KEY POINTS:
Although Bridgecorp's collapse was widely expected in professional circles, it came as a shock to its many retail investors, trustee, auditor, some financial planners, the Securities Commission and a couple of small rating agencies.
Just how its trustee and auditors missed the problems will, no doubt, continue to
be a subject of interest in the media.
Investors will ask how a company such as Bridgecorp can report profits all the way up to the point that it is placed in receivership.
What do the accounts mean? Can they be relied on? What is the role of the trustee? How could the company keep raising money in New Zealand when it was banned from doing so by Australia's securities watchdog?
The finance company sector is of significant importance to the economy. New Zealanders, mainly retail investors, have $16 billion tied up with finance companies and yet the sector is almost totally unregulated.
Almost anyone can hang out a shingle and start raising money from the public. So what are the lessons to be learnt from Bridgecorp?
* That advertised interest rates give little indication of risk. Unfortunately, the old adage of the greater the return the greater the risk is not true when assessing finance companies. Some years ago, they discovered that if investors were presented with the same level of risk they would often choose the lower interest rate, believing it to be safer. Consequently, debentures that should have been offered at 14 per cent plus flooded out the door if offered at below 10 per cent.
* Credit ratings from internationally credible rating agencies are essential. Of the 50-odd finance companies operating in New Zealand, only about six have ratings from Standard & Poor's or Moody's. Of these only three are deemed of investment grade.
* Most finance company debt is mispriced. Sub-investment grade debt is known internationally as "junk bonds" and is priced at about 4 per cent above bank rates. For New Zealand, this would mean most unrated finance company debt should attract interest rates of more than 12 per cent.
* Don't put your capital at risk for a small gain. The margin between what can be earned at the bank or the finance company is small for the extra level of risk entailed.
* If someone recommends you buy any investment, you need to know what research they are basing that recommendation on and if they are conflicted in any way (by receipt of commissions).
* More finance companies will go bust. Do you know which ones they are likely to be? If not, consider leaving your money in the bank instead.
The Government is slowly moving towards more regulation for the sector. But it should bring in mandatory credit ratings from reputable agencies such as S&P and Moody's next year, not in 2010 as is planned, and needs to re-examine the role of trustees. Trustees are there to protect investors but receive all their income from the issuer. Surely this is a potential conflict of interest if not well managed?
* Paul Glass is executive director of fund manager Brook Asset Management.
* Disclaimer of interest: Brook has no exposure to finance companies or their offerings, in any of its client portfolios.
