Newsletter October 2010
October 1, 2010
Non-Bank Deposit Takers
The finance company sector continues to take a battering, and one wonders who will remain once the financial meltdown is behind us. The collapse of South Canterbury Finance and Allied Nationwide Finance has added a further layer of uncertainty to an already fragile market. The Government Guarantee threw the sector a temporary lifeline, however December 2011 will come soon enough, and it is at that point we will see who remains.
The non-bank sector plays an important role in the New Zealand economy, providing finance for small businesses and those that otherwise may not be able to attract bank funding. Investors, however, need to question whether or not they need to be exposed to the sector at all. In hindsight it’s obvious the finance company rates being paid prior to the global financial crisis were not adequate for the risks investors were taking. The property boom was in full swing, and there was a sense that almost any property investment was “secure” simply because it was property. The simple fact that finance company rates weren’t significantly different from bank rates also created a false sense of security. Investors assumed a finance company was safer than it actually was because their rates weren’t through the roof. If Bridgecorp or Lombard adequately rewarded investors for the risks they were taking they should have been paying 15% to 20%, and this alone would have prevented many from investing in the first place.
The risk/return relationship has been turned on its head with the introduction of the Government Guarantee – you now have a situation where investors can achieve returns in excess of bank term deposits without taking any risk at all. That will, however, only be the case until December 2011, and it is then investors will have to decide which companies warrant their support. Unfortunately the remaining non-bank deposit takers now have to overcome the crisis of confidence that dogs their industry. As if collecting loans in such a tough environment is not difficult enough, they must also cope with investors pulling their money out as it falls due. This, along with some poor lending, was a significant contributor to the later finance company collapses. Some of those companies would have survived had it not been for the contagion effect that swept through the industry.
Even the banks can be subject to a crisis of confidence, as Alan Bollard explained in his recent book on events surrounding the global financial crisis, and the introduction of the Government Guarantee Scheme. Depositors were withdrawing their money from the banks and hiding it at home! The very nature of banking means banks can be left exposed to bad publicity. Individuals deposit small sums at call, or for relatively short periods (1-2 years). The bank bundles those deposits together and lends the money to a home buyer or a farmer or a business owner for a long period (10-25 years). What happens when a rumour that the ABC Bank might be in trouble? Everyone lines up at the door to withdraw their money. The bank will have assets that match the value of depositors’ funds, but they can’t access them because the people they have lent the money to don’t have to pay it back on demand. This happened to Northern Rock in England in September, 2007. I think the remaining non-bank deposit takers will need to look at various alternative sources of funding (outside short-term retail deposits) until an adequate level of confidence returns. This might take years, not months.
The Government has recently introduced strict regulations for the sector, to be administered by the Reserve Bank, and in time these could provide the basis for some level of confidence to return.
- All non bank deposit takers to have a credit rating by March 2010
- A requirement for every deposit taker to have a risk management plan
- Each deposit taker to have an emergency source of liquidity
- Restrictions on related-party lending
- Minimum capital requirements
Once the Government Guarantee is withdrawn we will need to get back to some fundamental analysis of the various companies to determine whether or not they offer returns that are attractive enough to gain support. The type of information that will be important includes:
- Shareholder equity
- Level and type of security
- Reinvestment rates
- Alternative sources of funding
- Credit rating
- Related party lending
- Exposure to a single debtor or group of debtors
- Bad debts
Trustpower
Trustpower is one of a number of companies looking to soak up some of the South Canterbury Finance money. They have announced an offer of up to $75 million of fixed rate senior bonds, with the ability to accept oversubscriptions of $25 million.
- Maturity Date – December 15th 2017
- Interest paid quarterly
- Minimum investment – $5,000
- Interest rate – 7.10%
- Closing date – October 20th
Tauranga City Council
Tauranga City Council is also issuing bonds. They have announced an offer of up to $70 million of fixed rate bonds, with the ability to accept oversubscriptions of $20 million.
- Maturity Date – April 15th 2016
- Interest paid semi annually
- Minimum investment – $10,000
- Interest rate – 6.25%
- Closing date – October 12th
Finance Companies
With the South Canterbury Finance money coming back into circulation, there was an expectation the other Government Guaranteed finance companies would soak some of it up. In response, some of the finance companies have dropped their rates – they don’t want an influx of short-term money, preferring to concentrate on attracting funds outside the guarantee. Rates currently on offer include:
Company Maturity Rate
Equitable Mortgages 12 months 6.50%
PGG Wrightson Finance 12 months 5.70%
Marac Finance 12 months 5.50%
Marac Finance 6 months 5.50%
UDC Finance* 12 months 5.70%
* UDC has not applied for the extension to the Government Guarantee
Barramundi
Some of you will have Barramundi warrants, and it might be timely to explain again how they work. A warrant is a security that entitles the holder to buy a share in a company at a predetermined price. Barramundi investors received one warrant for every two shares issued in October 2006. These warrants expired last year, and holders of the underlying Barramundi shares were issued new warrants in their place. The important terms of warrants are the exercise price, the underlying share price, and the expiry date.
The Barramundi warrants now have an expiry date of October 27, 2011, and an exercise price of $0.75cents. Each warrant gives the holder the right to buy a Barramundi share for $0.75cents at certain dates up to October 27, 2011. The underlying Barramundi share price is currently at $0.81cents; therefore the warrants are valuable in their own right. All things being equal the warrants usually trade at a price reflecting the difference between the exercise price ($0.75cents) and the underlying share price ($0.81cents). At present the warrants are trading at about $0.07cents. If your intention is to exercise the warrants in order to acquire more shares then I would wait until the last opportunity (October 27, 2011) to do so. There is no point paying for them any earlier than you have to. If your intention is to sell the warrants then your decision when to do so is more difficult, as the warrant price will change with each change (up or down) in the underlying Barramundi share price.
Dorchester Finance
The Dorchester Finance recapitalisation has been completed, and Dorchester debenture holders will now have had various securities issued to them. Of all the finance company collapses this is one that has at least seen a significant return of capital to investors. Half the money has been repaid, and the remaining half has been replaced with units in Dorchester Property Trust holding four hotel properties, interest-bearing (5.00%) notes with Dorchester Pacific Limited, shares in Dorchester Pacific Limited, and options to acquire further shares in Dorchester Pacific Limited. The following table shows the number of newly issued securities in relation to an original $10,000 investment in a Dorchester Finance debenture.
Dorchester Pacific shares 2,230 Currently trading at 0.10cents
Dorchester Pacific options 1,220 Currently trading at 0.028cents
Dorchester Pacific notes 3,450 No recorded trades
Dorchester Property Trust units 2,020 Not yet listed
DISCLOSURE STATEMENT AVAILABLE ON REQUEST AND FREE OF CHARGE