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Rot revealed in finance company sector, but so far contained

By Melanie Carroll of NZPA

Thursday 3rd January 2008

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Experts breathed a sigh of relief a year ago as disaster loomed in the finance company sector but failed to materialise. It was only a temporary reprieve as many investors discovered to their dismay in 2007.

With 13 finance firms out of business since May 2006 -- and the collapses picking up pace with 10 of them in 2007 -- there seems plenty of bad news yet to come.

Some people believed they'd diversified when they sank their entire savings into different finance companies, rather than just the one, but that still left them sorely exposed.

Those who were not quick enough, or could not get their money out, became the victims as credit dried up when those who could, did get out, or closed their wallets altogether.

The rot revealed itself in 2006 with the collapse of National Finance 2000, Provincial Finance, and Western Bay finance owing around $375 million.

One of the highest profile defaults was the first in 2007, with specialist property financier Bridgecorp failing in July, owing about $500 million to 18,000 investors.

Bridgecorp, spurned several times over the years when it tried to list on the stock exchange, was originally a mining company before it came under the control of former 1980s high flier Rod Petricevic.

Receivers said at June 30, Bridgecorp's had 69 loans totalling $393m, with many of the better quality loans already sold off.

The last to fall in 2007 was Capital + Merchant, which was placed into receivership owing investors around $200 million, after breaching security agreements with the Australian branch of US giant Fortress Credit Corp.

Accounting company KPMG said the $18 billion sector, which more than doubled in the last decade to 43 companies with assets over $50 million, is in for a heavy cull.

That was despite a growth in profitability across the firms, record profits for some companies and only four reporting losses, excluding the companies in receivership.

Some of the common themes for the failures were poor asset quality, heavy related-party lending, poor profitability and cash flow, unfavourable redemption schedules (lending long and borrowing short), and high levels of debt.

Lachie McLeod, head of South Canterbury Financial, one of the few finance companies with a credit rating, believed collapses and forced mergers will slash the number of firms in operation from 80 to 20 within two years.

He blamed loose lending and loose procedures for the current situation.

Finance companies operate by borrowing money from willing -- usually retail -- investors and lending it out at a higher rate.

As early as May 2006, one leading corporate receiver warned that many second- and third-tier finance companies would fall over as liquidity dried up in the second hand goods and used car markets.

He likened the way finance companies worked to pyramid schemes or "glorified ponzi schemes", where new investors' money is used to pay returns to earlier investors.

The tales of people caught up in the failing companies were cautionary, and heartbreaking as some told of entering retirement uncertain how much of their life savings they would retrieve.

Geneva Finance investors were given a poor choice in November when they agreed to a moratorium on repaying investments to ward off receivership, stabilising the company and stopping them pulling their money out for six-and-a-half months.

Shareholders Association chairman Bruce Sheppard likened the collapses to the 1987 sharemarket crash, in which coincidentally some of the latest victims/perpetrators were closely involved.

"I'd say this series of collapses in the finance sector will have knocked retail investors' confidence in buying finance company debentures for probably a generation," Sheppard said.

The Trustees Corporation Association said the six member trustees who watched over the finance companies were doing their job properly, and while the association supported tighter rules it believed part of the problem was the poor level of financial literacy. Investors did not heed risk, and sometimes accepted lower returns than they should.

New regulations will ensure finance companies give more information to trustees, which had limited ability to act unless a company breached its trust deed.

KPMG echoed critics of the sector when it said an "unhealthy tension" had existed between fees and brokerage received by some financial advisers from some finance companies.

Some collapses, such as Bridgecorp and Five Star, had their beginnings obscured by possible operational irregularities, KPMG said.

Both the stock exchange operator and Securities Commission asked finance companies to confirm that their prospectuses complied with the law and were not false or misleading, prompting Five Star Consumer Finance to call in the receivers.

Only a handful of finance companies are listed on the exchange, none of them large enough to feature on the top-50.

The commission said it was also considering taking action against some companies over their prospectuses and information provided to the market.

The Government is tightening up regulations, bringing finance companies under the wing of the Reserve Bank with minimum prudential requirements and a credit rating, although it will take time for all the pieces of legislation to be put in place.

Trading banks, which are offering returns not much lower than finance companies under current high interest rates, are regulated by the Reserve Bank and must have a credit rating.

Despite the problems, finance companies play an important role in the economy, providing an alternative source of funds to consumers. But the party inevitably had to end after a decade of easy credit, strong economic growth, and a large consumer appetite for debt.

While otherwise solid finance companies have felt the effects, the news is not all bad. Assets were not the problem for some, it was retention rates on deposits.

Providing a backstop, the economy is robust with low unemployment and few sectors stressed outside finance companies.

Eventually, though, if market funding dries up enough overseas, and talk of a US recession comes true, there will be more carnage for finance companies in 2008.

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