Taxpayers to pick up finance sector tab

You may get 10 different answers on the value of Hanover's loan book, says one insolvency practitioner. Photo / Brett Phibbs

New Zealand's own sub-prime crisis, the finance company collapse that began with a trickle of failures in 2006 and became a landslide by 2008, entered a period of remission last year with the introduction of the Retail Deposit Guarantee Scheme.

But information from Treasury about the scheme and action by the likes of Hanover, Allied Farmers and Pyne Gould Corporation indicate finance companies are about to go through another period of turmoil.

In what may well prove to be the end-game for the sector in the current business cycle, the removal of state-funded life support for most finance companies will result in a spate of what is euphemistically referred to as "consolidation" - but could also be described as marriages, deaths and cannibalism.

This time though, it is not the hapless retail investor who bears the brunt of inevitable losses, it will ultimately be the taxpayer.

Shrewd, well capitalised opportunists, on the other hand, are even now placing bets there will be some good money to be made picking over the remains of the failures and filling the space they leave.

Treasury set aside an $816 million provision in the June quarter Crown accounts to cover claims under the guarantee it deemed were "more likely than not" to occur. Three months later the sum had risen by a further $47 million to $863 million.

Even as the guarantee was introduced in October last year, covering the finance company sector as well as banks, there were expectations it would distort investment markets and prove difficult to unwind.

Although it has now been extended, the new terms coming into effect when the initial scheme expires on October 12 next year, such as a minimum "BB" credit rating and higher fees, means most except the biggest and best capitalised will have little chance of qualifying.

That has fired expectations a number of finance companies will "hand the keys to Treasury" while they still can to ensure investors' cash is not lost.

Indeed it could potentially be seen as negligent not to do so if they know their chances of surviving without the guarantee are slim.

Given it was introduced in such a rush and has been subject to a number of tweaks on the fly, it's not surprising that there is a somewhat patchy understanding of its mechanics.

Treasury itself admits it is not entirely sure how things will unfold as the now inevitable-looking avalanche of failures and resulting claims gathers momentum.

"We have a best estimate of what is going to happen," Treasury spokesman Angus Barclay told the Herald this week, "but that is only a best estimate, there is some uncertainty."

Some of that uncertainty lies around the ultimate cost of the scheme. Treasury's estimate of likely guarantee costs is a gross figure and does not factor in subsequent recoveries.

No one knows what those recoveries might be but 50 per cent is as good a wild guess as any. The bottom line is the overall cost to the Crown is likely to be far short of the $863 million headline figure.

When it was introduced last year, the guarantee had a huge effect on companies and their behaviour. It probably prevented many from meeting certain death.

Finance companies live and die depending on their liquidity. With retail debenture funding drying up as companies collapsed in quick succession during 2007 and 2008, the introduction of the guarantee saw investors return to the sector.

But the short-term palliative of government guaranteed cash has been a mixed blessing for firms who mispriced their offerings or were unable to find suitable short-term lending opportunities, points out one leading insolvency practitioner.

"They could be actually cashed up and not lending anything, but if that's the case they'd be losing money hand over fist as the cost of taking money off the public will be much more than what you get holding it in the bank at say 4 per cent."

But the major concern lies around the so called "wall" of finance company debentures which mature just before the existing guarantee expires in October.

Although Treasury's tweaks have included measures to help the stronger firms wean themselves off the scheme before next year, many will have commitments to investors they have no chance of meeting on their own and that is why Treasury expects to pay out so much.

Kapiti Coast financial adviser Chris Lee says it appears Treasury expects the bulk of the casualties will be small to mid-sized finance companies, those with up to $30 million in deposits.

The larger finance companies, even South Canterbury which has yet to fully resolve all of its well publicised problems, can probably be excluded as they each have more deposits than Treasury has provisioned for losses on.

There are also a number of other companies that have either successfully recapitalised themselves or who have strong shareholder support and substantial equity, a group Lee says includes PGG Wrightson Finance and Equitable Finance.

"Treasury must be talking about, I would guess, 25 companies at $30 to $35 million each," says Lee.

On that basis, it would appear the carnage we've seen in the sector so far is only the half of it in terms of the numbers of failures rather than the value of deposits.

"It's fair to say from an insolvency perspective we still haven't seen the worst of it yet," says head of Deloitte's recovery and forensics team Barry Jordan. "That's down to two factors - one, there hasn't been a recovery in the property and finance sector which a lot of those finance companies are exposed to.

"Secondly in the capacity that they have now in terms of monitoring the activities of people subject to the scheme Treasury are turning over stones and probably gaining a better understanding of some of the exposures in that sector."

Aside from guarantee scheme implications, finance company failures are likely to be partly driven by generally tough business conditions, says Jordan. As Treasury's Barclay observes, the kind of conditions Jordan is talking about inevitably draws what he refers to as "vulture investors".

"There's a lot of potential targets, not just in the finance sector but in general whenever there's a distressed economy." Jordan says his work in realising failed companies' assets for the benefit of creditors has to some extent benefited from the emergence of these opportunists.

"If you wind back six to 12 months, if we were the receiver of a business, no one would register any interest for it. Now the situation is quite different. There are people out there that are cashed up and are looking for opportunities. With certain assets we've been selling we've been surprised how much interest there has been."

The likes of George Kerr, who has been instrumental in recapitalising Pyne Gould Corporation's finance subsidiary Marac, clearly sees hard times as good times to make money.

"Generally when you recapitalise a banking or finance stock at this time of the market you tend to do very well," he told the Herald recently.

Other prominent investors who are known to be sniffing around the distressed finance sector include South African-born Duncan Saville, whose big Australian securitisation firm Resimac this week was unveiled as a backer of Allied Farmers as it seeks to acquire Hanover's loan book. Even Sir Ron Brierley's GPG is rumoured to be taking an interest, and is not going out of its way to quash the speculation.

"There are people with equity who are willing to back the sector," says a leading insolvency practitioner who did not wish to be named. "You're going to see a small number of survivors out of this process positioning themselves so that in the next 12 months or so they can go back into the market again and start lending."

He names Marac, South Canterbury, Allied Nationwide and possibly Dorchester, which is in moratorium.

But although there are clearly opportunities in the finance sector, there are also still considerable risks.

Uncertainty about the outlook for both the particular sectors the assets lie in and the wider economy means it is very difficult for prospective buyers to accurately value any loan book that comes onto the market or evaluate some types of lending opportunities.

"Hanover is a classic example," says the insolvency practitioner.

"What is that loan book actually worth? You'll get 10 different answers depending on people's optimism.

"If I was the director of a finance company, I would want my plans clearly made or be in the process of doing it. If you leave it to the end of the guarantee you'd be mad, it's too late. They need to get their ducks lined up now, which is why you're seeing activity now and not in six to nine months times."

RETAIL DEPOSIT GUARANTEE
* Introduced in October 2008.
* Covers $124.2 billion in deposits held by 73 financial institutions including banks, finance companies and building societies.
* Participating institutions have contributed $74 million in fees under the scheme.
* It has been drawn on twice, paying out $34 million to investors in Mascot Finance and Strata Finance.
* The existing scheme expires in October next year and will be extended for a further 14 months, but with more stringent conditions.