Bank warns on finance company bonds

By BRIAN FALLOW

The Reserve Bank has warned the thousands of investors buying bonds in finance companies to tread warily.

The bank has highlighted finance companies lending to property developers, saying investors in these firms could face losses.

A drop in the property market could hurt the finance firms that have backed more speculative property developments.

The bank says it classifies more than 10 companies as "property finance" lenders. Like other finance firms, they typically rely on mum and dad investors for funding.

Property finance companies' lending has climbed from less than $500 million in 1998 to nearly $2.5 billion now. That compares with nearly $200 billion in assets for the big four banks.

"Where developments have been financed conservatively - on the basis of strong pre-tenanting arrangements or contracts to purchase - financiers should experience few stresses," the bank says in a report on the stability of the financial system released yesterday.

"But a downturn in the property market could pose some difficulties for any financiers who have financed property on a more speculative ... basis."

The Reserve Bank says the big banks found it useful to have a "second-tier" finance company take subordinated loans on the larger residential apartment developments that began to proliferate from 2000.

Property development is traditionally one of the riskier investment areas and property financiers' credit quality and risk management skills are usually only put to the test as property development cycles slow.

The sector's rapid growth has been helped by people seeking higher interest rates than those offered by the banks.

The Reserve Bank notes concerns by the Securities Commission and other commentators over whether the rates on offer adequately compensate investors for the risk.

Governor Alan Bollard said yesterday: "People investing in those [companies] should take proper advice and if they are looking for high levels of return they should be assessing whether they are taking on a significant risk."

The sector had grown rapidly from a low base and taken on quite a bit of debt.

"There are differences between institutions and people have to make their own assessment about those different institutions."

The Reserve Bank does not supervise non-bank lenders and is interested in them only to the extent they might pose a threat to the stability of the financial system as a whole.

"We would not expect that any problems around one institution would have systemic effects," Dr Bollard said.

However, problems in the non-bank sector could damage New Zealand's corporate financial reputation.

"But they are not big enough to impact across the New Zealand financial system."

The bank judges that system to be in good shape to handle any shocks.


David Russell, chief executive of the Consumers Institute, said last night that people should always be wary of investing in companies promising high returns.

"It's the old story - the higher the interest rate, the higher the risk."

He said risk increased as the market came under pressure.

"You may win, but you may also lose in a falling market."