KEY POINTS:
Two things are true about finance companies and their debentures. Investors will continue to invest in them, and more finance company dominoes will fall sooner or later. The question for investors then becomes how to minimise the risk.
One way to sort the good from the bad is to check out finance companies' credit ratings before investing. But this isn't a foolproof method. There are ratings companies and ratings companies and the letters "AAA", "A", "BB+" or "BBB-" aren't as meaningful as they appear at first glance. Each ratings agency has its own system.
For example, says Chris Lee, managing director of Projects Resources, an outspoken stockbroker who also has his own ratings system, the website Interest.co.nz has a ranking system that is not the same as a credit rating system. It ranks companies according to their size, not the health of their balance sheets. Grosvenor Financial Services Group has a service available to financial professionals called BondWatch, which analyses the prospectus and investment statement, but doesn't interview the managers.
At the top of the heap are the international ratings agencies Standard & Poors (S&P), Moody's Global Credit Research, and Fitch Ratings, which all carry out in-depth research, analysing balance sheets and visiting the firms in question on the ground. The trouble is that these ratings cost finance companies tens of thousands of dollars to obtain and many simply can't afford them.
While other systems such as Australian-based Rapid Ratings don't have the kudos of these international ratings agencies, their results can help investors make a decision, says Lee.
The words "smoke" and "mirrors" come to mind when finance company credit ratings are mentioned. Bridgecorp, for example lorded its AAA SQP score from Interest.co.nz last year, but as soon as the rating was downgraded, the company dropped it from its advertising.
Likewise, says Lee, nine of the 14 finance companies that have been rated by Rapid Ratings refuse to publicise the results.
Unfortunately the investing public doesn't often understand the nuances of the systems - a fact born out by the B+ S&P rating that Geneva Finance advertises.
It sounds good, but hang on a minute, B+ in S&P speak is two notches short of "investment grade".
Another company, Property Investment Research (PIR), made a brief foray into New Zealand last year. PIR gave doomed Bridgecorp an investment grade rating. Since the collapse of Bridgecorp, a handful of other finance companies that had been advertising PIR ratings have gone quiet, says Lee.
Ratings aren't the only judge of a company's stability. Investors could always read the investment statements and prospectuses, something that Lee says rarely happens.
Those with access to the internet can also see a financial analysis of 91 finance companies at www.interest.co.nz/Coinfo/index.asp which can be helpful providing you understand the information.
Another imperfect way to gauge the strength of a finance company is to ask financial professionals to disclose the level of commission they're paid to recommend the investment. Bridgecorp, for example, was paying 3 per cent on a three-year investment, while the equivalent rate from a more stable firm was likely to be 1.5 per cent.
Investors should always beware of flash adverts and austere sounding names, which mean nothing. The name "Blue Chip Finance" sounds like a better bet than "Instant Finance". Yet the latter, says Lee, despite being willing to "lend people 50 bucks to buy KFC", is a well managed firm, whose chief executive Richard De Lautour is an "experienced and respected member of the industry". Blue Chip gets an "E" rating from Lee, the worst available.
Nor can the time a finance company has been in business tell the investor much. Names such as Marac and Broadlands Finance have been bought and sold.
Too many investors still see finance company debentures as safe, and equities as risky, says Jeff Matthews, senior finance adviser at Spicers Wealth Management. "Finance companies are often a hell of a lot riskier than owning shares in Telecom or Fletcher Building. But [investors] think you can't lose your money in finance companies.
"I was in the National Bank the other day and they are offering 8.6 per cent for 18 months, so why would I go with Hanover, Geneva or anybody else to get 9.25 per cent for two years, where's the risk premium?"
Although Spicers has Marac and UDC Finance on its approved list, little investors' money is placed in them, says Matthews. Instead he prefers to buy bonds on the NZDX debt market. Recent investments included GPG Finance, which was paying 8.75 per cent, and ANZ paying 8.15 per cent.
The beauty of these investments is that they can be sold on the open market by an investor if he or she wants the money back. That isn't the case with debentures where money is locked up for a fixed period of time.
A number of finance companies are listed on the NZX and its smaller cap market the NZAX and as a result are subject to continuous disclosure, meaning, that companies need to disclose relevant information to the NZX as and when it happens.
If the ordinary shares of the company are listed on these markets then the movements in the share price, can be a "very good indication" of the market's view of the creditworthiness of the business, says David Speight, director of fixed interest at Direct Broking.
The fact that Bridgecorp's price on the unlisted independent market halved in the first six months of this year before the company went to the wall might have been a red flag, had investors taken notice.
Share price movements aren't always an indication of the long-term viability of a company, points out Geoff Brown, head of listed products at the NZX. Events which may affect a company's dividend could affect its share price, but not their ability to repay debt.
There is a lot of flak flying around financial planners and the Bridgecorp collapse. Too many, it would appear, were willing to risk their clients' money in order to reap the juicy commissions.
Some financial planners, Lee says, either didn't receive research such as the KPMG FIPs reports, FinanceWatch from FundSource, and the various systems such as BondWatch, or didn't act on that research.
It's also worth considering checking the lending criteria. If the company is lending on first-ranking commercial property mortgage it might be a safer bet than a used car. Having said that, the Instant Finance example suggests that this isn't always a true indicator of the safety of an investment.
Finance companies are to be regulated by the Reserve Bank and there are plans to bring in compulsory credit ratings. Regulation isn't the be-all and end-all, companies will still fail. But it's another level of protection for the consumer.
Finally, the moral of the tale is: Research your finance company investment well, keep on top of news, and never put more than 10 per cent of your investments with one single finance company.
The return isn't worth the risk.
