Thursday, 30 August 2007

Finance company: Reinvestment reliance killed us

Five Star Consumer Finance has collapsed, the seventh finance company in recent months. A comment attributed to the board of directors is revealing:
The board of directors says it has serious concerns about the state of the debenture market and the ability of the company to attract new funds and retain existing investments. The board has decided that Five Star is unable to operate in such a market.
As Elijah points out,
The owners and managers are [effectively] saying "The rate of reinvestment has been cut to zero and that is why we are going under." I find this absolutely shocking!
Me too. As he suggests, a finance company that requires continual reinvestment to keep its head above water is nothing more than a simple pyramid scheme,
with total reliance on using the money of new investors to repay existing ones ...with a tacit endorsement from Lianne Dalziell about this being standard business practice! Had these companies been more prudent in their lending and management there would have been no problems with redeeming investments as they fell due.


  1. "nothing more than a pyramid scheme"

    Well at least you know how the banking system works :-)

    If any minister actually understood the money system i would be very surprised.

    I'm hoping the inquiry into monetary policy will bring up some of these issues but i'm not holding my breath.

  2. Rubbish - that is a simplistic view and is not how pyramid schemes work. The problems go much deeper than renewing debenture stock.

    Try looking at audit procedures, related party lending, and debt reserve. You still don't get it, do you?

    It is all too easy for people to just repeat what they hear in the media to sound educated during cocktail parties. And to show hindsight bias. As you will find out.

  3. Read it again anomymous (You pedant) put simply it is nothing more than a pyramid scheme...pehaps you could expand on the wider issues in your own blog

  4. In light of the lead post, please comment on Hanover and Sth Canty Finance's record profits.

    I presume you think they are safe because they have no liquidity problems.

    Don't give me any garbage about bad management.

    Interested people want to know if they should reinvest. If not, why not?

  5. A businessman with a 'proper' business, with proper customers, making proper profits is wasting his time seeking a business loan from any of these Finance Companies...(gosh, he may be making a profit and want to engage in exporting, job and wealth creation)....whereas slimey 'flash harry' with his cheap jewellery, vulgar suit and dolly bird girlfriend seeking a couple of million for a dubious real estate development is welcomed with open arms and has (superannuitants') money thrown at him.

    Then everyone (right about now) stands around scratching their heads wondering how it all turned to custard.

    If you believe this sort of sneering bullshit then you are a lot dumber than I thought PC.

    Anyway we are working with Lianne to fix it.

    I am interested in this person's response to my Hanover enquiry. I suspect I won't get it because he is pulling this stuff out of his keister.

  6. How about you anons choose pen names so that the dialogus is not as confusing.

    Second point. "Working with Lianne to fix it" will result in far more vexatious problems and far worse trouble in the future.

    As is well said, "A fool and his money are easily parted." Nothing will change that. A government scam, device or scheme will only add cost, make the scene worse and do absolutuely nothing to solve problems. It is naieve to think otherwise.

    The finance business scene here is crook. Let it sort itself out. In the end each'll receive what is deserved.


  7. The regulation is nothing that's going to have large compliance costs.

    I am hoping that all this will expose auditing for the rout that it is. So far the auditors have managed to fly under the radar.

    It is more than annoying that all and sundry - and capitalists who should know better - are using this finance coy issue to smear financiers, Banks (pryamid/ponzi schemes!), and those who are left holding the risk as Gordon Gecko types. Simply not true. There is no fraud involved in 99% of cases.

    Look to those who signed off the accounts.

  8. I feel I should respond to a couple of posts.

    (Firstly, I could make observations about the "bravery" in Anonymous posting when you criticise someone, but I won't)

    1. Far from showing 'hindsight bias' I was discussing Bridgecorp in 1999 with a close friend of Mr Petricevic, where I expressed grave concerns about certain lending activities, and pointed out that although certain matters were legal it is not how business is supposed to be conducted.

    I also disclosed those concerns in a letter to the head of Unlisted when Bridgecorp joined that share trading platform.

    2. However you want to dress it up and engage in semantics, the finance company practice of using money from new investors to repay existing ones meets the definition of a 'Ponzi Scheme'.

    3. Finance companies do have an aversion to making loans to 'proper' businesses, (i.e non property companies) and I stand by my comments.

    (I suggest you call a Finance company and ask for a business loan)

    4. If you are 'working with Lianne' (which I seriously doubt) it is far too late to prevent huge losses for investors, and some rating system is hardly going to overcome a book full of loans made to 'leaky home' developers, who will just shrug their shoulders and skip town to Queensland.

    5. If Hanover and South Canterbury Finance are making large profits that is splendid news.

    Well done!

    I suspect the reason for that is the 'good name' of the people owning or running these companies who would never allow an investor to lose money.

    6. The subject of 'debt reserve' rather comes back to my criticisms of bad management.
    If people running finance companies had half a brain they would have voluntarily ensured there was a prudent reserve, rather than needing regulations to do so.

