Markets plead for guarantees signal

Finance companies are warning of a freeze in new lending while they wait for the government to decide what to do with the Crown Retail Deposit Guarantee Scheme.

The guarantee was hastily cobbled together last year in response to the collapse of some major financial institutions overseas and fears this could cause a run on finance companies or banks in this country.

It was designed to shore up investor confidence by providing a government guarantee on money invested with participating institutions. Most of the banks, finance companies and many smaller institutions such as credit unions have signed up to the scheme.

It was put in place for two years, which means it will expire on October 12 next year, unless the government decides to extend it.

This is creating a conundrum for the retail investors that the guarantee is designed to reassure.

As its currently stands, any money they invest for a term which extends beyond October 12 next year will not be covered by the guarantee after that date.

So if a company they invested with defaulted on a repayment the next day, investors would be at risk of losing their money.

With so many investors having already been burned by the collapse of companies such as Hanover and Bridgecorp (before the guarantee was put in place) it is not surprising that many are investing their money only for terms which mature before the guarantee expires.

At the moment that means investing for a maximum term of 15 months, and as time goes by, that time-frame is shortening.

This could create major problems for financial institutions, because they are receiving plenty of short-term deposits from investors, but need to make long-term lending decisions.

"The weight of maturities is heavily skewed to inside the guarantee period," said Peter Thomas, chief executive of Equitable Mortgages, which has signed up to the scheme.

"So it's harder to make longer-term, strategic decisions because typically you want to have a matched profile of assets and liabilities. So as your liabilities are getting shorter, your ability to make longer-term loans, such as for three years, declines."

This could result in a logjam where everyone was frozen into inactivity, Thomas warned.

There are also signs the uncertainty is pushing up interest rates for terms beyond 15 months, as finance companies in particular have to offer a premium to attract money which may end up not being covered by the guarantee.

Last week Fisher & Paykel Finance increased its two-year investment rate from 7.25% to 7.5% and its three, four and five-year rates from 8% to 8.5%.

Another indication of the risk premium investors are factoring in to the possible expiry of the guarantee was a sharp jump in the yield of South Canterbury Finance's NZDX-listed bonds. Last week the yield on SCF's bonds which mature in 2012, after the guarantee expires, hit 14% compared to their coupon rate of 10.43%, while the yield on its 2010 bonds, which mature before the guarantee expires, were trading at 7.3%, a discount to the coupon rate of 8%.

A complicating factor for the government is that the Reserve Bank is undertaking a more comprehensive overhaul of the rules which govern the way financial institutions operate, particularly around capital adequacy and related-party transactions. The changes are not yet finalised and are unlikely to be fully in place before the third quarter of next year, roughly coinciding with the end of the guarantee.

Within finance industry circles there is a belief the government is looking at three main options.

Extending the guarantee as an interim measure for another year, perhaps with some minor changes, allowing the Reserve Bank more time to implement its plans.

Allowing the guarantee to end in October next year and relying on the changes planned by the Reserve Bank to maintain investor confidence.

Replacing the current guarantee with an insurance-based scheme, similar to that operated by the Federal Deposit Insurance Corp in the US. This model has also been adopted in many other OECD countries.

Justin Kerr, chief executive of the Financial Services Federation, which represents most non-bank financial institutions, said a clear signal was needed.

"We are not telling the government what to do. What we want is for them to be aware of the fact a decision or some sort of indication really needs to be given before too many more moons have passed."

But last week a spokesman for Finance Minister Bill English, who is responsible for deciding the guarantee's future, was issuing a firm "no comment" on all questions relating to the scheme.

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