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How to avoid fin coy chaos

Friday, August 31st 2007, 6:50AM 5 Comments

by Philip Macalister

It seems like a bomb has gone off in the finance company sector and things are total chaos. Seems like Iraq. The reality is quite different.

The two latest companies are collateral damage in the whole finance company explosion

One feels for Propertyfinance (PFS). My impression of them is that they were a good company with an innovative approach to business. When I say innovative, I mean it in the true sense.

PFS has been caught out by the global credit crisis.

There are three ways a finance company can fund their operations. One is through investors (either direct or through advisers), the second is to have a wholesale funding line and the third is securitisation.

With the latter companies package up loans and sell them to institutional investors. Following the sub-prime collapse in the US institutional investors aren’t interested in buying loans from crowds like PFS.

I have heard news that Marac was looking to do some securitisation, but I guess those plans maybe shelved now.

Five Star looks like collateral damage. It only had one funding line – investors. Reports seem that reinvestment rates and new money dried up pretty quickly.

No money in the door spells trouble. As regular Blog readers will know this was part of the problem with Bridgecorp.

Around two thirds of their money came from advisers. Over the past few months support fell and they ended up with a liquidity problem.

The two big things for me are that not all finance companies are bad or at risk of falling over. The good, big companies are increasing their disclosure and showing they are in good shape. The caveat here is that one still has to be careful about what finance companies are saying about themselves. At least two, Nathans and Five Star, had made public comments days before their collapse saying they were in good shape.

Secondly, investor panic will cause a widespread collapse.

If everyone clamours for their money back there is only one outcome. Chaos.

My suggestion is that investors make an informed decisions about whether their company is sound or at risk.

Readers of know I outlined a five point plan people should consider when looking at finance companies. Use it as a starting point to understand each company.

« Supporting advisersRegulation won't save companies (or investors) »

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Comments from our readers

On 31 August 2007 at 2:10 pm Hugh Anderson said:
Once the dust settles and money is once more flowing freely into the surviving companies, the problem is going to be educating investors on how the rating system works. Both S&P and Fitch have a system where bbb- is the lowest investment grade.
There is a large NZ company advertising their BB+ rating but not explaining that BB+ is speculative and not investment grade. Good on them for getting a rating and publishing it, but they should explain what it means.
On 31 August 2007 at 2:41 pm David Taylor said:
Phil I strongly applaud you on your efforts to bring a balanced view to the media. I support you 5 point approach.

Trustees are surrogates of the debenture holder's interests - and investors could do no harm in putting questions directly to them on a particular finance company. I have found that an informal, constructive but in-depth phone call to the finance company by an investor will enhance their understanding of the risks involved.

Salutatory lessons for finance companies are 1). To apply the matching principle of asset and liability timing of funds flows and 2). Recognise that the Trustee equity requirement is a minimum. Directors should formulate their independent views of shareholders funds held, based on what they see as the business risks over time. There is substantial treasury experience in NZ to take advice on policy and practice in these areas.
On 31 August 2007 at 3:14 pm Julian said:
One recent press release by a market commentator says that many of these loans and mortgages will be called in. There will be blood on the streets if property investors have to suddenly refinance in this climate, to pay receivers. I would have thought, given the reason for collapse, the mortgage books will be bought. What's your view on the likely scenario?
On 31 August 2007 at 8:17 pm Barrington Smythe said:

Unfortunately, it was always blindingly obvious that once one or two 'mainstream' finance companies failed, many others would follow. Part of the reason that Bridgecorp failed was that one or two advisory firms withdrew large support, a fact acknowledged to you at the recent IFA conference.

The problem is that too many finace companies and advisers marketed debentures as being guaranteed, safe, secure, good financial sense, solid as, etc etc, leading to a market where investors didn't understand the risks they were taking.

Now that the risks have become apparent, of course mums and dads are going to run for the exit as soon as they can. That's rational behaviour.

As far as ratings are concerned, having a compulsory rating system is not a panacea.

Firstly, many investors (and advisers I suspect) don't know or understand what ratings mean. How many people know that a B+ credit rating implies a 20% chance of default in the next 5 years?

Secondly, once all finance companies are rated (and most will receive a very low rating), investors will then look to invest in the highest rated companies and avoid the low rated ones, unless the latter increase the rates at which they borrrow from investors to a more reasonable 13%+ p.a. (or 5% more than AAA rated bank deposits).

This will lead to lower rated companies either having to increase the rates they charge to borrowers, leading to higher defaults, or suffer greatly reduced profitability, or both. This will lead to more failures.

There are any number of companies out there who might be looking OK now, but wait till the next annual reports come out.

One medium size company which is very largely funded through advisers (the 3% commission rate probably helps..) had just 5% equity at the end of March (if you include capital notes), and just $10m in cash, down from over $30m last year. Around $160m of its debenture book is due to mature in the next 6-12 months. All this is publicly available information. As we have seen, a letter from the CEO reassuring investors that all is well is not necessarily a guarantee that this is the case!

Much as some might wish for mums and dads to hang in there and continue to support finance companies, it's not going to happen, apart from the highest quality ones. Ask yourself what you would do if it was your own money at stake!
On 3 September 2007 at 6:15 pm Suzanne edmons said:

The new action group, EUFA, is formed to expose financial advisers who do not hold their own industry in high regard. Losing money through shonky advice is the issue.

Financial advisers should welcome this initiative as it is aimed to tidy up the industry and obtain some accountability.

Commenting is closed



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BNZ - Classic - 7.14 6.79 6.65
BNZ - Green Home Loan top-ups - - - 1.00
BNZ - Mortgage One 8.69 - - -
BNZ - Rapid Repay 8.69 - - -
BNZ - Std, FlyBuys 8.69 7.74 7.39 7.25
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CFML Loans 9.45 - - -
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China Construction Bank Special - - - -
Co-operative Bank - First Home Special - 6.79 - -
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Co-operative Bank - Standard 8.40 7.49 7.29 7.15
Credit Union Auckland 7.70 - - -
First Credit Union Special - 7.45 7.35 -
First Credit Union Standard 8.50 7.99 7.85 -
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Heartland Bank - Reverse Mortgage - - - -
Heretaunga Building Society 8.90 7.60 7.40 -
HSBC Premier 8.59 - - -
HSBC Premier LVR > 80% - - - -
HSBC Special - - - -
ICBC 7.85 7.05 6.69 6.59
Lender Flt 1yr 2yr 3yr
Kainga Ora 8.64 7.74 7.35 6.99
Kainga Ora - First Home Buyer Special - - - -
Kiwibank 8.50 7.99 7.79 7.55
Kiwibank - Offset 8.50 - - -
Kiwibank Special - 6.99 6.79 6.65
Liberty 8.59 8.69 8.79 8.94
Nelson Building Society 9.00 7.65 7.25 -
Pepper Money Advantage 10.49 - - -
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SBS Bank 8.74 7.74 7.09 6.95
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SBS Bank Special - 7.14 6.49 6.35
SBS Construction lending for FHB - - - -
SBS FirstHome Combo 6.19 6.14 - -
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TSB Bank 9.44 7.79 7.55 7.45
TSB Special 8.64 6.99 6.75 6.65
Unity 8.64 6.99 6.79 -
Unity First Home Buyer special - 6.55 6.45 -
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Westpac 8.64 ▼7.49 7.35 6.99
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Median 8.64 7.14 6.82 6.65

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