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LRBA risks exist at individual level

LRBA risks

While LRBAs do not pose large-scale risks to the super system, issues may arise at the individual level where SMSFs may hold high concentrations of assets via borrowings.

Risks related to limited recourse borrowing arrangements (LRBA) are considered to be low on a macro level, but concerns remain about those faced by individuals for whom an LRBA represents a significant portion of their SMSF assets and liabilities, according to a report from the Council of Financial Regulators (CFR).

The recently released report found LRBAs do not pose any significant risk to the superannuation sector or the broader financial system, but the concentration of assets by some SMSFs was of concern, given that in 2020, 95.8 per cent of the value of assets held under LRBAs was real property.

“This large concentration of LRBAs in a single asset class, particularly if coupled with the concentration of all or a significant proportion of an SMSF’s assets within a single asset in that asset class, raises the investment risks for SMSFs,” the CFR stated.

The report also noted a steady increase in the concentration of assets under an LRBA with many funds still holding high levels of assets under one.

“Of SMSFs with LRBAs in 2020, 43.3 per cent had 90 per cent or more of their assets backed by an LRBA – up from 41.2 per cent in 2017 and 28.8 per cent in 2014,” it said.

Similar figures were reported at lower concentration levels, with 64.2 per cent of SMSFs having 80 per cent or more of their assets acquired under an LRBA and 70 per cent of funds having 76.4 per cent or more of their assets associated with one.

The CFR, which is compromised of the Australian Prudential Regulation Authority, Australian Securities and Investments Commission, Reserve Bank of Australia and Department of the Treasury, added this concentration of assets may create problems for SMSFs with lower balances, which could flow outside the super system.

“As most SMSFs using LRBAs have net asset values less than $500,000, the high purchase price of property relative to their fund balance can mean this asset class often makes up a large proportion of their portfolio and leads to high levels of asset concentration in an SMSF,” it said.

“Depending on the age of the member, there may be little opportunity to recoup losses.

“Some of this downside risk is implicitly transferred to taxpayers who underwrite adverse outcomes in the superannuation system through the age pension and costs may be incurred by government in the form of forgone tax revenue from superannuation tax concessions.”

It also noted rising interest rates may exacerbate risks and deplete the SMSF of any retirement savings.

“The increase in borrowing costs and its impact on the return to property investments may present risks to the retirement savings of many SMSFs using LRBAs. In particular, there is a risk that leveraged funds with smaller balances will sell assets to meet LRBA repayments, potentially exhausting their entire balance,” it said.

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