Days numbered for small finance companies?

Wednesday, December 6th 2006, 6:56AM

The prediction that there will be rationalisation in the finance company sector is a pretty easy one to make - after all there are more than 100 of these firms in New Zealand.

However what caught my attention at KPMG's latest report on the sector is that the Ministry of Economic Development's discussion paper on deposit taking institutions may be designed to force smaller players out of the market.

Under the proposals deposit taking instititions will essentially be split into three categories based, to a large extent, on their capital. At the top end are the banks, then there are the so-called Approved Deposit Takers (ADTs) who will come under prudential supervision from the Reserve Bank. Below that are the small frys who will face increased supervision and higher compliance costs.

The two points worth noting are that the higher compliance costs may force small finance companies out of business.

The second is that firms who decide to become ADTs may expect to get some additional differentiation (and support) based on their decision to invest in the necessary requirements. However the proposed levels may be too low and therefore the opportunity for differentiation will be diminished.

A view expressed by KPMG is that the minimum capital required to become an ADT should be doubled from $5 million to $10 million.
But maybe market changes may force some of the smaller guys out anyway. There is evidence that there is a flight to quality. I've talked to many finance companies in recent weeks. The general theme is that reinvestment rates and funds flow slowed in the wake of the Provincial, Western Bay and National Finance 2000 collapses.

However most now report that reinvestment rates are back to normal levels and in some cases at or near record highs.

While this is happening there is also evidence showing a shift from debentures to bank online savings accounts.

This tells us a few things. One is that investors see finance companies as a valid investment option. Secondly money is already leaving the smaller companies, which no doubt will be putting them under financial stress already.

The possible conclusion is that their days may already be numbered.

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