Loan finance bubble pricked

Bad credit has been able to buy good cars at inflated prices.

Growth in the used-car market has been fast and furious. Fuelled by ready finance, selling has been easy, one Auckland salesman with a background in vehicle finance and debt collection told the Business Herald.

"A chap will turn up, 21-years-old and with bad credit. He wants to buy a car and I work on commission," said the salesman, who wished to remain anonymous.

"Anybody who was remotely close to qualifying for a loan could get one. If they breathe on a spoon and it fogs, they can get one."

Chances are some of the money lent to those buyers by companies such as National Finance 2000, which went into receivership last month, belonged to Auckland woman Dianne Saecker-Battley.

Last year, she invested $19,500 with National Finance, money she had saved for her three children's tertiary education.

"I have been making small investments for more than 30 years and this is the first time I have had a company go under, and am naturally very upset by it."

The crash of National Finance 2000, owing investors $25.5 million, and Provincial Finance, which failed a week ago owing more than $300 million, suggests that the dramatic rise of at least some finance companies has been too rapid.

For now, the failures have been limited to those firms dealing in used car loans. But industry participants are nervously eyeing the wreckage and hoping it doesn't spread to other areas of the sector - in which people now have between $12 billion and $14 billion invested. Beyond that, problems with finance companies tend to be "an early warning indicator" for the banking industry, says accounting firm KPMG.

Auckland's used-car dealerships are where the rubber met the road for National Finance 2000 and Provincial. In fact, National Finance 2000's boss and former fish-and-chip shop operator Allan Ludlow also ran a chain of four caryards.

The car salesman spoken to by the Business Herald said some dealers would sell a car for almost double what they paid for it. Add consumer credit insurance charges of about $2000 and other fees and buyers could be driving out of the yard owing a company like Provincial $15,000 for a $4000 car. "And that's classed as a secured debt. All the grannies in Mt Maunganui writing their $1000 cheques feel comfortable because the ledger's secured, but what's it secured with? An asset worth $4000 in the case of that $15,000 car."

Furthermore, vast numbers of cars were sold to young drivers on learner's licences and were quickly smashed up. Some people believe Provincial, with its relatively soft loan criteria, was systematically targeted by fraudsters who made no payments and stripped the cars for parts.

"And then what have you got? Unsecured lending," said the car salesman.

True degree of risk

Despite the efforts of several finance industry figures who have urged investors to check out what sort of risk they are taking before sinking money into debenture stock, the true degree of risk involved in many "secured" products is probably news to many with money in National and Provincial.

That's certainly the impression given by the National Finance 2000 and Provincial Finance investors who have contacted the Business Herald in the wake of those companies' failure, including Saecker-Battley.

"I always understood secured debenture stock meant just that - secured. To receive a letter last week informing that if I'm lucky I may get back 30-50 per cent is devastating."

For his part, the car salesman is planning a career change because of the "crash" in the industry which had been coming for some time.

He intended to get back into the debt-collecting business where there was "a boom time coming for sure".

"Put it this way, I bought Baycorp shares."

Asked if he thought the troubles in the car finance business had implications for the wider consumer finance sector, "It has to".

The same sentiment is echoed by analyst Chris Stone, of McDouall Stuart Securities, which produces an annual report on finance companies.

"Rising interest rates and a slowing economy are all bringing pressures across most of the lending sectors," he said.

"We identified vehicle financing particularly but, more generally, consumer finance as an area where problems could arise, simply because the people that are borrowing in those sectors probably are unable to borrow from anyone else, and there may not be the level of security that most lenders would be seeking."

As well as splurging on property in recent years, people have been spending up big on other consumer goods apart from cars. That has seen the level of consumer debt and the investors' funds backing it balloon to unprecedented levels.

Latest figures from research house Fundsource estimated finance companies, including those that lend in other areas, had $12 billion under management at the end of last year, having enjoyed growth of 20 per cent a year for the past five or six years.

