Spotting a Risky Investment

ratesIt is now much easier than it was to spot a risky investment. On 1 March, 2010 it became compulsory for all non-bank deposit takers (including finance companies, building societies and credit unions) to have a credit rating from an approved rating agency such as Standard & Poor, Moody or Fitch.

The exceptions are those deposit takers with less than $20 million in deposits. Investors now have an objective, independent measure of the likelihood that these organizations will fail. Of course, rating agencies sometimes get it wrong and it is possible that a company will provide information to the rating agency that is incorrect or misleading. Ratings are based on statistical probability, but sometimes even a highly rated institution will fail in unusual circumstances. Nevertheless, investors are now better able to make informed decisions about where to invest their money.

Ratings range from AAA (extremely strong) to BBB (adequate) to D (Default). The probability of default over a five year period is 1 in 600 for AAA and 1 in 30 for BBB. The minimum rating that is considered to be investment grade is BBB- and the minimum for a deposit taker to be eligible for a Government guarantee is BB. There are only three non-bank institutions with investment grade ratings and these are UDC Finance, Medical Securities Ltd and Oxford Finance. A number of others, including PSIS, South Canterbury Finance, and Marac have lower ratings with a default rate of between 1 in 10 and 1 in 30 over a five year period.

A full list of credit ratings can be found on the Reserve Bank’s website, www.rbnz.govt.nz or on www.interest.co.nz. The Reserve Bank also has a fact sheet on credit ratings available. Ratings can change over time, so it always pays to check the most current ratings before investing.

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