Brian Gaynor: Unlucky mascot for guarantee scheme

The failure of Mascot Finance demonstrates that the New Zealand Government can make the same dreadful mistakes as Guinness Peat Group (GPG).

Mascot became an approved institution under the Crown Retail Deposit Guarantee Scheme on January 13 and was placed in receivership on Monday, just 48 days later.

GPG acquired a 9.3 per cent interest in Ennstone in October and the UK listed gravel and concrete company filed for Chapter 11 bankruptcy on February 25, just four months later.

At least GPG can argue that its poor decision was based on inadequate public information but the New Zealand Government has no excuses as it should have had access to all the facts it required, including Mascot's latest accounts and trustee reports.

The Mascot debacle has heightened interest in the guarantee scheme and raises questions about its effectiveness.

The stated objective of the scheme, which was announced by former Finance Minister Michael Cullen on October 12 last year, is to "cover all retail deposits of participating New Zealand-registered banks and retail deposits by locals in non-bank deposit-taking entities. This would include building societies, credit unions and deposit-taking finance companies."

The overarching principles of the scheme are the maintenance of public confidence in New Zealand's financial system and maintaining the confidence of general public depositors in New Zealand finance institutions.

The Treasury lists 14 factors that it takes into account when considering the eligibility for a Crown guarantee. Among these are:

The creditworthiness of the entity.

Its related party exposures.

The quality of information provided.

That the individuals that control the entity have the business experience and acumen relevant to the operation of the entity.

Whether, and the extent to which, the entity's overall business is bank-like in nature.

The importance of the entity to the New Zealand financial system.

However The Treasury also stated: "The decision to enter into a Crown guarantee with any specific entity is at the sole discretion of the Crown."

In other words the New Zealand Government has the ability to ignore all of its guidelines and approve any company it wants to under the scheme.

It is difficult to understand how Mascot Finance qualified for the scheme. The company breached a trust deed financial ratio on March 31, 2008. Although this was remedied by May 31 it reported a loss of $7.5 million for the March 2008 year and had 57 per cent of its loans to the troubled property sector.

One of Mascot's major loans, which is reported to represent over 20 per cent of its loan book, is to Jim Boult's joint-venture Lake Hayes development. Boult, who is currently acting chief executive of Christchurch International Airport, has had a colourful business career, which includes stints as executive chairman of Baycorp and managing director of Shotover Jet, his own listed company.

David Stock was chairman of Shotover Jet and Brian Kreft a director. Kreft is now chairman of Mascot and Stock is a director of the finance company and has been a fellow director of Boult in a number of other companies in the past.

Boult is not a related party of Mascot but should a Crown guarantee company have large loans to an individual who has had business associations with its directors in the past?

There are a number of other concerns regarding Mascot, including the capitalisation of interest - particularly on projects where the interest may not be recovered - and a relatively high level of non-performing loans.

The inclusion of Mascot Finance in the guarantee scheme doesn't enhance investor confidence in the financial system because it demonstrates that the Government agencies with oversight responsibilities, in this instance the Treasury and Reserve Bank, don't make insightful decisions.

The Crown has approved 79 entities under the guarantee scheme and more of them may fail, particularly the smaller ones.

A number of organisations raised fairly substantial sums of money when they were first included in the scheme. These issuers offered interest rates of around 9 per cent per annum and paid additional brokerage fees of up to 2 per cent. In addition the Crown is charging non-bank deposit takers that have a credit rating below BB, or are unrated, a fee of 3 per cent per annum to participate in the scheme.

This means that the total cost of money for some of the smaller institutions is as high as 13 per cent per annum, made up of the 9 per cent interest, 3 per cent Government fee and the 2 per cent brokerage spread over two years.

The other problem with this money is that it usually matures before October 12, 2010, which is when the guarantees are due to end.

It is extremely difficult to lend money for this specific period, unless borrowers are fairly desperate, and a number of non-bank guaranteed institutions have money on deposit earning interest of less than 4 per cent while paying 13 per cent for this money. Obviously this cannot continue as these companies are making large losses on their Government guaranteed funding.

If financial conditions remain tight, and the guarantee is removed in October 2010, then a number of boards may put their guaranteed companies into receivership before the scheme ends.

This would enable depositors to get all their money back whereas if guaranteed companies go into receivership after the scheme expires then investors could lose a high percentage of their money.

If the guarantee is extended then existing companies will continue to have a huge advantage because start-up companies have to be BBB-rated or better in order to be eligible for the scheme.

One of the more interesting companies included in the scheme is FAI Finance, which is chaired by Greg Muir and owned by Mark Hotchin and Eric Watson. The company's secured deposits have plunged from $42.7 million to $18.2 million in the year to June 2008 and have probably fallen further since then.

Why do Hotchin and Watson, who have a poor track record in the finance company sector, receive a Government guarantee when a new entrant has almost no hope of achieving this because of the extremely high BBB- credit rating requirement?

How many of the six criteria listed above do FAI Finance comply with, particularly the requirement regarding "the importance of the entity to the New Zealand financial system"?

Finally the guarantee system has positive implications for owners of existing guarantee companies in terms of sale value.

A good example of this may be Priority Finance, which has total assets of less than $5 million, and was recently sold by the Christchurch-based Gillman family to a company owned by Nick Wevers and his family. It is reasonable to assume that the vendors received more for their shareholding as a Government guaranteed company than they would have if it was not guaranteed.

Priority has changed its name to Viaduct Capital and has initiated a high-profile media campaign that contains a biography of Wevers. Neither the biography nor the prospectus mentions that Wevers was managing director of Blue Chip for a short period in 2004.

Wevers was definitely not the driving force behind Blue Chip but companies that raise money from the public, particularly those with Crown guarantees, should be transparent and Wevers' full biography should be disclosed to potential investors.

If the Crown doesn't insist on higher standards under its Retail Deposit Guarantee Scheme then there is little hope of full confidence in our financial system being restored.

* Disclosure of interests; Brian Gaynor is an executive director of Milford Asset Management.