Wednesday, April 23, 2008

More NZ financing companies set to fail

As America prepares for the next wave of credit market troubles (The trillion dollar mortgage time bomb, Isidore 21/4/08), New Zealand financing companies face heavy damage as well. The logic behind their failures remains simple, yet profiting off the coming disasters require a bit of work.

NZ financing company business model

Roughly 20 NZ financing firms have fallen in the past half a year, alongside private investment funds heavily positioned with debt instruments. Despite the lack of transparency and obscurity of management qualifications, it has become highly probable that their businesses models entail mostly high risk debt securities from American investment banks.

More will fail

Due to the above, it becomes plausible that these poorly managed funds hold a highly positive correlation to US credit conditions; in other words, when Americans default on their car, credit card, home, or student loans, NZ financing companies take losses alongside Wall Street. While Ben Bernanke may attempt to remedy the impending storm, US Federal Reserve will not save NZ firms, where mom and pop investors take harest falls.

Profiting off their collapse

With such negative outlooks, downside bets on these firms carry very attractive reward/risk ratios. The NZSE has not developed mechanisms for short selling yet, but it is possible on the ASX. One could look for NZ financing firms listed on the ASX to take on short positions. As soon as the companies fail, values of their stocks will drop to nearly nothing and provide short sellers great returns.

If available, loading up on option spreads would require more meticulous strategies but at the same time offer higher potential returns due to leverage. Reverse butterflies, calendar spreads or even simple straddles could allow investors to exploit the coming volatility spikes (regardless of underlying stock price direction).

Some work becomes required in areas of research besides fundamentals for optimal entries and exits. Other means probably exist to exploit their coming demise, and simply require a bit of searching. In the mean time, local NZ mom and pop investors would do well to stay alert of these debt instrument pools and make more prudent money decisions.

0 Reflections: