KEY POINTS:
Deep-pocketed international investors - until recently an important tool in the box of marketing tricks needed to convince retail investors to keep putting their money into small finance companies - may now be the ones pulling the plug on the weaker players.
The demands of Capital + Merchant's
backer, Fortress Credit Corp, are proving to be the crucial factor in any attempt by receivers to get money back for its 7000 investors, who are owed about $190 million.
Capital + Merchant's collapse may also have a wider impact on the retail investment sector than its relatively small size would indicate, due largely to its high-profile sponsorship of One newsbreaks on TVNZ.
Its commercials were removed from the airwaves on Thursday night, just hours after it went into receivership. The Capital + Merchant website was removed from the internet within a day.
Its big backer, first ranked creditor Fortress Credit Corp, and Capital + Merchant's trustee, Perpetual Trust, called in the receivers on Thursday.
Fortress has a prior charge over its assets and is owed about $70m.
As part of its deal to provide funding for Capital + Merchant, Fortress was paid a higher interest rate than its New Zealand retail investors - 13 per cent, compared with 9.5 per cent.
US-listed Fortress increased its $18m loan to $22m to Capital + Merchant earlier this year, which was not due to expire until next year. Capital + Merchant, which had borrowed $18m at the end of August, had also secured a loan facility of up to $50m with Fortress through a subsidiary, of which $46.9m was drawn down.
The loans were an attempt by the company to diversify its borrowing pool, after reinvestment rates fell to 30 per cent in August from a 50 per cent average over the previous year.
One of Fortress Investments' specialties is the investment in undervalued and distressed assets. The New York-based fund, with more than US$30 billion ($39b) under its management, has also lent $30m to New Zealand's Instant Finance.
Financial commentator and publisher of Good Returns investment website, Philip Macalister, says the Capital + Merchant collapse has shown that for a finance company to be successful it must have a diversified sources of funding - not just a big wholesale investor and not just so-called "Mum-and-Dad investors".
He says finance companies should start being more open about what kind of conditions are attached to the money coming from these big investors. Companies that are going to be successful are the ones that have Mum-and-Dad investors, have a wholesale funder, such as Fortress or Bank of Scotland.
Another popular way of diversifying funding is the securitisation of loans, where loans are pooled together and are then sold as securities to institutional investors.
"The problem is these wholesale funding lines aren't necessarily as secure as they appear to be," says Macalister. "Fortress can turn around at any time basically and say 'I'm out of here' or put an interest rate on that is so high it wouldn't work."
The recent problems at Geneva Finance, which had promoted its $50m funding line from the Bank of Scotland, have shown that there are very strict criteria and covenants around the money. The Bank of Scotland has been provided with various ways of getting out of its investment.
The finance companies need to make better disclosures of the details of these wholesale funding lines, says Macalister. "Currently you can go out and say 'I've got such and such a funding line, you think it's there and secure and tens of millions of dollars".
Macalister says big promotions - such as Capital + Merchant's TV news sponsorship deal for medium or small-sized companies - can sound alarm bells. "When you see small companies doing things that are out of kilter for a company that size, that raises a flag."
Some of the smaller "tin-pot companies" that had earlier collapsed had paid for expensive television commercials to promote themselves when desperate for new investment. This did not apply to big companies such as Hanover, which runs big campaigns but is a big company.
"Small companies doing big promotions - you know - are a flag to me. Capital + Merchant was a middle-sized company. But I know they were paying pretty big money for that."
It has not been hard to find information showing an investment in Capital + Merchant is at the riskier end of the spectrum.
Some things that may have set alarm bells ringing are:
Its reliance on a small number of loans - its entire book at the end of March this year was comprised of just 47 loans.
Its relative youth - the company started just five years ago and heavily concentrated on the Auckland property market.
In August, following the collapse of Bridgecorp, the Herald on Sunday ran a list of finance companies and ratings assigned to them by the Grosvenor Financial Services, and also gradings given out by Kapiti-based financial adviser Chris Lee.
Capital + Merchant's debentures were rated G7 by Grosvenor Financial Services Group's Bondwatch.
Such a rating is described as being "Highly exposed to unfavourable economic and/or business conditions, ability to repay highly conditional on assumptions made in the investment statement and prospectus being met, [and] more suited to sophisticated investors". Lee subsequently rated Capital + Merchant an "E".
"I urge investors to seek early repayment and exit now those companies we rank as an E, and there is now concern that any flow-on from a lack of public confidence might affect any company we rate below B-minus," said Lee.
Investment website Good Returns quoted an interview with Capital + Merchant chief executive Owen Tallentire in the August edition of Asset magazine. In it he said the group was well-placed to weather the storm in the finance company sector following the then recent collapse of Bridgecorp.
He said the firm's line of credit from Fortress should help it through any crisis.
Research conducted by McDouall Stuart, a Wellington-based investment banker and broker, reported Capital + Merchant as having the second lowest liquidity level of the 29 finance companies analysed. It was not all bad news though, with McDouall Stuart saying that Capital + Merchant's loan book "appears of good quality," with no bad debts written off last year and only 1 per cent of its loans more than 90 days in arrears.
A good quality loan book will be welcome news to the 7000 investors hoping to get their money out of the receivers, who will be looking to sell the loans to the highest bidder.
The research also reported that all the Capital + Merchant loans were secured, with 70 per cent of them classed as first mortgages.
Most recent research shows the big finance companies will continue to increase in size, while the smaller players either go bust, wind down, or are swallowed up by the big ones.
With compulsory credit ratings coming for finance companies - or "registered deposit takers" as they will soon be known - smaller, more risky companies may find it increasingly difficult to convince retail investors to part with their money. A spokesman for Finance Minister Michael Cullen said the requirements for credit ratings were "one element among many in a significant package of new regulatory requirements being introduced".
- Additional reporting NZPA
