KEY POINTS:
Aggrieved investors hoping to get money out of collapsed finance companies through official legal action shouldn't get too excited, says a leading insolvency lawyer.
The Securities Commission is thought to be preparing cases relating to the failures of finance companies over the past year.
"The number of cases
coming out of the finance company sector may exceed what we have available for litigation," commission counsel Liam Mason told Parliament's commerce select committee last week, referring to the size of the litigation budget the commission has available.
The commission is refusing to be drawn further on when, or against whom, it will launch court action.
It is now five months since one of the biggest finance company collapses, when Bridgecorp went into receivership owing $458 million to debenture or capital note holders.
Murray Tingey, leader of the national insolvency practice for law firm Bell Gully, says while court action may serve a sense of vengeance for investors, it doesn't mean they will get their money back any quicker.
It is not just the Securities Commission that can launch legal action against failed finance companies, with the receivers also able to head to court. The commission pursues matters in the criminal area. Some of the remedies it could ask for would be the banning of company directors - but its job is not to try to recover money for investors.
Tingey says investors should probably not get too excited if the commission starts legal action against finance company directors.
"The focus of the Securities Commission in bringing criminal proceedings is not making recoveries for the benefit of investors on those particular matters, it's more corporate governance overall, to ensure it doesn't happen again."
As for the receivers choosing to also take court action, they will have to decide not just on whether they have a claim, but "probably very significantly" if there are any assets that can be recovered.
"Generally speaking a lot of assets directors of finance companies have will be in trust. It'll be difficult, more difficult to receive payment. That's something the receivers will have to take into account."
Directors' assets, particularly those of finance companies that have been operating for some time, are "deeply embedded in trusts", which are difficult to break.
The main role of the receiver is to recover money, and while they have a role in reporting criminal law breaches they come across in investigations, it is not in the financial interests of investors for them to spend money trying to bring criminal charges against directors. "... while that might give investors some sense of vengeance, it's not their role. They are primarily there to get money."
Tingey says he is not surprised at the length of time taken by the commission to launch legal action.
"Most of them are very complex. The receivers are faced with quite an enormous task, first understanding what there is, and then trying to find out what they can recover. Litigation is normally an expensive and time-consuming route that doesn't often lead to quick results. So I think quite properly they'll be focused on trying to get more liquid assets first.
"The biggest issue is recoverability. This won't make investors happy, but most people in the position of directors of finance companies would have well-established trusts, they would have limited assets in their own name.
"At the end of the day if you spend a lot of money, get to trial, succeed in a civil action, they may choose just to go bankrupt and live off their trust assets, and it is very hard to turn over those trust assets."
Last week's confirmation of finance company litigation comes as merchant banker McDouall Stuart released a weighty research report into the sector, predicting consolidation and even more failures in the sector over the next few years.
The report covers those companies that raise money from the public and have loan books of more than $35 million. This year there were 38 companies that exceeded this level, and 38 last year.
Only one company grew enough during the year to cross the $35 million threshold.
The report says New Zealand has about 400,000 retail debenture investors, about 50,000 of which have been affected by the recent failures.
The report says that further industry consolidation is inevitable.
"Continuing weakness in debenture flows, an easing in activity levels and the arrival of a tighter regulatory framework in 2009 are all factors likely to encourage greater con-solidation," says the report's lead author, John Kidd.
"In our view, consolidation will likely come in the form of company amalgamations, managed wind-downs and unfortunately, the likelihood of some further failures."
It's not all doom and gloom in the finance company sector though, says Kidd. "Across the biggest companies in the sector, profitability has increased, liquidity has improved and there has been no meaningful decline in the quality of their loan books."
Debenture flows for the big companies have been "considerably stronger" than for the weakest.
The 10 biggest finance companies account for two-thirds of the sector. "While unnerving, company failures are part of the correction process.
"Companies that remain will emerge as stronger and better operators for it."
The rise, the fall, then the rise of finance companies
Markets go through a series of predictable stages, according to conventional management theory, with the finance company sector fitting the sequence well, says John Kidd, of McDouall Stuart.
First was the establishment and initial growth over many decades.
Then there was rapid expansion, spurred by financial reforms that started in the 1980s. This was followed by 10 very prosperous years, up until 2006, when growing pains began. The market became very fragmented, with many smaller, niche players.
The McDouall Stuart report into finance companies says a coming widespread industry consolidation is "inevitable" over the next two years and smaller companies will find themselves marginalised by:
Liquidity: "As the ebb in debenture rollovers works its way through companies, those that do not have funding contingencies in place and face unfavourable maturity profiles will be hit the hardest."
Margins: "Most in the industry are facing some flat years, with tighter liquidity and thinner loan books. For smaller and debenture-exclusive companies, the decline in activity levels will expose fixed cost bases. With a looming rise in compliance costs from 2009, pressure on margins will intensify."
Regulation: "Tighter trustee and regulatory oversight and financial flexibility requirements are likely to prove particularly onerous for small to mid-sized companies that do not have the balance sheet flexibility to absorb liquidity and cost pressures."
Credit ratings: "Compulsory credit ratings will prove difficult for smaller companies to implement and manage. As well as bringing significant additional compliance cost, companies with limited financial flexibility and, therefore, the recipients of the weakest credit ratings may find themselves avoided altogether by investors."
