Investments, Superannuation

COVID-19 liquidity risks threaten SMSFs

SMSFs liquidity risks

Liquidity issues within SMSFs have been exposed by COVID-19 and relief measures may not be sufficient to prevent the failure of some investments.

The impact of COVID-19 on rent and limited recourse borrowing arrangements (LRBA) within SMSFs has uncovered liquidity risks which may result in the failure of some investments, according to an SMSF educator.

SuperGuardian education manager Tim Miller said the rent relief and loan deferrals created by the federal government under wider COVID-19 relief measures, and supported by the ATO, have highlighted the fact many SMSFs do not have sufficient liquidity to survive a financial downturn.

“COVID-19 has uncovered problems we have in the industry and brought to the fore the liquidity risks many SMSFs have and given us the capacity to speak out loud about these issues,” Miller said during a presentation at the Chartered Accountants Australia and New Zealand National SMSF Conference Online 2020 today.

“We should have been doing that all along because it has always been a ticking time bomb. We saw this issue arise during the 2000-2001 technology bubble and in the 2007 global financial crisis, and we are seeing it now as a result of COVID-19.”

He said events that heavily impact the liquidity of SMSFs are occurring at least once a decade and they affect a fund’s investments by reducing the members’ retirement savings and their capacity to make further contributions.

While SMSFs made use of the rent relief and LRBA loan payment deferral measures to offset any financial impact due to COVID-19, their implementation was not fully considered and issues remained that could threaten an SMSF’s underlying investments, he noted.

“As an administration firm, we saw this regularly and many SMSFs went straight out and adapted their rental terms without considering the long-term consequences,” he said.

He pointed out while every fund had the capacity to provide rent relief, the level at which the rent would return and pay off an LRBA loan where applicable could vary greatly.

Businesses that relied on tourism in states with closed borders, such as Queensland, were far more likely to still be seeking rent relief on properties compared with businesses that returned to operations in the middle of the year, he said.

“An accounting firm in Adelaide that returned in June will have their rent back on track compared with a tourism operator in Queensland who may not be back until next year and their recovery may take 12 months,” he noted.

“These rent relief issues are obvious, but less obvious is the impact on LRBAs because the time will come when banks stop playing nice and start demanding payment.

“If we consider related-party loans in an LRBA, and unless we see some form of legislative instrument that expands the length of time LRBA safe harbour loans can be paid, then this will create a negative liquidity dynamic.

“Some SMSFs will still have a large debt under the LRBA and a shorter time frame to pay it off because they have had a deferral for up to 10 months.

“They will then have to compress payments into a shorter period, and if they are still under rent relief provisions, how will the fund meet those LRBA repayments without defaulting on the loan?”

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