Comparing Mortgage Trusts and Finance Companies

Mortgage Trusts and Finance Companies - What is the difference?

In the light of all the recent publicity involving the financial sector it is important that the fundamental differences and risk profiles of Mortgage Trusts and Finance Companies is understood.

A Mortgage Trust is a collective investment fund, where a group of investors (referred to as Unit Holders as they invest in units in the scheme) contribute funding to a pool for a specific class of investment within defined parameters.

It is a trust (not a company) managed for a fixed fee by a professional Manager for the purpose of maximising the returns for all Unit Holders. The Unit Holders share equally in all of the income of the Trust while also bearing all of the investment risks of the Mortgage Trust.

On the other hand a Finance Company aims to maximise the returns to its owners (ie shareholders). The role of depositors is to provide funds to the company, at a fixed rate of interest and usually for an agreed term. There is an inherent tension between the profit motives of the company and the legal obligation to repay in full the fixed interest returns sought by depositors.

When liquidity issues affect the financial sector, the Fund Manager must focus solely on the interests of all of the Unit Holders. This may involve freezing the fund assets for the benefit of all the Unit Holders to protect the direct interests they have in the Trust assets. This power is contained in a Trust Deed and is generally explained to potential investors in the offer documentation.

A Finance Company having entered into a promise to pay depositors interest and principal on agreed dates, is in default of its obligations (as set out in a Trust Deed)  if it does not or cannot make such payments. The redress depositors have is to the company itself and indirectly to the assets held by the company. Trustees may enforce those rights of behalf of the depositors with mechanisms such as receiverships or creditor compromises.

In summary, a Mortgage Trust investment is a direct interest in a pool of assets, while a Finance Company deposit is a loan to the company supported by a promise to repay on an agreed date. From an investor perspective the products offer quite different risk and return profiles.

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