KEY POINTS:
Financial company collapses have resulted in calls for more leadership, more regulation and credit ratings, but how about trying a little transparency?
This is allegedly given in endless investment statements and prospectuses put out by companies eager to get their hands on your cash. But these documents are up to 100 pages long. Although we are exhorted to read them thoroughly and in full before investing, they are essentially unreadable, not only by reasonably well informed investors, but also by the professionals that purport to advise them.
With finance companies there is some crucial information that should be highlighted in large type on the front page. First among these is the amount of funding provided by the company's shareholders, expressed as a proportion of total assets, otherwise known as the equity ratio. This indicates how much of the risk they are bearing, and the cushion provided for depositors if things go wrong.
This should be followed by the limits on types of lending, expressed as percentages of total assets, together with the permitted portion to any one borrower. The nature of loans should also be more specific, including those financing the development of properties prior to completion and formal leasing. This is the riskier type of lending that trading banks won't touch. Also it is not enough to say that loans are secured by mortgages. They should be split into first, second and lower ranking.
The security offered depositors should also be clearly stated, starting with the level of permitted prior charges that rank in front of everyone else. Although the actual amount may be low when the prospectus is issued, this can change rapidly if the company has to get cash quickly from outside if times get tough. This should then clearly detail the ranking of all other deposits such as so-called secured debentures, notes and so on.
The liquidity profile should then show financial assets and liabilities analysed into the timing of their maturities. Although total assets may exceed total liabilities (that is, the company is solvent), short term liabilities maturing in, say, six months often exceed short term assets. If sources of funding dry up through depositors not renewing their investments, the notorious credit crunch occurs, leading to the forced sale of assets and bankruptcy.
The other bugbear is loans to related parties. These are full of potential hazards in that cash may be circulating within the company's other activities and not be confined to the financial sector. In theory there should be no such advances if there are, they should be fully explained and justified.
So, in summary, the equity ratio, types of lending and the limits on it, ranking of security, maturity profile, and dealings with related parties should all be on the front page of prospectuses, in bold type, and clearly explained if necessary. This approach may not solve all problems, but it has a much better chance of leading to an informed investing public than the present mess of legal gobbledegook.
The situation gets even murkier with prospectuses other than those issued by finance companies. Sharebrokers promote various schemes promising guaranteed return of capital in bold letters on the front cover and interest of 9 per cent or more. A small asterisk by the interest refers you to a footnote in tiny type saying that payment of interest is subject to investment risk. Anywhere else this would be seen as deceptive advertising which indeed proved to be the case with one scheme where payment of interest has been suspended.
Some companies raise money on the basis of an interest rate that is re-set annually at a benchmark rate. It is not until you plough through half the prospectus that you find what the basis of the benchmark rate is. Even more sinister are clauses buried deep in the bowels of the prospectus that state interest may not necessarily be paid ... on each interest payment date. It transpires that if some obscure European regulation is breached, New Zealand investors will miss out.
All this arises because prospectuses have been drawn up to satisfy legal requirements. Even if you employ a financial adviser it is doubtful if he or she will be able to make much sense of them either. The fact is that prospectuses as drafted at present are essentially unreadable, with all the consequences that has for the investing public.
* Bill Jamieson is a retired accountant and author of The Accounting Jungle and a pending book on retirement
