The horse has bolted and this week parliament passed legislation to close the barn door. The Reserve Bank Act has been amended so the central bank is now also the regulator of finance companies, building societies and credit unions, as well as banks. Many of the 170,000 Mums and Dads who have NZ$5.7 billion frozen in 41 finance companies, mortgage trusts and investment funds will believe this has come far too late. See our Deep Freeze list for more details. But will the regulation of the sector by the Reserve Bank stop new horses from bolting? Firstly, there aren't many finance companies left to bolt of any size. The big ones left standing, UDC, Marac Finance and South Canterbury, already have investment grade credit ratings and are strongly capitalized with diversified funding, diversified lending and hefty backers.
Many of the rest are smaller specialized lenders in the rural, equipment finance and personal lending, which are less vulnerable to the current collapse in the residential and resort development sectors. But they will require credit ratings from March 2010 and have to meet minimum capital requirements. Their boards will also have to have two independent directors and an independent chairman who are deemed to be "fit and proper" and be subject to removal by the Reserve Bank. They will also have to disclose more information more regularly, although the details aren't worked out yet. But the biggest element of the new regime which hasn't had much public debate is the ongoing role of trustees. The Reserve Bank has said trustees will continue to have the frontline role as the supervisor for finance companies. This is a frontline role the Reserve Bank has itself in its regulator of banks. Trustees have been criticized over the last couple of years for not being aggressive enough in identifying problems within finance companies and not blowing the whistle on problems when they arise. They are supposed to be the debenture holders' representative inside the company keeping an eye on the company's practices and accounts. Here's what one commenter (shuttle) said this week when reading that trustees would remain the frontline regulators for finance companies.
Is this a joke? The Trustees have proved themselves to be totally ineffectual and have been paid to do absolutely nothing. If one or two had fallen over that could have been accepted but twenty odd having now been put into receivership or moratorium and it is plainly total incompetence. Time and again finance companies have proved to be nothing other than piggy banks for their owners, who have squandered investors' life savings and will get away with a slap with a wet bus ticket.
This is a common view that shows investor expectations of trustee oversight were not met. However, to be fair to trustees, they were reliant on what directors told them and the quality of the audited accounts. Their powers were beefed up in the last year so they could appoint independent auditors and advisors to scrutinize a finance company's activities. They also got the power to require 6 monthly audits. They have used these new powers quite aggressively in several recent cases (Dominion and Lombard) to expose poorly managed and valued loan books. However, I still query how independent and robust this oversight can be when it is paid for by the finance company. I hope that the Reserve Bank gives the trustees plenty of their own oversight as the system evolves. The more important aspect of the new regime will be disclosure. Finance companies have reported results and given financial updates much slower and less often than NZX listed companies. In some of the worst cases (Bridgecorp and Capital and Merchant), they were so obstructive and complicated in their reporting as to be virtually impossible to read. I hope the Reserve Bank is aggressive in ensuring accurate, fast and open disclosure. It's also worth asking if the Reserve Bank could do a better job than trustees in being the front line regulator for finance companies, particularly for the small and specialist lenders. The Reserve Bank simply has neither the staff numbers or the skills to be grilling and monitoring small lenders. By March 2010 there may not be all that many left. I'd be surprised if there were more than 3 or 4 big finance companies around by then. Many of the smaller ones will have consolidated (as seen recently with Allied Nationwide buying Speirs) into something larger or have been wound down. The bigger question is whether any regulator could have stopped the reckless property bubble lending by often suspect individuals. The likes of Mark Bryers and Rod Petricevic may not have passed the "fit and proper" test. Independent directors and chairmen may have made a difference. But somehow I doubt it would have stopped investors hoping to get a little bit extra from the bank. You could argue the apparent comfort of Reserve Bank regulation may have encouraged even more to take the plunge and invest in finance companies. Investors should know that Reserve Bank regulation or Trustee oversight is no substitute for doing some research, taking care and recognising these types of institutions are simply much riskier than a bank.