Fin coys to lose their provisioning cushion

New international accounting rules should help give investors a better picture of the level of bad debts finance companies.

Monday, 18 September 2006

However, he says, new accounting rules should significantly improve this information.

"New Zealand historically lacks accounting rules on how finance companies should calculate their provision for doubtful debts. Current practice by most finance companies has been to review large individual loans for specific problems, then carry a 'general provision' to cover problems that may exist in big portfolios of smaller loans."

He describes the general provision as a "kind of cushion".

"The problem with the cushion from an investor’s point of view is that it is too slow to respond and can hide the impact of escalating bad debts when trouble hits."

Prichard says KPMG’s 2006 Financial Institutions Performance Survey shows an average “cushion” of just under 1% of gross loans and advances, but a wide range between and within sectors. For instance motor vehicle financing ranges from 0.00% to 3.78%, Property development and commercial finance from 0.00% to 2.17%, diversified finance from 0.00% to 0.76% and consumer finance from 0.18% to 3.95%.

He says companies must adopt new international accounting standards by next year at the latest and these rules will fill a gap in accounting in this area by requiring a much more dynamic approach to recognising doubtful debts.

"The general provision cushion gets replaced by an estimate of exactly what bad debts exist today in the finance company’s books."

He says that 'loss events' such as missed or late payments, or environmental factors such as a fall in the market value of security held because used car prices fall, should be quickly reflected in a dynamic provisioning model.

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