KEY POINTS:
Investors in mortgage trusts and funds have been shocked by the closures of Canterbury Mortgage Trust, Totara First Mortgage Fund and the Guardian Trust Mortgage Fund in the past fortnight.
These three funds plus the closure of Tower's Mortgage Plus fund in April, brings the total frozen in these trusts to $801 million and the number of investors affected to 16,100.
Many investors believed, until now, that mortgage trusts and funds were much safer than finance companies.
They promoted themselves as funds that only lent on first mortgages over property and only at loan to value ratios of 80 per cent or better. Many only lent on 60 per cent or better.
They were often run by lawyers or trustees and appeared to have a sheen of respectability not shared so much by the property developers who often ran finance companies.
So what went wrong?
Mortgage trusts and funds now have some little secrets being exposed as the credit crunch wreaks havoc through New Zealand's property development and residential investment sectors.
Firstly, many of the trusts are exposed to property developers and residential property investors because they often make short-term bridging loans.
Anyone who needs a mortgage for the house they live in will borrow for 20 years or longer from a bank.
Short-term property loans are heavily exposed to the risk the property market will freeze and transactions won't happen to clear the loan. They are often connected with property investors or developers.
Secondly, the maturity of their funding sources is mismatched with the maturity of their lending.
This means they typically borrow short term (six months or less) from Mums and Dads - or more often their lawyers and trustees - and lend for much longer terms (six months or more) to property investors.
Both factors are potentially fatal design flaws in any financial institution. They open up the risk of a run on funds, and the risk a collapse in any one market will damage the institution's assets or loans so it can't cope.
A collapse in the residential property investment market was once considered unthinkable, yet that is what's happening. In the past six months, the average number of days to sell a property has blown out to more than 50 days from less than 30 days.
Investors in mortgage trusts often receive a variable return quarterly and have the right to withdraw their money at short notice, although they may not be paid out for 90 days.
Every mortgage trust or fund is different so it's worth asking your trustee or adviser the following questions:
How much of the trust's lending is for residential property investment or development?
What percentage of the trust's loans are in arrears or are being capitalised?
What percentage of loans are for longer than one year?
How much of the fund's assets are in cash?
The longer term the lending, the higher the exposure to development, and the lower the assets in cash, the higher the risk of a trust being frozen.
Bernard Hickey is the managing editor of www.interest.co.nz, a website for investors and borrowers wanting free and independent news and information about interest rates, banks, finance companies and the economy.