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New rules of the finance company game being established as risk pricing returns to 'fairer' levels

New rules of the finance company game being established as risk pricing returns to 'fairer' levels

By Gareth Vaughan

The risk premium finance companies are paying to borrow money off the public over bank pricing is returning to fairer rates following the shake out in the sector that has seen dozens of companies collapse over the past four years, says KPMG.

Speaking to after the release of KPMG's Financial Institutions Performance Survey - Non-banks Review of 2010, KPMG audit partner John Kensington also suggested big holes in the finance company sector, such as property financing, equipment and plant financing and car financing, could be targeted by banks.

A total of 62 finance companies and other financial entities have collapsed over the last four years putting NZ$8.5 billion of investors' money in about 205,000 accounts, at risk. See our Deep Freeze List for details.

Kensington said the premium finance companies with BB speculative, or "junk", grade credit ratings appeared to be paying over banks with AA investment grade ratings to attract the public's money was between 150 and 300 basis points. He noted that seven or eight years ago finance companies were paying 5-6% more to borrow money than the banks, but this narrowed to just 150 to 200 basis points at the peak of the finance company boom three or four years ago.

"Back when there was a 5-6% difference in what they borrowed, that perhaps is or was closer to being right than where it got down to at the peak of the boom," said Kensington.

If a company is borrowing money from the public to do something that's well controlled and well looked after, and the company has a good history of doing it, is well known in the market and has some control over the credits it's exposed to, then "probably" the 150-300 basis points premium was fair risk pricing.

"If you had a large number of smallish loans in your book that were to a demographic that had a history of repaying, funding that sort of book, then I think that (a 150-300 basis points premium over the banks) is a fair return," Kensington said.

He pointed to the example of Fisher & Paykel Finance's Farmers cards where loans have a relatively quick turnaround and a large number of small loans to a relatively wealthy demographic.

"Where it's not to that type of demographic, and where it's not that type of loan, or a smaller number of loans, it (a 150-300 basis points premium) is possibly not a fair risk, no."

Property development riskier

Kensington said the "very risky areas" were property development and dealing in loans to people who want to buy used cars priced at between NZ$5,000 and NZ$10,000.

Based on what's happening in the marketplace now, what happened before the boom and from what finance company chief executives and chief financial officers are saying, Kensington suggested the future could see finance companies with BB+ credit ratings paying 300-500 basis points over bank rates and BB- rated ones an extra 150-200 basis points to reflect risk.

That said, Kensington noted that after October's end to the Crown retail deposit guarantee scheme, the extended guarantee scheme - with just seven companies participating - lingering on until the end of 2011, and Reserve Bank non-bank deposit taker regulations introduced as recently as December 1, the finance company sector was still in a state of flux.

"Things really have changed in this sector and I don't think it's settled down just yet," said Kensington.

"There are non-bank deposit taker rules that now have to be obeyed and followed, there is still some change coming in the market. I think there will be further amalgamations or acquisitions, and just where the funding for non-bank deposit takers, in terms of where the margin over bank rate ends up, is an unknown. And all these things actually mean that the whole sector is still undergoing a huge degree of change as the new rules of the game are sorted out."

Banks to target gaps in market?

Meanwhile, Kensington said there were now "very, very" real gaps in the market for property development financing, financing the lower end of the used car market and the financing of assets such as bulldozers and trucks. The gaps come after the demise of all 10 property financiers covered in previous KPMG annual surveys such as Hanover Finance, St Laurence, Strategic Finance and Equitable Mortgages. The demise of South Canterbury Finance had also left a broader hole.

In the plant and machinery space he suggested the likes of ANZ subsidiary UDC Finance, which recently posted a near sevenfold increase in annual profit, and Pyne Gould Corporation's Marac Finance, which is merging with CBS Canterbury and Southern Cross Building Society, are in a good position and set to grow.

"The question is will one of them try to acquire something else, like South Canterbury Finance, and do that growth quite quickly or will they just keep to their current approach to life which is steady as she goes. I think undoubtedly at some point whatever's in that South Canterbury Finance book will  be sold to somebody," said Kensington.

"Maybe one of the other banks, who don't have an operation like UDC or have it too closely entwined in the bank where everything's secured over property and they perhaps don't want to lend over income earning asset, I would suspect that maybe some of those other (bank) players may emerge."

Used car financing?

A strong parent or financial backer would be required for any new entrant. In the plant and machinery funding sector it would probably be existing players like UDC and Marac picking up more market share. In the car market KPMG had heard some credit unions were expanding into financing second hand cars worth between NZ$5,000 and NZ$15,000.

And property development financing would re-emerge when there was demand.

"I think property development will now be done by people who have a balance sheet big enough to do it, (like) Fletcher Building, who can fund it and get bank funding, get some skin in the game," said Kensington.

"The other style of property development - your 200 sections somewhere north of Auckland, in Queenstown or Matarangi, I think those sort of things will be very quiet for a long time until demand from the end user purchaser comes along again."

As for the banks, Kensington noted Westpac used to own finance company AGC, which it sold to GE Money for A$1.6 billion in 2002, and BNZ had a business called BNZ Finance which it pulled into its commercial division.

"UDC has had its challenges over the years but it's still there and it's still doing very well and is poised to take advantage of what has happened," said Kensington.

"It is specialist lending when you're lending off cashflow, you're analysing what a truck or bulldozer can earn for somebody and you're not necessarily getting their house as security. And that's why I think if the banks were to look at it (finance company lending) they might say 'maybe that's better left outside the ordinary core operations of the bank.' Maybe a subsidiary with a slightly different set of guidelines for how it analysis and manages credit."

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if there are no finance coys left (and I exclude UDC here as it is a sub. of ANZ National) then why not just close them down?

it is all very well talking about risk premiums but if there is no supply then this doesn't come into play. Finance coys will pay what a will buyer is prepared to accept ie bugger all.

the finance sector developed out of the fact that they realised investors were not satisfied with bank returns and there was a gap in the market. In addition banks only lent on property (as is the case now) and were therefore constrained on what they could actually "pay" to make a return.

if banks begin to crowd this space then they will NOT pay the risk premium. This can only therefore lead to gouging.

Australia have recognised that no competition in the market leads to distortion and are endeavouring to open it up. NZ on the other hand is playing right into the hands of Australian investors.

I see years and years of dividend flows heading west unless our regulators wake up.









Kane - are NZ investors really that happy with their returns from finance companies, or is return of capital not important ? Return is related to risk - if banks aren't willing to do it, understand return may not be what happens to your capital.

We need finance companies, or banks who will fill the avoid at higher prices, but investors have to become better educated on the risks they take - I don't hold out much hope that greed will be overcome by education