Finance investments: 10 things to check

Bridgecorp is the latest example of the investment rule: buyer beware. In December of 2006, Rob Stock offered 10 tips on what to look for when investing in finance company debentures.

Investors in finance company debentures should become amateur sleuths or enlist expert help in tracking down the best rates for the lowest risk.

Just like Sherlock Holmes, they should amass the evidence they need to help them draw elementary conclusions about who to entrust their life savings to, rather than judging companies on brand and the interest rates printed in newspapers.

The clues to the best investments are there to be found, but only if investors are willing to put in a little effort to gather them. Depending on who you talk to, New Zealand investors are either a savvy bunch of Poirots, or a crowd of Inspector Clouseaus.

Many finance company bosses say investors are careful when they choose who to invest with.

But Ron Keene of Rapid Ratings, which has decided to stop providing credit ratings for finance companies, speaks of a nation of investors aware of the risks they are taking, but preferring to ignore them. So how do investors cut through finance company advertising - which cheerfully assures investors how safe their investments are - and decide where to invest their savings?

The Sunday Star-Times has spoken to experts and compiled a list of 10 lines of investigation for careful investors. But be warned, there is no smoking gun, no killer indicator of a good or bad company, says David Chaston of interest rate comparison website interest.co.nz. Instead, investors must build a rounded picture of firms they are considering.

Ratings: The easiest way to get a view on the stability of a finance company is to look at its credit rating. Standard & Poor's rates Geneva Finance and UDC, and Rapid Ratings has ratings on Strategic Finance, Bridgecorp, St Lawrence Mortgages and Instant Finance, although those will come to an end in the next 12 months. Companies rated by Standard & Poor's are considered to have safe "investment grade" rankings. UDC is rated AA- and Geneva B+. Ratings can be cross-referenced with interest rates. UDC pays $5000 investors 7.1% for 12 months. Geneva pays 9.2%.

Size: Go for a biggie. Size is one indicator of stability - though not a perfect one. Investors should demand a premium on interest rates to invest with one of the rats and mice of the finance company market. Why settle for 8.5% from a finance company run by one man and his dog over the garage when you can get the same from a $200 million-plus operation?

Founding date: A company founded 20 or even 10 years ago is much easier to trust than one founded last year to cash in on the boom in lending. Let Johnny-come-lately earn his stripes before you entrust him with your money.

Interest rates: The higher the rate you are offered, the more risky the investment, right? Not necessarily. Some high-risk finance companies pay far less to investors than they should. Chaston suggests investors look at the average rate at which finance companies lend to their borrowers. For example, Dominion Finance lends at 14.3%, and pays debenture investors 8.5%, and Instant Finance lends at 29.3% and pays investors 8.25%.

Who is getting a better risk/return? The data is available for free.

Who they lend to: Some finance companies lend your money to help businesses grow, others to help people buy stereos or cars. Some lend to property developers, some to a mixture of all these. Some loans are riskier than others. Some lending is secured against real assets, some debt is not. The more you know about who finance companies are lending to, the more forewarned you are. Finance company prospectuses help here. The more you know, the easier it will be to diversify your portfolio.

Gearing: All finance companies are leveraged. They borrow money to lend, and tend to have little shareholder capital. Should the worst happen and a finance company goes bust, the first investors to lose their money are the shareholders. Then come the debenture holders (in some cases the banks take precedence over them). The more there is in shareholder funds, the bigger the loss the company would have to make before debenture investors feel the pain. Again, www.interest.co.nz can help with research. High gearing levels aren't necessarily bad, but can be an indicator of a higher risk and investors should demand a premium for investing in a company whose shareholders have little of their own cash at risk.

Free advice: Some websites, such as Bondwatch and the site of Sunday Star-Times columnist and New Plymouth financial planner Peter Hensley, provide ratings on stocks which investors can use to help them make decisions.

Management: Spend a little time to look up the finance companies, and their bosses, on the internet. Look for stories from newspapers which could indicate something fishy is going on.

Get a guarantee: Some companies, such as Capital & Merchant, offer insurance-backed debenture investments which reduce the risk of debts going bad.

Profitability: Look for a history of profitability. Companies that do not make much money do not last long. If you are investing for three years, you want to see at least three profitable years. Past performance is no guarantee of future performance, but it is one indicator. Just ask Crusaders supporters.

- © Fairfax NZ News