Finance company rates about right

Risk premiums in New Zealand’s finance company sector have been commensurate with the United States – but both the top and bottom end of the sector have been out of line, say Westpac Bank economists.

Monday, 7 August 2006

That research has found that “over the last couple of years, the premia of finance company one-year rates has broadly tracked the premia for BB (the highest quality non-investment grade) debt in the United States.

“Thus, on average, the premium for credit risk would appear to be in line with overseas markets, on the assumption that the overall credit rating of finance companies is around the BB grade.”

The key words in that last sentence though are “on average” and “assumption”.

The “on average” is important because it is talking about the aggregate figure for the entire sector.

“The main point we want to get across is that it doesn’t look as though that, on aggregate, the finance company sector has been mis-priced,” Westpac economist Nick Tuffley told Good Returns.

“But within that sector bad companies are probably not have their risk reflected in their rates.

“And some of the higher quality company rates might not be getting the benefit of the cheaper funding costs they might otherwise have got.”

Tuffley says “some quite sound companies are now being tarred by the sins of others.”

The lack of knowledge which caused investors to pile into the market in an indiscriminate fashion now risks having the opposite effect.

The Westpac research notes that “those finance companies that have publicly disclosed their credit ratings tend to be at the upper end of the scale and have historically had a better performance in terms of impaired assets, indicating that they are attempting to differentiate themselves from the rest of the pack.

“Logically, the lack of disclosure on the part of other finance companies should be seen by investors as something of a warning sign that they could inherently carry higher risk.”

Of the country’s 49 finance companies only 11 have a credit rating, and the lowest of those was a B+ from Standard and Poor’s, “suggesting that many other finance companies are of considerably lower quality.”

The bank’s economists questions whether more disclosure and other regulation will help, given New Zealanders seem to have ignored much of the information already required to be disclosed.

“Given that investors have been happy to fund many finance companies without a credit rating, the implication is that Kiwis may be more risk loving than widely perceive – or simply financially naive.”

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