* Paul Glass is executive director of fund manager Brook Asset Management
KEY POINTS:
Another day, another finance company collapse. It is apparent that we are now witnessing a run on the sector that is gathering momentum in a mercilessly indiscriminate manner.
Future collapses may have more to with the absence of investor confidence than with imprudent lending practices.
The irony for
the finance companies is that many of the factors that led to the sector enjoying such rapid growth and apparent profitability are the same factors that are now hindering their efforts to rebuild investor confidence: almost no regulation, a lack of transparency, a reliance upon funding provided from generally unsophisticated investors, cultivated confusion about credit ratings, and the mispricing of risk.
In the short term, despite the belated efforts of the Minister of Commerce, it is difficult to see a circuit-breaker to the cycle of finance company collapses.
In the medium term, it is important to the economy that we have a viable non-bank financial sector because these companies fund many of the higher risk or specialised activities that banks can't or won't fund. So it is important that the sector is cleaned up and confidence restored. The Securities Commission, the Commerce Commission, the Reserve Bank, trustees and auditors all need to play a more active role.
While we have long advocated that the sector needs meaningful credit ratings provided by reputable agencies, an education process as to the limitations of such ratings is also required.
Of the main 50 or so finance companies, only five have ratings from RBNZ-approved rating agencies Standard & Poor's, Fitch or Moody's.
Of these five, only three have investment grade ratings (UDC, Marac and South Canterbury Finance). The other two, Hanover and Geneva Finance, have received below investment grade ratings. This means that the bulk of the sector is either unrated by the major agencies or rated below investment grade.
Below investment grade issues are often referred to as speculative investments or "junk bonds". Internationally, junk bonds trade at much higher interest rates than those offered by banks. With registered banks in New Zealand offering 8.3 per cent or more for 12-month deposits, the additional margin offered by many finance companies looks very slim for the extra risk involved.
As finance companies have failed, the roles played by trustees and auditors have come under the spotlight.
A common question is: How can finance companies report profits right up to the point at which they go broke? Another is: How did their shareholders' funds suddenly disappear?
The answers will vary, in every situation, but a common thread is the opaqueness of many finance company accounts, where even professional investors would struggle to pull apart some finance company accounts and answer questions such as how much of the reported profit came from "paper" increases in the value of their land holdings, why they have land holdings, whether the reported income is real or whether they have been accruing interest on loans that are unlikely to ever be repaid, whether the accounts accurately reflect the bad and doubtful debt situation or have non-performing loans simply been ex-tended.
It quickly becomes apparent that the sector needs to be under the close supervision of a party such as the Reserve Bank, which has the skills set required to ask the necessary questions. This needs to happen forthwith. Nonetheless, it will still come too late for many investors.
One solution to the growing crisis may be to establish a system akin to "Chapter 11" in the United States, whereby companies of better quality can seek protection from their depositors for a period of time while they sort out their affairs.
The danger of a run on the sector is that it will inevitably bring down well-run, well-capitalised businesses because of the short-term liquidity crunch.
Allowing such businesses to seek a Chapter 11 equivalent would permit them to better match the maturities of their assets and liabilities and provide an opportunity for much-needed sector consolidation.
The "do nothing" alternative may result in a greater level of investor losses than need be as receivers liquidate assets at fire-sale prices.