  9. If you had (or have) serious concerns about finance companies you should have taken them up with Securities Commission. If you are using your real name it doesn't appear to be on any papers on the matter.

    FC's are not a Ponzi scheme. Current liquidity problems are an effect, not a cause.

    Everyone is aware FC's lend to the higher risk end of the market. That does not mean staff and clients should be pompously smeared as Mr and Mrs Infomercial, or greedy whiteshoe used car salespeople. They do business loans, I can assure you.

    Mandatory credit ratings will help with risk visibility, as will other regulations which are in the pipeline and coming to a FC near you, like it or not. The market is always figuring our new ways to manage risk - some will work, some won't. It helps if you remove your ideological blinkers - not all regulation is bad.

    Re debt reserve - Here again it is not a case of FC staff being morons just circling the drain, as you seem to think. Doubtful debt has to be recognised before it can become doubtful.

    I look forward to you alerting us to the next collapse BEFORE you read about it in the media ;-)

  10. Sorry I may be being a bit thick here (and have no vested interest in or great understanding of the sector), but why is a finance company different from any other company that suffers a cashflow problem and goes under? If I owned a shop and my sales dried up to zero, I too would have problems paying my creditors and staying in business, as might some of my suppliers if they were too reliant on me.

    Would anyone be complaining if they went under because people weren’t borrowing?

    These finance companies are selling a product (investments or loans) and people now don’t want to buy or supply the material for that product. And the company has gone under. It happens in business all the time.

    The common issue here is that the level of risk wasn’t reflected in the rates they offer to investors, but that is not illegal or immoral, if you can sell something for a lot more than it costs to produce that is good business. That is an education issue, and unfortunately it is an age old one when it comes to money.


  11. Insider said...
    why is a finance company different from any other company that suffers a cashflow problem and goes under

    Good question. Feltex went under last year. So, I am waiting for the experts on this thread to answer Insider's question.

    Finally, wouldn't a company that takes risks such as each of those individual companies that went under over recent years be something to be applauded for starting up a business in the first place?

  12. Ah yes, using new business to pay for existing overhead. It's an old & desperate strategy that in the end amounts to nothing more than common fraud.

    Not so long ago there were a few companies in the insurance game that tried the approach. When caught with a looming cash flow problem (due to writing dubious business to the underwriting portfolio) they'd issue a new, attractive insurance "product" to the market (that is, they'd ask cheap premiums relative to the risk inherent in the covernotes issued). They'd offer big sales commission to agents and apply minimal qualification against new business. Suddenly there'd be a whole lot of new cash income. Problem solved! Hooray. Or at least it was hooray until the overhanging liability they'd assumed asserted itself and the claims began rolling in. Then the cash flow problem would mysteriously reappear. Desperate to escape they'd hang on and hope, issuing more bad covernote to suck up some cash income (new premium). And after a while the nature of those actions would become evident. Bad loss business. Doom. Collapse. Revelation of fraud. Convistion and/or disgrace. For underwriting without the means to settle claims is fraudulent.

    Now in Australia there were some spectacular collapses of this type in the insurance sector. There was also a retail communications company that imploded in similar fashion. All the regulations did nothing to prevent it.

    Same deal in NZ. This time around for you it's the finance sector. There are going to be some collapses and some people will get to see their money is already gone, spent and finished. They'd have been better off spending it all in the first instance. Still, that's the consequence of being greedy for returns and assuming that there is no risk to investing money with people you DO NOT KNOW, in schemes you DO NOT FULLY UNDERSTAND. Lianne and her fine pedigree will make no difference. As for compulsory credit ratings and new regulation... dream on! Won't help at all.


  13. All finance companies (and banks) raise money and lend it on, adding a margin. That is what they do , and arguably must do in order to be viable and attractive investments for their shareholders.

    As with any other business, these institutions must manage two "risks" successfully in order to stave off receivership: profitability and cashflow.

    The margin (interest rate) that finance companies and banks add to their product (money/debt) has to be more than the company's operating costs plus any bad debts incurred, or else the company will fail. This is called the "profit risk", which must be managed successfully in order for the business to survive.

    "Cash flow risk" is equally important and is determined by the short and long term borrowing and lending mix employed by the business, and how well this mix is managed. Where a company borrows short (e.g. most of the money raised requires repayment in 6-12 months) but lends long (e.g. most loans written are a 36+ month term), then when the reinvestment rate drops, there will not be sufficient funds for the lender to cover its repayment obligations. A company that borrows long and lends short increases its profit risk, as too large of a percentage of its borrowings will be left sitting in the bank earning a lower interest rate than it is paying, reducing its margin.

    Which ever finance companies manages the two risks best are the ones that will survive and ultimately prosper.

    The companies that have gone under, and those that are still at risk of going under, have failed and are failing at managing one or both of their profit and cashflow risks.

    In other words it is bad management, rather than a fundamental flaw in the borrow to lend model used by finance companies and banks, which is causing the failures. It is as simple as that.

  14. Terry..youre the man...


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