COMPANIES BACK IN 2005. NO ONE LISTENED
Bernard Hickey Reporting in 4 April 2008
Those with a long memory may recall a column I wrote in March 2005 while Business Editor of the Dominion Post. Back before the finance company collapses, I warned of the dangers of finance companies and how the government was doing little about it. I had hoped to spark some urgent action. I failed.I described the fears many in official circles had at the time that some of the weaker finance companies might start collapsing. Few officials or politicians or finance executives would talk publicly about the issue. I described it then as “the Elephant in the room”.I then went on a sort of journalistic jihad to warn investors about the dangers of indiscriminate investing in finance companies, particularly those without credit ratings. I warned many were dependent on consumer lending and property development lending that would come unstuck as soon as the economy started to slow, disposable incomes started getting stressed and the property market slumped.It was an akward thing for me to write. At that time, the business pages of newspapers were jam packed full of ads from finance companies. It’s a tribute to the editorial independence of the Dominion Post and Fairfax Media that I was never told to shut up. I was also an early prophet of doom on house prices, but apart from the odd grumble from real estate advertisers, was never told to tone it down. Those who argue newspapers simply pander to the interests of their major advertisers (which at that time included finance companies and real estate agents at the top of the list) are just plain wrong.
I even managed to convince the front page editors at the time to lead the Dominion Post on a Saturday with a warning from Standard and Poor’s that finance companies would start collapsing soon. It took another year before the first one imploded. National Finance 2000 fell over late on a Tuesday night in May 2006.
At the time I was the managing editor of the Independent Financial Review and the story broke after our Tuesday afternoon deadline. But I remember working with Denise McNabb, who broke the story and who has been head and shoulders above anyone in New Zealand business journalism in uncovering the finance company dirt, to ensure it was published first in the Dominion Post and Christchurch Press the next morning.
It was to be the first of 17 finance company collapses and now NZ$2.02 billion of Mum’s and Dad’s money is tied up in debentures owed by these companies. My current estimate of losses is NZ$761.3 million with the potential to go to NZ$1.18 billion.
Over the next year I worked with Denise to fend off various legal attempts by Blue Chip Investments and Bridgecorp to try and suppress the stories she and the Independent Financial Review were writing to blow the whistle on these not-so-fine companies. Our good friends at law firm Izard Weston were very helpful and we were happy to pay the substantial bills necessary to defend ourselves. Readers of the Dominion Post, the Press and the Independent Financial Review should have had some inkling that finance companies were a risky place to be. We tried awfully hard and paid a price.
Denise broke the story that Bridgecorp was about to collapse in the Sunday Star Times on June 24 last year. It was placed in receivership three days later.
The demise of Bridgecorp was, rightly, a shattering blow to the confidence of investors in finance company debentures. This was because it had advertised so widely, had taken in so much money and was heavily involved in lending on real estate deals. Until then, everyone had thought real estate was the biggest sure thing in the investment history of New Zealand.
Fast forward to Lombard and it’s all so sickeningly familiar. It lent too much money to too few projects and was the lender of last resort to investors who had already been turned down by more respected finance companies and banks.
The management had been in trouble before. Lombard Chief Executive Michael Reeves pleaded guilty in December 2006 to charges of misleading investors in contributory mortgage schemes 8 years ago.
It’s like watching a car crash in slow motion. You can see it happening but there’s nothing you can do.
Except, that is, but to be sceptical about all finance companies and to challenge the authorities to at least think about trying to protect investors and ensure decent disclosure and some prudency.
I’ve been challenging the powers that be on this since 2005 and expressing scepticism widely. We should all do so because there are many good finance companies who will survive the scrutiny and go on to be profitable and successful.
The 3 biggest finance companies, Marac Finance, South Canterbury Finance and UDC, all have investment grade credit ratings from Standard and Poors. They have all got strong backers, diversified funding sources and rigorous lending practices. These are all qualities not shared by the 17 who have collapsed.
Many people bare direct responsibility for these collapses. The first “fingers of blame” (a beautful Neil Finn lyric) should be turned on the directors and managers. Lombard’s chairman, the Right Honorable Sir Douglas Arthur Montrose Graham, should be asking himself and others some hard questions right now.
The comments by Lombard CEO Michael Reeves about Lombard being the victim of a systematic collapse in an industry are contemptible. Reeves needs to look a lot closer to home for reasons for Lombard’s failure.
How can any prudent chief executive of a finance company believe that having 30% of your assets exposed to one project is a good idea. How could he believe that loaning twice the value of the entire equity in the company to one developer for one project is a good idea. More than 60% of the book was in just 6 loans.
How dare anyone who did these things and pledged to ”Invest Wisely” be in a position to blame someone else for their own predicament. This from somone who plead guilty to misleading investors less than two years ago. He was sentenced to pay a NZ$1,000 fine.I hope the 4,700 investors in Lombard who are owed NZ$127 million get a chance to question Reeves and Graham. Hard.
Meanwhile, here’s a copy of that column that was published in the Dominion Post on March 19, 2005.There’s an elephant in the room and it’s getting bigger very fast. It’s now so big that it could stop economic growth in its tracks if it fell over. But trying to force it back into a safer place could actually trip it up. So everyone is waiting and hoping it can walk out the door without an accident. That could be a short wait with painful consequences.So what am I talking about? The sustainability of the amazing growth of finance companies. They have borrowed more than $10 billion from “mum and dad” investors in the past seven years.
They have then lent this money to all manner of property developers, used car owners, small businesses and basically anyone who can’t borrow the money from a bank.They don’t play by the rules of the banks. They don’t put some of these deposits away into very safe securities for a rainy day. They don’t have to make sure their shareholders have a good chunk of their own money at stake when they lend. Most of them are well managed and profitable. Some have been around for more than five years, but most have not. Many have never had to survive an economic downturn and a property slump. Some have single loans worth eight times their equity. Some have equity-to-debt ratios of less than 5 per cent. They can do this because they are virtually unregulated. The big question is what happens when the economy cools and property prices fall? What happens when one of the bigger ones falls over? Will the flow of fresh money from mums and dads dry up for the rest? Privately, every financial bureaucrat and banker is deeply concerned. It’s also a subject few politicians really want to tackle. Helen Clark and Michael Cullen are thought to be privately concerned about it. It is suggested it is one of the reasons they appear so keen to have an Australian-led joint banking regulator. That’s because an Australian regulator would also oversee finance companies.
The danger for the Government is that, if it tries to impose tougher capital controls, it could push many out of business. Warning mum and dad voters about investing in them would be even more damaging.
The best option is for mum and dad to check very carefully. Then they should cross their toes and hope the elephant doesn’t squash them.The depressing postscript to this is that after I wrote that column, the amounts invested in finance company debentures rose to a peak of NZ$11.8 billion in September 2007 from NZ$9.7 billion in March 2005.About NZ$2 billion extra was invested in finance companies in the 2 1/2 years after that warning was published. That’s almost exactly the amount that is now frozen in these companies. The amount invested in finance companies dropped almost NZ$1 billion to NZ$10.9 billion at the end of December. That cash is now flowing hand over fist into banks, who are aggressively targeting that money with interest rates over 9%.There is still an awful lot at stake. My only hope is that investors are much more careful over the next three years. And I hope the people who wouldn’t talk about the elephant in the room do the next time. Now is too late.
Bernard Hickey is a financial journalist by trade who's also worked in the business world. As a former editorial writer for BusinessDay and the Independent Financial Review, Bernard's views on business, government and the economy were often provocative and unconventional.