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McDouall Stuart Finance Companies Report 2007

Release of McDouall Stuart Finance Companies Report 2007

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Wellington, 20 November 2007 – McDouall Stuart today released its 2007 report on the New Zealand finance company sector. Titled ‘Flow and Ebb’, the report analyses the volatility that has affected finance companies over the 18 months since McDouall Stuart’s last report on the sector, and discusses the likely future impact of lower investment flows on finance companies.

Although deposit-taking finance companies account for just 3% of all New Zealand financial system assets, this still involves more than $10 billion of investor money.

John Kidd, McDouall Stuart analyst and the principal author of this year’s report said, “With probably around 400,000 debenture holders in New Zealand, the finance company sector is very important to retail investors, but one that receives very little specific independent research coverage.”

The 130 page report analyses the performance of all finance companies which raise money from the public and which have loan books exceeding $35 million. This year, 29 companies exceeded that threshold. When McDouall Stuart last reported on the sector, there were 38 companies that met the same threshold. The reduction in company numbers reflects a mixture of failures, mergers and acquisitions. Only one company grew sufficiently to cross the $35 million threshold.

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 consolidation. In our view, consolidation will likely come in the form of company amalgamations, managed wind-downs and unfortunately, the likelihood of some further failures,” Mr Kidd said.

The failure or default of eight companies since July has undermined confidence in the sector, and many investors have responded by not renewing their debenture investments. The financial profile of some companies is therefore likely to have declined since the end of their 2007 financial year. For those companies, the result has been significant and, for the worst-prepared, fatal pressure on liquidity.

“The companies that failed were the ones least prepared for exactly the kind of scenario that unfolded.

“With 80% of finance company funding traditionally sourced from the public, the best positioned companies are those that already have alternative funding arrangements in place to manage the decline in debenture flows,” Mr Kidd said.

The report also analyses the biggest company failures to date, concluding that there are a number of common risk markers that investors should look for.
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“Debenture investors do not share in company profits. For those investors it is cash flow, and not profitability that is most important.”

But the report also gives reason for optimism.

“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 larger companies have been considerably stronger than for smaller companies. With the largest ten companies accounting for two-thirds of the sector, this gives reason for some optimism that the downturn is not as dire as many are suggesting. Recent figures released by the Reserve Bank showing a net 5% increase in finance company funding for the year to September 2007 tend to support this view.

“In the turbulence of the last 18 months, some have forgotten the vital role that finance companies play in New Zealand’s funding mix. No other providers offer the property, business, motor vehicle and personal finance that banks are currently unwilling to lend against. The financing of these types of assets has been an important part of New Zealand’s growth and development over the past decade, and will continue to be in the years ahead. While unnerving, company failures are part of the correction process. Companies that remain will emerge as stronger and better operators for it.

“As with any investment, investors must assess the available return against the risk the investment presents. Our view is that many finance companies are not yet pricing to a level that supports their risk profile.”

McDouall Stuart is of the view that this trend will continue, particularly as companies move towards a regime of compulsory credit ratings.

“Possibly the biggest collective challenge the industry faces over the next 12-24 months is educating the investing public on credit rating issues. In this respect, we support recent initiatives by the Securities Commission and the Reserve Bank aimed at increasing public awareness of these issues. However, much work still remains to fill this space,” Mr Kidd said.

- Ends -

About McDouall Stuart
McDouall Stuart is a full-service sharebroking, corporate advisory and investment banking firm. An NZX member, McDouall Stuart has a particular interest in the finance company sector, having undertaken a number of capital raisings for finance company clients. Specific mandates have included as Lead Manager for the initial public offering (July 2004) and capital note issue (March 2006) of Dominion Finance Holdings Ltd and for the September 2006 capital note issue for New Zealand Finance Holdings Ltd.

Notes to Editors
McDouall Stuart has published three comprehensive reports on the finance company sector, in 2004, 2006 and 2007.
Company failures: Companies that were covered in McDouall Stuart’s March 2006 report, but which have since fallen into receivership are Five Star Consumer Finance (Receivers appointed 30 August 2007), Propertyfinance Securities (29 August 2007), Nathans Finance (20 August 2007), Bridgecorp Finance (2 July 2007), Western Bay Finance (3 August 2006) and Provincial Finance (30 May 2006). On 15 October 2007, Geneva Finance, which was also covered in the report, defaulted on debenture repayments. On 5 November, Geneva secured debenture-holder support for a 6½ month moratorium on debenture principal repayments. Other companies to have fallen into receivership since March 2006, but which did not meet the scale threshold to be covered in McDouall Stuart’s last report include Clegg & Co, LDC Finance and F&I Investments. Beneficial Finance recently also secured agreement from debenture holders for a moratorium on debenture repayments.

Mergers and acquisitions: PGG Finance and Wrightson Finance (separately covered in McDouall Stuart’s March 2006 report) completed their merger shortly after the release of that report. The operations of Nationwide Finance (acquired by Allied Prime Finance), Pacific Retail Finance (acquired by GE Money) and Prime Finance (acquired by Allied Farmers) have since been absorbed into existing finance companies. North South Finance (acquired by Dominion Finance Holdings) continues to operate under its own Prospectus.


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