Agony Aunt: Credit union term deposits are higher risk

Dear Janine,

In a recent column I noted your remarks about term deposits.

There are better interest rates than the banks you quoted.

I have been investing on and off with New Zealand Credit Union Baywide for about 12 years.

Deposits start at $1,000. Current interest rates on term investments are 4.6 per cent for 12 months and 5 per cent a year for three years.

For smaller investments this is an excellent way onto the investment ladder.

The minimum for banks I have visited is $5000.

This is a disincentive to start saving for people who may not reach these thresholds.

I have never seen any commentators mention Credit Unions.

Maybe because they are not registered banks, nonetheless, it has been very profitable for me.

ANSWER:

Quite right, I do avoid talking about credit unions when discussing term deposits.

It's not because of a registration issue – the Reserve Bank licenses them and they fall into a category known as 'non bank deposit takers' or NBDTs.

Finance companies and building societies fall under the same hat. 

My side-stepping has more to do with ensuring the general public don't confuse interest rates from investment-grade banks, with more risky options.

All of New Zealand's credit unions are sub-investment grade.

We have 14 licensed credit unions and four have credit ratings.

Baywide are one of the four, with a BB rating on negative outlook; vulnerable to their financial strength getting weaker. 

The other 10 credit unions are exempt, most likely because of size.

If they have less than $20 million in liabilities (your deposits) it would be too costly and onerous to get a rating from the likes of Standard & Poor's.

As an educated stab in the dark, I'd say the unrated bunch would be sub-investment grade like their peers, if they went through the rigmarole of getting rated.

The fact they are so small bothers me.

It would hardly create a political ripple if one failed, due to their size.

But for an individual investor it could be catastrophic.

Would you invest in 'Junk'?

More cruelly (and a little unfairly) common investment terminology for sub-investment grade is 'junk'.

Any deposit or bond issued with less than a BBB rating picks up this delightful title. Hardly a suitable marketing term.

Hence, issuers of junk, tend to prefer the term 'high yield' to reflect that you get paid more interest for taking more risk. 

In the entire NBDT taker sector (31 institutions) only 13 have a credit rating.

Three are investment grade (UDC Finance, Liberty Financial and Medical Securities).

Ten are junk and 18 are exempt from needing a rating. 

One man's junk is another's jewel 

Despite side-stepping the issue of higher rates from the NBDTs, it doesn't make them a bad investment.

You just need to understand they are not comparable to Westpac, ANZ, BNZ, ASB or Kiwibank deposits.

Due to the lower credit ratings and higher interest rates, it would be prudent to spread your savings around and diversify.

As the investor Warren Buffet once said, "never test the depth of the water with both feet".  

Tossing the dice with risk

There is a big difference in risk between investment and sub-investment grade deposits.

It's difficult to understand until you see the numbers.

On paper a BBB rating and a BB look like close pals.

But the statistics tell a different story.

There is a one in 30 chance of default on a BBB deposit or just over 3 per cent chance.

Yet with a BB deposit, the risk triples to one in 10, or a 10 per cent chance of default. 

As the Reserve Bank points out: "don't confuse the letters used in credit ratings with school grades. While a 'B' grade may look good on a school report, a single 'B' credit rating actually indicates a company with a 1 in 5 chance of default over 5 years". See table.

Janine Starks is a financial commentator with expertise in banking, personal finance and funds management. Opinions in this column represent her personal views. They are general in nature and are not a recommendation, opinion or guidance to any individuals in relation to acquiring or disposing of a financial product. Readers should not rely on these opinions and should always seek specific independent financial advice appropriate to their own individual circumstances.