - debts extinguish after three years from the date when it became payable if the debtor is not commutated with regarding the debt. Thus, if BCFS did not provide the Body Corporate with correspondence regarding the outstanding debt, this would be a threat. BCFS have always communicated monthly. Furthermore, loan agreements with BC’s have all been updated to further negate this possibility.
In Duplum - Literally translated, in duplum means 'double the amount'. This is not a capital threat but rather the limiting of interest to 100%. This, (and Prescription) applies to all loans. Consider this scenario… Every 20-year housing loan will have a greater than 100% interest implication. How is this overcome? In Duplum is constantly ‘delayed’ when payments are made by the debtor. i.e. every bond payment delays the In Duplum. The same is true on BCFS loans. A condition of loan is small regular payments which delay In Duplum. To this end, all loan agreements with Body Corporates were updated in 2016 & 2017, making provision for mandatory payments, thereby removing this threat.
It was also estimated that these two items could potentially affect only around 1% of older loans on the book, yet BCFS still took the necessary actions to protect client capital.
"and what would the process be if the body corporate cannot continue to repay its debt?"
When a loan becomes due and payable as per the terms of the loan, the Body Corporate will have the option:
Take a further loan, assuming all due diligence criteria is still met, or
Take action against those units with unpaid levies:
During the loan, BCFS’s legal department and / the BC’s lawyers will have taken the necessary steps to action court proceedings:
A Sale in Execution (SIE) is issued. At this point, the arrear levy contributions often magically appear. Movable items can be attached. The property is attached and will most likely be auctioned. Here we have personally witnessed auctioneers making buyers aware of the obligation to add any arrear levies to the bidding price to settle creditors (creditors are first ranking). Creditors have to be settled before a clearance certificate can be issued. Once all creditors are settled, the property can be transferred (Banks and SARS engage here). Note, all unitholders can still be held jointly liable if necessary as well.
Sorry, a bit lengthy
Thanks for what is rightly a very detailed response. It seems like there are many layers of protection and what puts me at ease is that it seems like in the event that any of these complications do arise it is not the job of us the investor sitting at home to go out and chase the money. Talking about sitting at home, could you tell me about the profile of investor that you would feel this investment is suited for? What investments should they already have and how could this be structured into their portfolio?
Brett, you have raised a very important point, the entire process end to end is handled by the skilled team of highly qualified individuals at BCFS, some of whom even consult to parliament and have written sections of the legislation. You would never have to get your hands involved with collections or anything, BCFS handle it all. I feel this is an asset class in its own right.
This should form part of every investor’s portfolio, after a careful planning process, risk analysis, tax analysis, and cash flow analysis has been concluded. What this product does cater to is all life stages of investors. So you have some paying a monthly contribution to building capital, you have others with capital who want security, stability and certainty to grow it further and lastly, you have those retiring or in retirement battling to make their funds cover their expenses, we can do that at around double what is available traditionally. As this is a cautious profiled solution, I feel it caters for all investors (repeating myself but it is important).
Importantly, this is a wealth creation or wealth maintenance vehicle, not a short-term savings vehicle.
Could you elaborate on the different plans that you offer on this product, what are the minimum investment amounts or minimum monthly contributions that need to be made?
Body Corporate Funding Solutions (BCFS), have four different plans to meet clients’ needs and to match life stages.
For those lenders who want to start with a monthly recurring contribution, the solution would be the POWERED WEALTH product. This product has 60 months contribution requirement (Contribution, not repayment), starting at R1000 per month and has zero or 10% annual escalation. Prime + 5% per annum rate. Interest is calculated daily and compounded monthly.
If you are a lender with capital to deploy, then there is the FORTIFIED CAPITAL PLUS product, which has a minimum requirement of just R50 000. (Repayment profile is an average of 3-5 years at Prime + 5% per annum). Interest is calculated daily and compounded monthly.
Many retirees or those requiring income on a monthly basis, make use of the INCOME ENERGISER product which earns them a Prime + 3% rate. Interest is calculated daily and paid out monthly for income. Important to note that income will vary slightly per month, as it is calculated on the number of days in the month; IE: February 28 days, March 31 days and April 30 days. However, this is very easy to calculate.
Lastly, for those who want an extra layer of protection, BCFS have an insured product offering from Hollard, called the INSURED CAPITAL product which requires an initial deposit of R250 000 at Prime + 3% per annum. Interest is calculated daily and compounded monthly.
I have a fantastic excel calculator which illustrates all the above in an easy to read table and provides certainty on what to expect on a month to month basis.
In closing, what is vital to note, is that there are no fees on the above as the Body Corporate cover those. The rates above further enhanced by compound interest, therefore the effective rate is about 1.2% higher.
I like no fees, and it is a very important point to note about the effective interest rate when compounding is taking into account. You mentioned a 60 month period. Are we as investors locked into this investment for a certain period of time and what happens when a Body Corporate repays their loan faster than expected?
The good news is that although 60 payments are required on the monthly plan via debit order, should an investor be unable to continue for whatever reason, they may stop contributions and are encouraged to resume when they can. What would happen during this period is that rate would drop to prime + 1% until they resume normal payments, then it would go back to prime + 5%.
Body Corporates do repay their loans early and this is encouraged and without fee or penalty to them. When that happens, the funds pass from the Body Corporate to Cash Custodian (SANNE) and straight back to the client. I have had this happen to many clients, long before the 60-month period is up.
So the loan agreement between the lender and the body corporate will be concluded once the body corporate has paid back the full loan amount plus all interest. If the investor then wants to maintain their investment for a longer period, I assume that they will then be matched to a different body corporate looking for a new loan agreement?
Correct, however, the repayments profile dictates that a client will receive any repayment back to their account via Sanne (the point above implies that the funds may be pooled for further lending). With funds having gone back to a client, the client would submit a further application. As such a new Sale of Claims Agreement would be issued with new body corporates.
Once the funds are back with the lender what kind of tax is he or she liable for?
The only tax payable is on interest earned, which is taxed as interest in the investor’s hands. Don’t forget that if the investor is under 65 there is an interest allowance of R23 800 per tax year tax-free and if they are over 65 it increases to R34 500.
Thank you for all your time in answering my questions Terence. If a reader would like to contact you for more information, how should they reach you?
The best is via email, email@example.com, WhatsApp or call me on 083 3379576. My office number is 011 5681338, but I am seldom in the office. I am able to assist anywhere in South Africa and the products can accommodate, non South African citizens or residents, South African citizens and residents, companies and local trusts.