KEY POINTS:
Three heavyweight finance companies are throwing their weight behind a call for mandatory credit ratings in a sector they say is riddled with mis-pricing and confusing for individual investors.
Hanover Finance, Marac Finance and Geneva Finance say credit ratings should be required for the country's 100 finance companies
- a move that would give consumers a true indication of the strength of the finance company and its investment products.
The current situation is a key concern of the Reserve Bank, which is said to be working hard behind the scenes to ensure that the regulation of non-bank organisations is not lost in the Ministry of Economic Development's (MED) current policy review of financial products.
In two weeks, say Wellington sources, the MED and Reserve Bank will put recommendations to ministers on regulations for non-bank deposit takers.
On the list of regulations likely to be introduced to the under-regulated finance industry will be a formal licensing regime overseen by the Reserve Bank. Companies will be asked to appoint more independent board directors and have to have minimum capital requirements.
These should gain ministers' approval without too much debate, but what has not yet been resolved is the issue of mandatory credit ratings.
These are seen by many in the industry as an essential addition to provide investors with a benchmark to help them with the 'risk/reward' assessment.
This leads to another controversial question. Who should be doing the rating? At the moment, a mix of companies are rating finance companies which can be confusing for amateur investors: the New Zealand-based Risk Analysis, which uses methodology of the international Rapid Ratings; and the world's three best-known ratings agencies, Moody's, Standard & Poor's and Fitch Ratings.
Companies such as Hanover Finance, Marac and Geneva Finance, all with international credit ratings under their belt, are arguing that ratings should be down to the internationally based agencies.
As David Jansen, head of structured credit at ING wrote in NZ Investor Monthly recently: "If they say it's junk, it probably is junk."
"We believe mandatory ratings from the three main international credit agencies would provide a consistent measurement of risk to aid the public in their assessment of an investment," says Greg Muir, chairman of Hanover Finance.
"Consistency is the critical issue as it makes the use of ratings easier for the investor. Any ratings organisation that wishes to be approved for rating non-bank deposit takers should, as a minimum, have to provide the same ratings scale and standards of assessment that the three major agencies have made the global standard.
"This is the ratings standard required for the licensing of banks in New Zealand and we don't see why it should be any different for non-bank deposit takers."
Ron Keene, director of Risk Analysis, which is awaiting a decision from the Reserve Bank on whether it will be one of its approved credit rating agencies, says that his company knows the New Zealand market best and has already rated 16 finance companies - more than Moody's, Fitch and Standard & Poor's put together.
Mispricing is a problem in the market, says Keene, who is about to publish an "optimal yield curve" next month which will map the interest yield maturity for different levels of credit-rating risk.
"That will provide some incentive to start pricing risk more realistically," he says.
For now, many amateur investors are making investments, unaware of the true risk they are taking. They are not alerted by the interest rate because finance companies are loath to offer double digit interest rates for fear of scaring off conservative Kiwi investors.
"One of the key reasons mis-pricing is present in the market is the relatively low barrier to becoming a non-bank deposit taker, something that we hope the changes being proposed by the regulatory review will address," says Muir. If a part of this change is the introduction of mandatory credit ratings, then for the first time investors will have a standard scale to assess pricing.
New Zealand's larger finance companies are, unusually, joining ranks on this subject.
"We would like to see a much more transparent disclosure regime," says Alan Williams, chief financial officer at Marac Finance which has a BBB-rating from Standard & Poor's.
"There's some people who would very much like a more enhanced return from a higher risk player. The problem is it is not transparent, you don't know what the risk is."
The finance community is concerned that Minister Lianne Dalziel may not be pushing mandatory credit ratings to ministers because she believes consumers do not understand them.
Godfrey Boyce, deputy chairman of financial services at KPMG says education is key. "We have got to do something about helping people understand investment grades."
Despite the finance company hiccups in the past year, people have continued to invest in their products.
"I don't think it has been held back. The industry has grown pretty quickly over the past five or six years," says Boyce.
If credit ratings are made mandatory, a few of the smaller finance companies may fall by the wayside. Although Dalziel last month dismissed the idea of a two-tier organisation, Boyce thinks "two camps" are likely to emerge.
"You've got the top 15-20 finance companies for whom it is doable, then you've got the finance companies below that - that are not of a size they would have to make quite an investment," says Boyce.
Geneva Finance founder Glenn Walker thinks the sector is going through a consolidation phase. The five-year-old Geneva has a "B+ stable" rating from Standard & Poor's.
"I think the consensus was that with closer alignment of Australian and New Zealand financial markets, you need to have a similar standard for both. The feeling was that international rating would best meet the needs of both," says Walker.
"There is a reluctance to put yourself on the map in case you don't get a grade. New Zealand has become a bunch of cynics and pessimists. Let's encourage companies to take on board the process."
Some believe that introduction of ratings will make investors more savvy.
"We acknowledge that currently investors have a low understanding of credit ratings, but we don't see this as a valid reason not to introduce mandatory ratings. The great advantage is that they are a pre-existing global standard," says Hanover's Muir.
"We don't have to reinvent the wheel here. Introducing mandatory ratings will drive investor education and understanding, which has to be a good thing."
Credit ratings are giving their clients a lot more comfort about recommendations, says Craig Bennett, head of Standard & Poor's financial institutions team based in Melbourne. "A lot of it is about the transparency and how to evaluate risk and pricing," says Bennett.
"The New Zealand finance market is a very interesting segment; it is maturing and we would expect more consolidation."
