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Regulation won't save companies (or investors)

Friday, September 7th 2007, 9:12AM 5 Comments

by Philip Macalister

Talk of rushing legislation into action to avert finance company collapses is meaningless.

The reality is legislation won’t stop finance companies collapsing, nor will it stop investors losing money. Finance companies are falling over for a number of different reasons. The most common are a lack of money coming in the door, from whatever source a company uses, and the point we are at in the market cycle.

Coupled with these are the lending and management practices of the companies involved. In some cases, such as Provincial Finance, the two issues are management lending in a market they didn’t understand and possibly some fraud. With Bridgecorp there appears to be questionable lending and a reasonably sudden fall in support from advisers. Many of the most recent collapses are small companies who can’t in this environment get enough money in.

I would not be surprised if this rate of collapse runs at one little company a week for the next month or so.

The reality is legislation and regulation won’t stop failures. Likewise, mandatory credit ratings are no panacea either.

Credit rating don’t always get it right and they very rarely expose fraud and mismanagement.

The most important thing investors and advisers can do is understand what each finance company does, before committing money.

One thing which will help is the proposals yesterday for finance company trustees to have greater power. This is something which will help.

My question is will trustees use these powers and will they be able to publicly express their views? An issue they may have is that a company will seek to stop them publicly exposing issues when they are discovered.

This is a little like the issue where the Securities Commission banned Bridgecorp’s prospectus and investment statement, but couldn’t say anything until the company had a chance to respond.

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Comments from our readers

On 7 September 2007 at 10:25 am alan milton said:
Hi Phil, I have long believed that every prospective investor should ask the adviser if the adviser is personally invested in the products they are recommending. I have always volunteered this information. It would be interesting to know the personal exposure to these collapsed finance companies of the advisers who have recommended them. I had two retired clients who badgered me to invest in financxe companies and when I refused, they moved to another adviser. I have no idea how they are placed now

Cheers, Alan Milton
On 7 September 2007 at 1:01 pm Dr Steven Joynes said:
Good on you Alan, practice what you preach I say. Interestingly enough the question

"What do you personally invest in and how does this compare to typical advice you provide?"

is not a question suggested by any of the websites for the IFA, or the Securities Commission. It makes you wonder.
On 7 September 2007 at 1:21 pm Maurizio Piglia said:
A levelled playing field?
Let's face it plain and squarely. When there is a confidence crisis on a bank and people run to take their deposits out, the Reserve Bank prints as much money is required and sends their armored cars to supply what's needed....because you cannot risk a crisis of confidence in the banking system<br />

It is becoming the case, now, of a confidence crisis in the finance companies sector to which the watchdogs that should survey the state of the savings of New Zealanders are assisting passively....maybe because they hold an indirect stake into it. Finance companies perform a service in the New Zealand small financial market, they supply financing to smaller companies, to projects banks are not prepared to finance, take the riskier part of developments that otherwise will not be started...of course, then, they take higher risks, they earn higher returns and pay higher interests when they offer debentures.

They are, moreover, unbalanced in terms of their maturities, they lend long term, ususally, and take averagely short term at 18 months maturities (being probably a generously long estimate).

Of course, the rate of reinvestment is paramount to their existence.

A bank keeps no more than 9/10% of its book in cash. For a finance company prudently administered, given that imbalance that exists naturally, a figure of 12/15% should be considered a very good prudent one.

Well, no matter what, but with the run on the money that we have seen on finance companies, fuelled also by superficial media reporting (and I'm talking generalist media), that amount kept in cash could have been wiped out bringing to receivership, as it has, even good asset holding and decently managed finance companies. Only an exceptional combination of cash holdings and cash flow generating assets could have saved them...taking into account, also, that a high cash holdings impacts profitability.

All said, can someone explain why banks have a lender of last resort and finance companies, even if they can prove their assets quality is sterling (Property Finance could!) have only the receivers in case there is a panic run on the money and how increase the frequency of reporting to the Trustees can change that outcome?

