Warning issued about risky investments

Credit rating agencies have warned "mum and dad" investors they are pumping billions of dollars into relatively risky finance companies without enough quality information.

International ratings agency Standard & Poor's said the lightly regulated finance company sector was showing "red flags", which raised concerns about how some would cope when the economy slowed and property prices fell.

Thousands of people were investing in finance company debentures that would not qualify as investment grade if they were rated, the agency said.

Bonds categorised as sub-investment grade are often referred to as "junk bonds" overseas and pay out much higher interest rates to reflect their greater risks.

Global research showed on average about 12 per cent of companies with "junk" ratings defaulted on their debts in any five-year period, it said.

Many investors in New Zealand finance companies were receiving lower interest rates than they should if all the risks were taken into account, Standard & Poor's and fellow ratings agency Fundsource said.

Standard & Poor's said it was inevitable some finance companies would fail when the economy slowed.

"The sector does have some vulnerabilities in terms of its future performance," said Gavin Gunning, director of financial services ratings for Standard and Poor's in Australia and New Zealand.

The number of finance companies has grown very quickly in the past five years as strong economic growth and a rising property market fuelled robust lending growth.

Retail investors searching for higher interest rates have pumped more than $10 billion into finance company debentures during the past seven years.

There was now a large number of small finance companies, many of which had never been through an economic downturn, Mr Gunning said.

"That by itself is a bit of a red flag," he said. "If you have a small capital base it doesn't provide a lot of protection if there is an unexpected loss. On the publicly available information, many would be challenged to achieve an investment-grade rating."

Mr Gunning said mums and dads, financial planners and private fund managers lacked the information needed to make good decisions about whether the interest rates on offer matched the risks.

Fundsource research manager Binu Paul, speaking at a conference for fund managers and financial planners, also warned that some finance companies were not financially strong.

Mr Paul said Fundsource's review of 30 finance companies had found that on average liabilities were forecast to exceed assets by more than 30 per cent during the next 18 months to two years.

Many were dependent on fresh issues of debentures during the next two years to raise cash, he said.

One unidentified finance company had a loan worth eight times shareholders' equity and others were in a position where 90 per cent of their assets were not matched by their liabilities, Mr Paul said.

"If there is a downturn, is that a long-term strategy?" he asked.

Mr Paul said finance companies covered a much wider range of risk than was reflected in the interest rates they offered.

"There is a wide risk spectrum, but they are pretty much returning the same amount to investors," he said.

- NZPA