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Maybe ratings do mean something after all?

Wednesday, June 25th 2008, 6:42AM 13 Comments

by Philip Macalister

St Laurence’s decision to pull the pin on property lending has surprised many in the industry, including myself. The company was always regarded as one of the better operators in the market, run by people who were up front and worked on the refreshing ethos of putting the investor first. That is what was refreshing when talking to St Laurence boss Kevin Podmore last night. He describes the move as acting early and putting something in place which was good for everyone including investors, staff and the shareholders in his business. He said, as reported on Good Returns, that hopefully everyone can be paid back and there will even be something left over for the company’s shareholders. This attitude is in marked contrast to other companies, like Bridgecorp, which seem to be in denial over what has happened and how much damage they have caused people. Podmore’s comments, when I asked him how does he feel about everything, sums the situation up well. “It’s a bit of a relief actually,” he said. Looking at the St Laurence issue with a wider view it is clear that the commercial property/development sector is stuffed and that other finance companies with exposure to it must be suffering too. Again Podmore’s comments are revealing. He thinks the finance company sector, especially when it comes to property finance, will disappear. Strong words from a man who generally understates everything. Another issue which I am wondering about is this. None of the companies which are in trouble have a proper rating. Maybe there is something in this? It seems to me some of the companies which have got into trouble could have sought ratings and in doing so that would have fitted their corporate philosophy, however they haven’t done so. My, early, thoughts are that they didn’t go for ratings because they knew the result wouldn’t be satisfactory? It’s a thought I am developing some more, but the early conclusion, if I am right, is that maybe ratings do mean something?
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Comments from our readers

On 26 June 2008 at 5:34 pm Barrington Smythe said:
The problem with ratings is that it depends on who the rating is from as to whether it means anything.

Bridgecorp had a rating from PIR, which probably nobody in NZ had heard of before it rated Bridgecorp. An 'investment grade' rating from a small company without a long record of correct ratings is not the same as an 'invesment grade' rating from S&P, Fitch or Moody's. In addition, Bridgecorp's rating was paid for by Vestar, not Bridgecorp, which should have caused some concern anyway.

One would hope that ratings from S&P, Moody's and Fitch mean something, otherwise they are spending a lot of time and effort for no obvious benefit. These companies have a long history and the resources and knowledge to do a proper job (in the plain vanilla non-structured rating business, at least).

Ratings are usually paid for by the issuing company and as such the company has no obligation to reveal the rating if they don't like it. I suspect that many NZ finance companies did get ratings but decided not to publicise them either because they didn't want to raise their debenture rates to a level that properly reflected the risk, or because they were worried that a low rating would lead to a fall off in reinvestment rates.

Still, this is history now as there will be very few finance companies left before long, and those that survive will be the ones that have a decent rating. Sadly for most advisers, they also tend be the ones paying the least commission.
On 27 June 2008 at 1:25 am Peanut H said:
It is disappointing St Laurence failed in it's contractual obligations to provide continuous disclosure to it's ratings company Axis Ratings. Having just completed a re-read of the Axis report in light of St Laurence failure, I believe Ron Keene of Axis Ratings was bang on in his identification of the risks involved with investing in St Laurence. For those of you who haven't read the report Keene identified several key weaknesses; Capitalised interest loans were high representing 74% of its book as at 30 June 07; Reliance on brokers for investment funds, dependency on a small number of major suppliers of funds. From a personal point of view I struggle with the Standard and Poors finance company reports. I much prefer the Axis method of mining down to find out significant strengths, moderate strengths, moderate weaknesses, significant weaknesses. Full marks Mr Keene, for me ratings reports do work.
On 27 June 2008 at 10:37 am Majella said:
The ratings companies - S&P and Moody - have their own reputation in tatters after the very high investment grade ratings they provided to the fatally flawed CDO and MBS issues made some 4 and 5 years ago. Even NZ suffered directly, through the two Generator bond issues, both of which were rated "investment grade" and which are now selling at a 50% discount.
Surely the better protection is provided by either (real) insurance over the loans (viz Compass et al) or strong equity and deep-pocketed shareholders.
Better yet would be the commercial banks to find their "nuts" again - it is their pressured capital positions that is choking the mezzanine lenders who's borrowers cannot re-finance their 2nd mortgages as they had expected to be able to do, mainly due to the banks reneging on prior commitments to take out the expensive lending when specified developmental milestones had been acheived.
BS is right - there will be few finance companies left soon, and the publically raised debenture model is well and truly broken. But the survivors will not be there BECAUSE they have a rating, but because they have strong equity and committed shareholders.
On 27 June 2008 at 12:48 pm Wattie said:
Just goes to show that ratings (any ratings!) will not be the "cure all" that govt thinks. they say a week is a long time in politics - looks like its a long time for development funders as well.

Of more concern to me is the downstrean effects of the finance company demises. Whats going to fund retail HP, used cars, industrial plant, etc,. What about the carpenters, plumbers, painters, suppliers as more builders go under?

