FundSource launches finance company research
FundSource has launched FinanceWatch, an initiative that analyses and reports on finance company debentures to assist financial advisers in making robust, diligent and defensible debenture investment decisions.
Monday, March 21st 2005, 10:22PM
FinanceWatch has been formed to answer advisers’ calls for increased transparency and readily available comparisons of the key financial characteristics of finance companies.
The research comes at a time when finance company investments are likely to once again come under the microscope following the Reserve Bank’s decision to raise the official interest rate to 6.75%.
This reiterates FundSource’s view that New Zealand is nearing a peak in the business cycle with tougher economic conditions imminent.
Key Initial Findings
Notable are the wide ranging findings across many of the key performance figures in the FundSource research.
A few of the more interesting findings are highlighted below.
Profitability: It is of no dispute that the finance company industry has been an extremely profitable industry for the vast majority of participants in recent years.
The average net profit margin for companies three years or older is 15%, with a range of 34.73% down to -4.14%. Interest margins, the difference between what money is sourced and loaned out at, ranges from 29.66% to 3.3%, with an average of 7%.
Capitalisation: The primary risk to a debenture holder is the potential for the company to become insolvent - as the only security provided is over the assets of the company.
Therefore the level of equity within a finance company represents a buffer to debenture investors against any loss that the loan portfolio may suffer.
Equity within a finance company should be at a sufficient level so as to absorb any foreseeable or unforeseeable shocks – such as defaults on loans. If equity is insufficient to cover any loan default the loss may be born by the investor.
FinanceWatch has found that New Zealand finance companies are highly leveraged investments with some having adequate to inadequate levels of equity to cover the future risk of default. While consumer lenders have average equity of 13.8%, they range from having 32.81% equity down to just 4.37%. Property lenders, who across the board have much larger loans as is demonstrated below, average just 9.7% equity and range from 18.54% equity to just 0.90%.
Asset quality: Many finance companies, especially those that lend on property, have been found to have concentration (lack of diversity) within their loan book, where a default by a single loan, or in a single industry has the potential to expose investors to risk not compensated for.
For example, property finance companies average single loan size - on average - is near 30% of their entire equity, while their largest single loan on average is 171.3% of the entire equity of the company.
Conversely, consumer lenders average loan size is typically 1.2% of equity, and their largest exposures average 50% of equity. In general, non-performing loans and bad debts have been declining over recent years, largely enjoying favorable economic conditions.
Companies ranged from having no non-performing loans to some with over 10% of their assets non-performing. The challenge for finance companies will be to cater for and manage escalating non-performing loans as the environment turns toward a less favourable economic environment.
Asset/Liability Management: A theme that has emerged from our survey is the level of liabilities outstanding in the industry that are not matched by assets. While on average around 30% of liabilities are not matched by assets companies ranged from some with over 90% of liabilities not matched by assets while others enjoy an excess of assets maturing in the coming year or so over their liabilities.
While any such mis-matches may be made up by issue of debentures the profitability of such strategies will be challenged by any slowdown in the economy.
FinanceWatch research consists of individual and specific profiles of the top 30 finance companies by size, where key risk assessment factors are disclosed. In addition, FundSource has produced a comprehensive report and guide on the finance company industry, aggregating the findings and providing risk assessment guidance.
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