In its Financial Institutions Performance survey, KPMG put the figure at $13.9 billion.

"It's been an extraordinary period," said Stone.

But the slowing economy means all finance companies will now be finding the going harder.

"The good ones recognise that, they just say we've done very well, we just have to prepare for tougher times, and they will do so."

While there have been numerous warnings over the last year or two about the risks inherent in the fast growth of finance companies, particularly small newer ones and some of those lending to property developers, many of those warnings have come from business rivals such as fund managers and banks.

But there have also been warnings from more impartial sources such as the Reserve Bank. KPMG recently highlighted its concerns in its annual survey.

"Should a major finance company fail, the result could well be a flight of capital which would put the weaker finance companies in the country under extreme pressure," said KPMG deputy chairman Godfrey Boyce.

While National Finance 2000 with a $25.5 million of debenture stock on issue was a small player, Provincial with $300 million is not.

Provincial was the subject of a rescue bid led by South Canterbury Finance, one of the larger and more established finance companies. South Canterbury had offered to buy a $25 million chunk of Provincial's business and tried to gather sizeable contributions from other firms towards the $11 million that will need to be added to $16.5 million raised by Provincial's owners to put the company back on its feet.

The bid to recapitalise the company was seen by some as an attempt by the industry to limit the damage to investor confidence of such a substantial firm's failure.

But by late yesterday the deal had fallen over, with some market commentators questioning South Canterbury's motives.

Although some concerns were flagged in past months about Provincial's aggressive lending policies and mounting bad debt provisions, it was generally perceived to be fairly solid.

As Fundsource general manager Binu Paul said this week: "If someone like Provincial, who's had deep pockets and commitment to the business, cannot withstand an internal issue like this, how well are other companies who may have problems positioned to do that?"

Stone said Provincial's failure was surprising, despite his firm's research.

"We hadn't seen anything from publicly available information at the time that we wrote our report that there was real problem."

If it is difficult for professionals like Stone to pick up early warning signs, what are the chances for the average retail investor?

"The information in the public domain is quite dated," Stone says.

Nevertheless, there are some quick checks investors can make.

"How big are they? How long have they been around? And what do they lend in?

"If you're a bit more financially literate you'd look at how their performance had been. If that's as much as you did, I think you'd be okay."

Other criteria

Unfortunately, some investors make their decisions based on other criteria. A number of Provincial investors contacted the Business Herald concerned at the endorsement of the company by All Black legend Colin Meads.

Others, up to 70 per cent by value invested, took the advice of professional financial intermediaries.

The son of an 81-year-old Northland woman said his mother had $150,000 invested with National Finance. She had initially invested in the company on the advice of an investment adviser after being wooed during dinners and seminars.

She had been badly rattled by the news she would receive just 50 per cent of her money back at best. "It's been a kick in the teeth."

Stone said McDouall Stuart produced its report because it wanted its advisers to be well informed "but we're not aware that there are a lot of advisers out there that are doing their own work".

Another analyst, who did not wish to be named, said some advisers' recommendations might be coloured by the commission they received from debenture issuers rather than by their knowledge of the company's credentials.

"There is not full disclosure of the commissions the advisers earn. That is one of the areas that causes me a little bit of disquiet.

"I don't mind if they earn substantial commissions as long as they're well disclosed."

That is something the Government is looking to address in its review of regulation around financial intermediaries, but changes to disclosure rules will come too late for those who have already lost money.

Another problem was the lack of interest rate differentiation between good companies and risky ones.

"It's a market failure issue," said Stone. "Some of the poorer quality finance company issuers are offering yields that are similar to good quality companies and I don't understand why the market would support those companies. An efficient market should establish that pricing more accurately."

Nevertheless, poorer quality companies were starting to have difficulties attracting debenture flows.

Stone welcomed the increased scrutiny of the sector resulting from the recent failures.

"What I wouldn't like to see is the whole sector tarred and people saying, 'Look, steer clear of this because they're really risky'; on the basis of a lot of research I do not believe that is the case."