The irony is that banks created most of the current mess (sub-prime; credit crunch) but are currently getting huge inflows from Mum n Dad investors. No wonder they are scrabbling to issue pref notes/shares to shore up the equity ratios. Who can believe that said banks would be dumb enuff to lend 100% mortgages on overpriced houses. Watch out for their spate of foreclosures on "negative equity" properties in the next few months. Don't see any sign of Govt legislation about bank practises.
On 27 June 2008 at 2:35 pm Appleaday said:
What we are seeing now with Finance Companies are the inevitable results of the Banks behaviour in tightening credit. Quite simply if the money supply gets switched off by the Banks the downstream players relying on it perish. According to Neville Bennett the (AussieNZ) Banks borrowed and brought $180 Billion into NZ during the good times and over the next two years have to pay it back. This is a huge sum- more than $40,000 per man woman and child. In addition they have reduced leverage on lending from nine times to between one and two times and raised their deposit rates to levels that Finance Companies have no chance of competing with.
This is a scenario where Finance Company failures are going to occur even amongst the healthy well run companies.
If you look at those responsible for this situation unfolding it is a combination of greedy Banks and the Ratings Agencies such as S&P. Viewing those same ratings agency as the solution really misses the point. What would be appropriate is to discuss setting common standards of research for Ratings Agencies and establishing a body to monitor them.
On 27 June 2008 at 2:53 pm Richard Hurley said:
The generator Bonds mentioned by majella are still rated By S&P as AA- and are curently trading on the NZX bids at 99.79 and offers at 100.38.
I dont understand the reference to a 50% discount
On 27 June 2008 at 6:30 pm Barrington Smythe said:
Majella, the finance companies with strong ratings have those ratings because they have committed owners, strong equity and diversified funding lines - that's part of what ratings agencies assess. And Generator was actually upgraded by S&P recently, as it was issued at A-.

If you set up a body to monitor the ratings agencies then who do you employ to staff it? Probably ex-rating agency analysts. And who monitors the monitors to make sure they're on the ball?

I think it's a bit harsh to blame the ratings agencies for the current problems, especially in NZ. There are two sides to the ratings business; the standard fixed income ratings and the structured ratings. It's only the latter that have been shown to be flawed.

The fundamental problem in NZ is that debentures were sold to mums and dads as 'guaranteed', risk-free etc. and as soon as it became apparent that they are anything but, reinvestment dried up.

Many finance companies were set up as a quick road to riches for the owners, who could fund through the debenture markets at far cheaper rates than they would have had to pay in the bank or bond market. Just look at C&M, who had to pay Fortress 14%+ p.a. with priority over the debenture holders, who were getting 5% less p.a.

Insurance is not the answer either, as both Bridgecorp and C&M found. And don't forget that Compass was the company that was set up so Bridgecorp could sell its 'good' loans to someone else.
On 1 July 2008 at 9:05 am Majella said:
GTR010 - last sale 30/6/08 5:22 pm @16.5%. With a coupon of 8%, isn't that's a 50% discount? I stand to be corrected.
On 1 July 2008 at 9:20 am Barrington Smythe said:
Err.. no. Can't see where the 16.5% came from, but anyway, there were $50,000 of bonds traded for value of $49,932.95, which is not a 50% discount. Think about it - why would anyone, unless they have taken leave of their senses, sell a bond with a AA- rating (recently upgraded) that matures in 2 months, for 50% less than its maturity value??
On 1 July 2008 at 4:45 pm Majella said:
BS - I know, it wouldn't make sense, but I had referred to the Direct Broking site which quotes last sale at 16.5 and current offer at 12. I believed these to be yeilds. Are they not?
On 2 July 2008 at 11:42 am Arthur said:
For those of you that don't understand the bond values there is a very helpful guide to valuing fixed interest on Directs website. It is under education in the fixed interest section.
On 4 July 2008 at 8:35 pm The analyst said:
Time for a bond pricing lesson to clear up the mystery.
GTR010 has an annual coupon of 8.0% p.a - pays interest quarterly = 2.0% per quarter.
Bonds mature 20 August 2008 when last coupon + interest will be repaid.
Bonds are sold on a purchase yield basis - last quote 16% p.a.
Price is found by discounting cashflows by this yield.
These bonds have 46 days to go.
They will pay 1.02 in 46 days.
To get the price that you would have to pay to buy them today, divide 1.02 by (1 + (46/365)*0.16).
In other words what is the present value of $1.02 in 46 days at a 16% p.a. yield.
That's why the price is close to par currently - BS calculation.
Majella, if you double the yield, you do not halve the price.
Easy isn't it.
On 8 July 2008 at 8:47 am Barrington Smythe said:
Maybe this is why (apart from commission) most 'financial advisers' don't recommend bonds?
Commenting is closed



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ICBC 7.85 7.05 6.69 6.59
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Kiwibank 8.50 7.99 7.79 7.55
Kiwibank - Offset 8.50 - - -
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