KEY POINTS:
More than half of the money New Zealanders have tied up in finance company debentures is with firms that face a one in six chance of going bust over any given three-year period, suggests a new report on the ailing sector.
Local merchant banking outfit Bancorp took a
snapshot of the risk-reward characteristics of the finance company sector two weeks ago and compared it with the US fixed-interest market. The research explores the notion that many finance company investors are receiving insufficient returns for the risk they are taking on.
The comparison suggests that perhaps only half of the estimated $11 billion to $12 billion in total finance company debentures is earning enough.
Seven New Zealand finance companies have failed in the past year-and-a-half.
Bancorp said the New Zealand market showed similar characteristics to the US in terms of the increase in the magnitude of returns according to the the length of investment term and decrease in credit quality.
"The risk-reward profiles align to a greater or lesser degree between New Zealand and the US down to an implied credit rating of around BB."
But below this implied level of credit risk "the increased returns shown in the US are not evident in New Zealand".
Only four New Zealand finance companies have ratings from any of the big three international ratings agencies - Standard and Poor's, Fitch Ratings, and Moody's - who are likely to be the approved agencies under the Government's plan for mandatory ratings for the sector.
Of those, Hanover's rating of BB+ falls just short of "investment grade" but is still within the range where Bancorp's research suggests investors are getting a fair return for their risk.
Below a BB rating the probability of a company defaulting on its obligations in the next three years rises sharply from 5.5 per cent to 15.9 per cent and worse, according to the Ministry of Economic Development.
"Clearly any company below that isn't providing the kind of returns relative to what they'd have to provide in the US," said Bancorp managing director Craig Brownie.
The US market was chosen as a yardstick, says Brownie, because it is "the deepest and most liquid" in the world.
However, the recent credit market ructions sparked by sub-prime problems suggest the US market has itself arguably been mispricing risk for some time.
Nevertheless, Bancorp estimates New Zealanders have about $5 billion in debentures with companies that have a big three rating, and they are earning $35 million a year more for doing so than they'd earn if that money was in the bank.
Brownie says there are a few other companies including Dominion and St Laurence that would probably achieve a BB or better rating from one of the big three and therefore offer an adequate return for risk.
"Everyone else falls into the other category," said Brownie.
"That doesn't mean you shouldn't invest in those guys, it's just saying on this bit of analysis you're probably not getting the right reward for that investment."
One of the main reasons most New Zealand finance companies would not achieve such a rating is simply their relatively small size, even if they are well run.
In the fall-out from the string of seven recent collapses in the sector it was evident that better quality companies which offered a good return for risk were being tarred with the same brush as those that didn't.
Hanover, for example, reported last week that its reinvestment rate had fallen from about 80 per cent before Bridgecorp's failure, to 50-60 per cent.
Last week, Five Star Consumer Finance became the seventh finance company to fold in the past 18 months. It thought to owe $50 million to about 3000 debenture investors.
RATINGS GAME
NZ firms with ratings from the big international ratings agencies:
* UDC - AA (Standard & Poor's)
* Hanover - BB+ (Fitch Ratings)
* South Canterbury Finance - BBB- (Standard & Poor's)
* Marac - BBB- (Standard & Poor's)
* Geneva Finance - B+ (Standard & Poor's)
