The decision by credit agency Fitch Ratings to downgrade Hanover Finance's rating today, a day after the finance company announced it would default on interest payments, raises questions about the effectiveness of credit ratings to help investors.
Last year, following a raft of finance company collapses, the Government proposed new rules to govern the non-bank financial sector and to help protect investors, including a mandatory requirement for them to get a credit rating.
Finance Minister Michael Cullen said in August the requirement for a mandatory rating would help clarify the risk/return profile of investments.
Fitch today said it was downgrading Hanover's rating from "BB+" to "C" and putting it on creditwatch negative.
A "C" rating indicates a default is imminent.
When it defaults tomorrow as planned, Hanover's rating will be cut to "D" for default.
"This rating action reflects details of an announcement made by the company regarding a suspension of interest and principal repayments, effective immediately," Fitch said.
It noted Hanover was primarily funded by retail debentures (deposits), which have scant chance of continuing, and on the asset side it had been affected by the slumping property market.
Asked why Fitch had not been able to forewarn investors, analyst Tim Roche said Hanover had been pro-active placing a moratorium on redemptions and interest rate payments on the $554 million it owes to 16,500 investors.
Hanover has said if its debtors repaid their loans as they fell due, it should be cashflow positive through to next year, but it anticipates some borrowers will default.
Mr Roche said there "wasn't anything that was flagging (problems) to us".
Even to the financially literate, the language of credit rating of credit rating agencies is arcane. While Hanover's BB+ rating may have seemed reasonable to the uninitiated, anything below the investment grade rating of BBB is known in the trade as "junk".
Had investors in Hanover taken the trouble to read what BB+ meant, they would have learnt it was speculative.
"BB ratings indicate that there is a possibility of credit risk developing, particular as the result of adverse economic change over time, however business or financial alternatives may be available to allow financial commitments to be met," Fitch says on its website.
In January Hanover reported net profit for the six months to December of $17 million, down from $28m a year before.
Chairman Greg Muir said he believed the outlook remained positive for finance companies "that are well-run and have strong governance and management, a consistent record of profit and an international credit rating".
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