The regulators are blatantly ignoring that the playing field is not levelled, and the fact that many banks are smiling in seeing so many finance companies go under, as they now are contemplating to retake territory.

Of course, they will not use the same credit criteria, so , to all effect, a big credit crunch is already in effect in New Zealand, with a lot of lending power taken out abruptly from the market.

Has, in this way, Dr Cullen fulfilled a (secret?) task to take out a nuisance from the way of banks and can now start reducing OCR in view of a brusque deceleration of New Zealand economy that is almost sure to happen now?

And considering that this will boost the banks' profits, which are all, by the way, Australian owned, whether the finance companies were mostly New Zealand owned (and for this reason, smaller and under-capitalised), and holding New Zealanders' money how can this be considered a service to the nation's economy?

Let's be clear, maybe Bridgecorp had a not so good assets quality, and maybe another one or two of the nine gone under will have "merited" the receivership, but a lender of last resort for the others, for the good ones, will have reestablished confidence, averted a crisis, and kept over a billion of NZ$ from being tied up in receivership procedures that will anyway cut 30 cents to the dollar out for their own sheer costs (receivers are not free...and are paid first and anyway) and for the fact that they are bound to sell assets as fast as they can...and not at best possible prices.

Yes, I have a conflict of interest, I work for a small finance company. No we are not going to go under, we saw the crisis arrive, we made cash provisions and our book is cash generating.

On 9 September 2007 at 8:42 pm Ed Aitken said:
Fortunately I have never felt inclined to recommend investment in any individual finance company to any of our clients in the past. The true risk profile of investing in any one of these companies (and yes I personally think that they are all potentially vulnerable) has been misinterpreted by many financial advisers and consumers over the years.

What I fail to understand is exactly why the powers that be, have on the face of it, taken years too long to look in to tightening regulation in this area. If there is a case to be answered as to why this whole situation has been allowed to develop over many years, then it is the Commerce Commission itself that needs to be shaken to the core and individuals within it held accountable for allowing this mess to manifest itself in the heart of the New Zealand financial services industry.
There is undoubtedly need for reform and a total investment risk reclassification of finance company investments would be a positive step forward towards ensuring that investors appreciate that investment in this arena sits typically right at the top end of the risk spectrum.
It’s also clear to me that the potential reward available has never been proportionate to the level of investment risk present.
I can assure you that there is no self righteous intent here. I’ve been lucky enough as an adviser to have spent my formative years in the UK environment, where finance company investment is really is not on the agenda for most advisers and investors. The main perceived reason for this is that the loose advertising and representation witnessed here in New Zealand would simply not be tolerated in the UK.
To sum this up, I strongly believe that finance companies have for years been allowed to paint a picture of security through the use of terminology such as ‘first ranking’, ‘income’ and ‘secured’. All future adverts should be restricted and regulated to ensure that investors are made aware of the risks they are entering in to.
As to where the adviser sits with regard to this, the jury’s obviously out although I’ll certainly be building an increase to PI premiums in to next year’s budget forecast!
To touch briefly on commission disclosure, if the UK’s experience is anything to go by it will not make a blind bit of difference to the quality of advice being offered here in New Zealand nor do I believe that it would in any way have reduced the scale of the problem that currently exists in this sector.
On 12 September 2007 at 2:42 pm a reader... said:

To Alan and Steven,

Duh! Since when does it reflect the professionalism (or not) of an adviser to reflect their own investments to that of a client?

The professional's role is to advise on what's best for the client - and that should have nothing to do with what the adviser's personal position is.

Personal risk appetites aside - the most galring example of the deficiency of this approach is when the adviser has a mortgage and is (hopefully) fully investing in repaying that; whereas the client is debt-free (if not they should be advised to get there first) and will not be interested in investing in the adviser's mortgage!!!

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