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McDouall Stuart Finance Companies Report

Published: Tue 2 Dec 2008 12:15 PM
Release of 2008 McDouall Stuart Finance Companies Report
Wellington, 2 December 2008 – McDouall Stuart today released its 2008 report on the New Zealand finance company sector.
This year titled ‘Re-engineering’, the report analyses events of the past 12 months and proposes an outlook for the sector.  “2008 has been an incredible year for finance companies” says John Kidd, Head of Research at McDouall Stuart and principal author of the report.  “Unfortunately, little of what has happened over the past year has been good news”.
“The overlaying of the global credit crisis and a steep downturn in the domestic property market onto a sector already suffering from a major crisis of confidence has had a profound compound effect” says Kidd.
At least another 10 finance companies have defaulted so far in 2008, placing a further $2.2 billion and more than 74,000 debenture holders at risk.
Consolidation across the sector has been intense.  This year there are just 11 finance companies unaffected by receiverships, moratoria or restructurings that meet the criteria to be included in the report.  Last year the number was 29 against the same criteria.  In 2006 it was 38.
Unfortunately, with only one notable exception (the acquisition in July of Speirs Finance by Allied Nationwide Finance), consolidation in the sector has been almost exclusively failure-led.  “The most striking trend in 2008 has been the capitulation of the mezzanine property finance sector” says Kidd.  The defaults of Dominion Finance, North South Finance, St Laurence, Dorchester Finance, Strategic Finance, Hanover Finance and United Finance have decimated the sector.  “Of the $3.8 billion of debenture money now at risk in distressed finance companies, almost $3 billion is tied up in property lenders” says Kidd.
“For those investors who have lost money, or have money at risk, this has been a painful process.  However for companies that have navigated their way through, the result is that the sector today is probably fitter than it has ever been” said Kidd.
Kidd says that, despite the apparent gloom, finance companies have genuine reason for optimism.  In particular, the announcement by Government on 12 October that it would guarantee retail deposits in approved deposit takers, including finance companies, has enormous implications.  “That decision turned the finance industry on its head” says Kidd.
“Probably the scheme’s most striking feature is its effect of decoupling default risk (the risk of a company defaulting on its payments) from loss-of-money risk (the risk that investors will actually lose money from a default event).  The upshot is that depositors do not need to worry about the risk of losing their money if they deposit money with a guaranteed retail deposit taker”.
“Investors have been very quick to understand the opportunities the guarantee scheme has presented”, says Kidd. “Because of their lending models, finance companies are able to offer higher deposit rates than banks.  Although finance companies tend to present higher credit risk than banks, for investors, the risk of losing money is no different.  Under either, their investment is
He cites an example of a good quality but as yet unrated finance company which until last week was offering 10.75% per annum for an 18 month term, double the equivalent yield offered by the major banks.  “Once the company was accepted into the retail guarantee scheme, the risk of depositors losing money became no different to that of investing in a bank term deposit, or for that matter, investing in Government bonds”.
Since 12 October when the guarantee scheme was announced, new and rollover money rates have increased substantially. “Some companies simply cannot absorb the volume of deposits coming in, and we are hearing that some are returning large volumes of application money to depositors.”  Deposit rates are dropping fast as companies react.  The example company Kidd refers to is now offering 8.00% for the same 18 month term.
Kidd labels this an unintended, but predictable outcome of the guarantee scheme.  Investors are responding logically, taking advantage of opportunities being thrown up by risk arbitrage.  “This is not a healthy outcome” says Kidd.  “Just when investors were starting to appreciate that there is no such thing as a riskless return, the guarantee scheme signals that there is.  The scheme ignores all the lessons of the past two years, where investors learned the hard way the consequences of mispricing risk”.
With all the headlines, the importance of the finance company sector to the New Zealand economy is often overlooked. With assets exceeding $22 billion, the sector has been an important contributor to New Zealand’s economic growth over the last decade in financing many projects and assets that otherwise would not have proceeded.  “Yes, there were a number of bad apples in the bunch” says Kidd, “but the role of the sector as a whole is arguably more important today than it’s ever been in financing assets that banks cannot”.
This is why, says Kidd, the departure of GE Money and GMAC from the local vehicle financing market is potentially such bad news for car dealers and buyers.  “GE Money and GMAC together finance probably up to half New Zealand’s vehicle dealerships.  Dealers are currently faced with finding alternative financing arrangements, which in the current environment is likely to prove very difficult for some”.
“Although there are clearly opportunities for incumbents to take up some of the slack, there is not enough capacity in the market to cover the full shortfall.  Already suffering, the motor vehicle dealership industry faces a further hollowing out if nothing further is done”, concluded Kidd.
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