It's Not All Gloom and Doom

The failures of Nathans Finance, Five Star Finance and Property Finance Group have again heightened media interest in the performance of finance companies.  It has also led to the Securities Commission taking a more active stance, with them writing to the directors of all the finance companies asking them to confirm that they were complying with their prospectuses.  Despite this, a small Nelson based finance company, LDC Finance, has just gone into receivership within days of its directors advising the Securities Commission that everything was fine.  What was unusual with this company was that around a third of its deposits were unsecured and on call.  Over a few days, investors pulled a lot of money out, effectively causing a 'run on the bank'.  It's amazing that people invest in such a manner.  Why anyone would leave money at call, unsecured in a very small finance company like LDC Finance defies financial logic. 

One area that there has been a lot of comment made recently, is the apparent lack of disclosure by finance companies.  This is a sweeping generalisation.  As advisers, we receive financial updates on a very regular basis from what we regard as the top echelon of finance companies.  Most of this is on a monthly basis, the exception being those which are publicly listed.  We cannot receive updates before they have been issued to the NZX which is quarterly. 

A lot can happen to a finance company over a three month period.  Given that their debenture book most likely will have a duration of say 15 months (and we suspect it is currently shortening heading towards 12 months as investors become less prepared to invest for periods of longer than two years), over a three month period almost a quarter of the debentures may mature.  There are some major implications for the finance companies.  Prior to the current problems, a 75% reinvestment rate would probably have been acceptable.  If the lending book was to stay constant, and the average debenture duration was 15 months, 5% of new money is required to maintain the book.  If the reinvestment rate falls to 50%, then 10% of new money is required.  If the duration decreases to 12 months, then the respective figures become 6.25% and 12.5% respectively.  These required growth rates are well below the historical growth rates achieved by the better companies.  We doubt that they are sustainable in the current environment by a number of finance companies; however they are probably sustainable by the top echelon of finance companies. 

Most finance company investors will not have read the prospectus.  All should have received an investment statement.  It is likely that many will not have read it, and will have simply completed the application form and mailed it off together with a cheque.  That is human nature.  Unfortunately, some finance company debenture investment statements are essentially no more than an application form.  The amount of information provided by the company with some is minimal, and the pertinent information about the company, its financials etc would occupy as much space as a $0.50 stamp.  If we go back a few years, there was no such thing as an investment statement.  All applications were made on a prospectus, which provided significantly more information on which to make an investment decision than what is currently required under New Zealand's securities regulations.  Somewhere along the line, a group of government officials, presumably from the Securities Commission, decided that investors needed minimum information to be supplied to them.  Perhaps we should blame the Securities Commission for the lack of information and transparency associated with a lot of finance company investing?

The fact that investors receive minimal information is endemic in the whole of the finance sector.  How many of us, have read our banks prospectus, or when we buy shares on the NZX, do we refer to the prospectus issued for the initial public offering? Of course we don't.  At least when investing in a finance company, all investors must receive a minimum of an investment statement.  They can also request a prospectus and the trust deed.  This information together with more recent financial information should be readily available to those who invest via qualified advisers.