RBNZ wants finance companies to disclose their exposure to capitalised interest loans

By Gareth Vaughan

In a case of better late than never, the Reserve Bank says it wants finance companies to start disclosing detail on the loans they write which capitalise interest.

In a discussion document released by the central bank and the Ministry of Economic Development (MED) on disclosure requirements for non-bank deposit takers (NBDTs) - finance companies, building societies and credit unions - the Reserve Bank says NBDTs take on a "significant amount" of credit risk when they offer loans with interest capitalised.

Many now defunct property financiers including Hanover Finance, Bridgecorp and Strategic Finance, did a significant amount of their lending on a capitalised interest basis and often on second mortgages. Lending on a capitalised interest basis meant interest accruing was added to the loan balance but not received until repayment of the loan, rather than being paid to the lender on a monthly or quarterly basis. This meant that if the borrower got into financial strife and defaulted on the loan, the lender potentially lost the outstanding principal sum lent and the promised interest payments.

However, accounting rules allowed companies to take into account the interest over the duration of a loan rather than when it was actually paid. That meant property lenders' financial statements showed they had received interest when they actually hadn't.

"When an NBDT offers loans with interest capitalised, the NBDT takes on a significant amount of credit risk," the Reserve Bank and MED say in the consultation paper. "The NBDT relies on the underlying asset generating substantial cash flow at a future point in time."

They note that companies aren't currently required to disclose detail of capitalised interest loans, but the information is important for an assessment of an NBDT’s risk.

"We propose that NBDTs should be required to disclose:

a) the number of loans offered that have interest capitalised;

b) the total value of these loans and as a percentage of all loans;

c) the value of these loans by sector (as described in the capital ratio calculation);

and d) the value of these loans in each sector as a percentage of all loans in the sector."

The Reserve Bank has taken on the regulation of NBDTs amid the demise of 63 finance companies and other entities that raised money from the public over the past five years. These collapses put NZ$8.59 billion at risk held in more than 205,000 deposits. See our Deep Freeze List for full details.

The Reserve Bank and MED also say they want capitalised interest loan disclosures included in prospectuses and updated every six months.

Submissions on the consultation paper, whose main proposals include requiring NBDTs to disclose a standardised set of prudential information and for these disclosures to be updated six-monthly, are due by May 19 with regulations on prudential disclosure requirements expected in the second half of 2011.

Grant Spencer, Reserve Bank Deputy Governor, said disclosure of standardised prudential information would provide investors with a framework for analysing an NBDT’s risks, and allow investors to compare risks between NBDTs more easily. This will improve market discipline and confidence in the NBDT sector, Spencer added.

“The six-monthly frequency also aligns prudential disclosures with financial statements during the life of a prospectus,” he said.

Other proposals include disclosures being subject to auditor reviews, and investors being notified when disclosures are updated as a result of material changes to an NBDT’s circumstances.

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