Pricing risk or buying market share?

Thursday, June 28th 2007, 6:58AM

The government's plans to make it mandatory for finance companies to get credit ratings has made me think some more about the value of these things.

As I have commented before the average retail investor has little clue about how scales work, and in some ways that is no surprise because they are convoluted.

As someone put it to me the other day a company would probably be happier with a BB+ rating than a BBB- as it looks better. People are attracted to positives.

The other thing which has been on my mind is that ratings are meant to help people understand the risk/reward trade off. And if everything went to theory, the organisation with the lower rating would offer the highest rate and vice versa.

So what do you make of someone like RaboPlus with its AAA rating offering the highest rates in the market? Theoretcially it should have the lowest rates. One conclusion, which can quite sensibly be drawn, is that the bank is just buying market share.

While, yes, the offer is a good deal for investors it does little to help people understand ratings.

It also highlights the competitive nature of the deposit taking sector. It is absolutely clear that pricing of offers has nothing to do with risk. It's all about market positioning. Some finance companies have said as much. They look at what their closest competitors are doing then set their rate.

This is not how risk should be priced. It makes me think the mandatory ratings thing is not the panacea to understanding the offers and that there needs to be changes in the way risk is priced.

As always I would like to hear your thoughts on this topic. Send them to blog@goodreturns.co.nz

Mike Heath, general manager of RaboPlus replies:

Hi Phil

Interesting to read your post "Pricing risk or buying market share?", and very timely given the recent collapse of Bridgecorp.

With regards to our pricing policy, and the rates we offer to customers, we have pledged to always offer amongst the highest rates in the market. The fact that we specialise in savings and investments, and leveraging our global business model, means we can honour this commitment.

Secondly, with regards to credit ratings, I believe it will help people make more balanced investment decisions, assuming the ratings come from respected and reputable agencies such as Standard and Poor's and Moody's (RaboPlus, as a division of Rabobank, have a Triple A rating from both of these agencies - the highest rating available, and the only bank in New Zealand with this rating).

At the moment it is pretty difficult for investors to answer the question - how risky is this opportunity, and equally as difficult to compare those opportunities.

There is a lot of technical jargon/information to interpret from prospectuses, and the current finance company practice of quoting credit rankings, as opposed to credit ratings, can mislead investors to think and opportunity is safer than what it really is. Credit rankings are after all simply a description of where an investor sits in the pecking order should the company fall over, and who is in front of them when it comes to getting their monies back. Whereas credit ratings define how risky an opportunity is.

As we know from our research, investors are not asking the classic risk versus return question, and they are predominately only looking at the reward side of that equation. Credit ratings, from Standard and Poor's and Moody's, will provide investors with a appropriate measure of how risky an opportunity is; make it simpler to compare opportunities; and at the end of the day make better informed and balanced investment decisions.

Regards
Mike Heath
General Manager

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