A guarantee is only as good as those giving it

During the credit crunch recession, money was leaving Irish banks at an alarming rate as people didn’t trust the solvency of the banks. To avoid a run on the banks, the Minister for Finance, Brian Lenihan, introduced the Deposit Guarantee Scheme, where the Irish State would guarantee up to €100,000 in deposit accounts for individuals. Now, instead of banks saying “your money is safe”, the government, with the weight of the ECB behind it, were saying “your money is safe”. People felt more assured when the government was giving the guarantees and not the banks. A perfect example of people looking at who is giving the guarantee.

The financial services industry is full of investment opportunities where customers are offered guaranteed returns on their money. A lot of these people are inexperienced investors, looking for a return higher than what they are getting on deposit and they are attracted to the guarantee bit.

Who is giving the guarantee?

But who is giving the guarantee? Is it being provided by a large commercial bank with deep pockets or are the returns insured? Or are the returns merely being guaranteed by the borrower? Which are usually small to medium sized businesses in Ireland. We’re not talking Apple!

So say a hotel group raises €3m in total from an investment project and offers a return of 6% each year for 5 years starting in 2019, so they have to pay €180,000 a year to investors. These are typically in the form of loan notes, which investopedia describes as “Legally, a loan note holds more significance than an informal IOU“. So that’s the level of comparison that a loan note is given with regards to how secure your money is.

Back to our hotel, the first year of business is always slow as they have just started and need to get word out and bookings in. Then Covid 19 hits and bam!! All bookings are cancelled. Even after opening up, you can’t rent out all the rooms, there’s social distancing in the bar and restaurant so income is down there too and you have to spend additional money on making sure the place is safe for staff and guests. And on top of that, you have to find €180,000 to pay investors?!! Where’s that money going to come from?

We all know what is going to happen. They can’t pay the €180,000. The promoter will say due to unforeseen circumstances the interest can’t be paid and that will be it. When you ask them about your guarantee, you will be reminded that the product brochure (which 99% of people don’t read), laid out all the terms and conditions which will include one that will say that all of the risks and conditions containing to the investment are listed in the prospectus (which 99.99% of people don’t read). In researching for this article, I looked at a number of websites for companies that promote such products. Not one of them had a product prospectus available online. This would have also told investors where they ranked in the order of creditors if the business went bust.

Most of these products are unregulated too, meaning the Central Bank of Ireland has no control over these products. Some of the debts are listed on the Cayman Islands stock exchange!! Why is that?!!

It also means that you can’t avail of the Investor Compensation Scheme where you can claim back up to €20,000 of your money if an investment fails.

If you are looking for a guarantee, make sure you know who is giving it and that they have the resources to pay it out if things go bad. Otherwise, you have two choices:

  1. Guaranteed option – stick it in the bank and accept the low return
  2. No guarantee option – invest in diversified portfolio of quality companies and bonds and accept the ups and downs but know that in all likelihood you will at least get your money back if you invest for long enough.

If you have any questions, drop me an email at steven@bluewaterfp.ie