Fears funds will fade without extra surety

The Government must provide some clarity around the future of the retail deposit guarantee and soon to minimise uncertainty and avoid another looming funding crunch in the beleaguered finance company sector, says McDouall Stuart analyst John Kidd.

After being starved of retail investor money after a string of high-profile failures in the sector, the introduction of the guarantee in October last year saw a flood of cash into finance companies. But there has been no official word on whether the scheme will be extended when it expires in October next year. Because of that, investors have been reluctant to invest further in finance companies for terms beyond the scheme's expiry date.

"There are very few finance companies able to fund lending activities beyond October next year at the moment because there's just no money interested in them beyond then," Kidd said. "It is becoming very pressing, the Government needs to play a hand."

In fact, Prime Minister John Key did tip the Government's hand last week, telling a business audience in Melbourne an extension to the scheme was likely to be announced in a few weeks.

Sharp price movements in South Canterbury Finance's listed bonds in response to that comment highlighted how acutely critical the issue is to the sector. The SCF020 bonds had been trading at a steep discount to face value because, says chief executive Lachie McLeod, they mature outside the current period of the guarantee. Following Key's comment, they quickly rallied from a yield of 18 to 20 per cent to 12.5 per cent.

To illustrate the distortionary effect of the deposit guarantee, Kidd noted that South Canterbury's SCF030 bonds, which mature with the period of the current guarantee, are trading at a yield of just 6.3 per cent. The issue is arguably even more pressing given that South Canterbury and Marac Finance have suffered serious setbacks in the past few months with both disclosing large impairment levels on property loans and both losing their investment grade credit rating from Standard & Poor's. The downgrades may trigger reviews of substantial credit lines at both companies - at South Canterbury a US$100 million private placement facility and at Marac, its five-bank syndicated facility. Aside from concerns about the health of these particular companies, which Kidd notes are - despite their recent downgrades - "otherwise strong and well managed" the sector requires assurance the rug will not be pulled out from underneath it next October.

"The fear is that very large quantities of maturing capital currently invested in finance companies will exit the sector over the next 14 months if nothing more is done," he said.

"People still do underestimate the importance of finance companies in the funding mix in New Zealand. In the recovery process you need people who are willing to fund development, and finance companies are traditionally the ones who have done that. They're not able to at the moment because of the lack of clarity around what happens beyond October next year."

However, while some extension of the guarantee is required, Kidd believed it should also be engineered to gradually reduce finance companies' dependence on it as its distortionary effect of the risk/reward equation should not be allowed to become a permanent feature of New Zealand's financial sector.

GUARANTEE SCHEME

* The scheme, introduced by the previous Labour-led Government during last year's election campaign, is set to run out in October 2010.

* The opt-in scheme covers all retail deposits of participating New Zealand-registered banks and retail deposits by locals in non-bank deposit-taking entities. This includes building societies, credit unions and deposit-taking finance companies.

* The deposit guarantee scheme does not include related party liabilities.