Finance and investments

Oceans of ink have been used in discussing the current and ongoing dramas surrounding finance companies. Here are some tips for you to consider should you be inclined to invest in these institutions; firstly consider the financial information. Start with key facts and figures-if you are happy with these then you can progress on to examine the company more closely. Ask the following;

- What are the current funds under management? (Size of portfolio)

- What is the reinvestment rate (the percentage of investors who put their money back into the company; this gives you some idea of the level of satisfaction among the current investor

- The current balance of loans.

- The size of average loan.

-The number of loans.

- The average loan to value ratio (usually expressed as LVR, this gives you the value of the loan as opposed to the value of the assets the loan is secured against

Assuming the above is satisfactory; you can then move on to examine the following;

- The loan and deposit growth.

- The companies’ liquidity (this may be expressed in cash and equity)

- The loan and deposit maturity profile (this will inform you that the company can meet its obligations as they fall due.

- The loss/recovery and provisioning as a percentage of loans (even with the best will in the world sometimes loans go into default or “past due”, usually this is a loan which is in arrears greater than 90 days. Has the company made satisfactory provision fort his?)

- Regional and Sector finance portfolios (this will tell you where geographically the loans are made and over what assets. Sectors range from vacant land, to commercial property and residential mortgages, to whiteware or cars. What are you most comfortable with? Provincial for example was over exposed to consumer items like vehicles)

The next consideration is the management and the company’s track record. For example Petricevic, the CEO of Bridgecorp had already been involved in a venture which lost investors millions. Has the management had experience in lending in good and bad markets? Be sure about what you are being offered. An unsecured debenture means that if the company fails you are the last to be repaid-as we know many investors have not had good news on this front. The rates are of course important. The rates however do not always reflect the level of risk a depositor may be taking. Bear in mind also that finance companies do not have to comply with the strict rules which apply to banks.

A sort of cousin to finance company investment is a bond. Bonds are debt instruments issued usually for a period of longer than a year with the purpose of raising capital borrowing from the public (us). Bonds are issued by governments, banks, companies and utility companies.

As with finance companies you must understand the risk and return ratio some companies follow: Returns need to compensate for risk.

Credit ratings can be useful here as a guide but you still need to be wary, Enron was rated investment grade right up until it imploded. A credit rating chart follows thanks to Brent Wheeler- check him out at http://www.brentwheeler.com/

Relying on ratings he says is a fatal delusion-and I agree- you still need to do your homework. Read Brent’s take on the language a prospectus should utilize.

It should be:

- Clear and simple
- Appropriate to the audience
- Direct and personal
- Favouring informal language, when appropriate
- Drawing on common, everyday language
- Accessible to a wide audience
- Explaining technical words in simple language
- Attempts to interest readers and hold their attention
- Rely heavily on simple sentence structures
- Generally avoids passive voice
- Respectful of the reader.

Any attempt to improve regulation has to look at the most important aspects of plain English. This would be simple to do if we could climb down from our awful pomposity and ego preserving traditions of writing in late Dickensian English, confusing volume of text with clarity of communication and strive to write short, sharp, simple truths.

The following terms very likely mean utterly nothing to the average investor and are grossly misleading:

- "1st ranking". First this is simply incorrect. The receivers get their fee long before they get their man or give money back to anyone. Then there is the IRD and employees both of whom commonly feature before debenture holders. Don't use the term.

What I think is meant or ought to be meant is "several people have claims on the cash the company has. It’s like a queue. Your place in the queue is, by law certainly ahead of the owners of the business and some other borrowers but you only get what is left after everyone ahead of you in the queue gets their money. If the company fails or goes into receivership there is a good chance that will be less than what you invested."

- "secured". Another misleading expression. Like a super tanker, if the wharf you are secured to is built on quicksand, the security is worth nothing in a storm.

I think what is meant, or ought to be meant is "If borrowers stop paying off their loans and we start to run out of cash we can sell the borrowers houses or cars or other assets and that should be enough to cover what you have invested so long as their assets are still worth something."

- "liquidity" and all related terms such as "liquidity carried" or "liquidity ratio". This is high jargon which means little.

I think what is, or ought to be meant, is "enough cash in the bank to be able to cover at the very least (1) the companies bills as they become due and (2) to be able to pay back investors as their investments mature, and (3) some left over for the unexpected."

- "equity" and all related terms such as "equity ratio breach", "in excess of the required equity ratio" and so on. More confusion - especially since a number of people think the term "equity" has something to do with "fairness".

I think what is, or ought to be meant is "a spare reserve of cash or assets which can be very quickly sold for cash which we can rely on to protect your investment if borrowers stop paying their loans off".

- "related party transaction". Another hopeless term. In recent cases the real problem has been that money has been invested in things and places which investors did not think it would be. Who is related to who simply obscures the fact that people raising money should be truthful about what they are going to do with it, stick to their promise and if they want to change that, go back and ask.

In plain English "We will invest your money in a, b and c. We will not invest it in anything else. In particular we will not invest in x, y, and z. If we want to change these plans we will ask you first and you may say "no" should you wish to."

If this all seems to hard or you want to discuss any aspect of this paper please email me at sheryl@strategies.co.nz, or call me on: 0800 64 MONEY (0800 646 6639)