KEY POINTS:
The $20 billion finance company industry may shrink by half or more within two years, according to Andrew Walker, chief executive of listed finance firm Dorchester Pacific.
One scenario could see it virtually disappear, he said.
"The retail market hasn't reached the tipping point, but it's getting close to being all over."
The industry essentially funds itself from retail debentures and the market for these was severely damaged by the collapse of 14 finance companies over 14 months.
Everything will depend on reinvestment rates as alternative funding sources were not viable, due to a storm generated by the US sub-prime mortgage crisis that has knocked international credit and equity markets.
The reinvestment rate, the proportion of investors who roll over their investments, fell at Dorchester to 21 per cent in October when a clutch of competitors collapsed.
It lifted to around 40 per cent last month, which he said was "not bad". Before the crisis, it had been 65 to 73 per cent across the industry.
"It's very simple mathematics. If it [the reinvestment rate] goes to zero and with average debentures 18 to 24 months, then in that time the industry won't exit.
"If the long-run reinvestment rate is 50 per cent, then the industry is going to halve.
"The real future of the industry is not just changing the business model. It has to change. You have to source your money from different places and you have to lend it out differently.
"Companies that have relied solely on retail debenture funding will find it tough."
He said banks were not really in a position to fill the void as "they have their own issues". Many had lost billions in the US sub-prime mortgage market resulting in a credit crunch. They were loath to lend and had lost their appetite for risk.
Raising money through equity markets was not an option, for similar reasons.
Walker said he wouldn't be surprised to see more finance company collapses. Others would simply close shop.
"We will see a number of finance companies that don't collapse but say, 'we've had enough'."
He doubts the analysis of many commentators who suggest there will be mergers.
Essentially, he said, finance companies' only real assets were their lending teams. Without propriety rights to funding lines these were worthless.
"The consolidation thesis doesn't work because the only thing another company would be buying is the lending team which is the first thing to be cut.
"Your lending team only has value if you've got stuff to lend."
To survive, companies had to take fairly radical action.
Before Christmas, Dorchester sold the Auckland Club Tower in Shortland St for $30.7 million, releasing $15 million in cash, plus it set up a $20 million funding facility from two of its main shareholders.
Between them, Hugh Green Investments and Kevin Podmore's Auguste Finance own 40 per cent of Dorchester, while Dorchester owns 25 per cent of St Laurence.
As well as those two moves, Walker has dropped a car lending business and slashed staff and costs by a third.
The finance company's profits were dropping - "not cascading, but they are dropping in line with our removal of costs out of the business".
Asked what he could do, Walker said that after cutting costs, and setting up the stand-by facility, all he could really do was try to instil investor confidence and point out the differences between his company and those that had failed.
"We jealously guard the people that stick with us.
"But even long-standing loyal investors will only have a certain amount of tolerance to industry failure."
He said Dorchester was providing monthly updates including hard data on reinvestment rates, which he said others in the industry refused to do, making it impossible for investors to make informed decisions.
"We have taken the view we have to share information whether it's good, bad or indifferent."
Walker believes future consumption lending such as hire purchase will have "a really, really rough time".
"As the economy slows down, which it will, and the cost of basic goods goes up, which they are, and mortgage rates go up, or stay constant, people aren't going to have the ability to borrow and consume." The demand there was dropping away.
He said the used car market in South Auckland, like the sub-prime market in the US, had been financed largely because lenders had surpluses to invest and those two markets had now collapsed.
"Without the finance company underpinning the car dealers' business model, they didn't have a business.
"When the money dried up, their business dried up."
Walker believes the speculative property market will also slow down.
Finance companies will be a lot choosier about who they lend to.
"It will be a tough market. Everyone is going to be cutting costs."
Developers who had been paying 14 per cent plus 2 per cent fees would soon be paying 18 to 19 per cent plus 2 to 3 per cent.
"That equation has yet to work its balance out but it's moving that way."
Dorchester's shares have slumped from $2.25 a year ago to 85c yesterday and the company, which is still forecasting a $6 million profit, had contracted in value from more than $100 million to around $36 million.
Despite all this, Walker is looking forward to the year.
"It's very rare in one's working life where you get the privilege of being in an industry at a time when you are in a position to see what's going on and see an industry fundamentally change and grapple with 'so what now'."
- NZPA
Dorchester Pacific
* Listed finance company.
* Dorchester's reinvestment rate fell to 21 per cent in October after a string of finance firm collapses but lifted to about 40 per cent last month.
* Shares closed yesterday at 85c, down from $2.25 a year ago.
