Up to NZ$400 mln taxpayer cost of guarantee scheme is 'premium paid to avoid potential catastrophic losses'

Finance Minister Bill English says the up to NZ$400 million haircut taxpayers will take on the Government's retail and wholesale guarantee schemes is the price they have to pay for avoiding potential "catastrophic losses" during the Global Financial Crisis over the past 18 months.

(Update adds comments from David Cunliffe and Russel Norman).

In a statement to Parliament this afternoon English defended the Government's handling of South Canterbury Finance (SCF) which was covered by the Crown Retail Deposit Guarantee scheme and sank into receivership last week at an initial cost to taxpayers of some NZ$1.775 billion.

English noted that the world was in turmoil when the guarantee scheme was introduced in October 2008 by the then Labour-led government. He said SCF's balance sheet had expanded only slightly whilst it was covered by the guarantee and that the "great majority" of its problem lending occurred prior to the Allan Hubbard controlled company entering the guarantee.

Once it became apparent SCF was in difficulty, English said there were proposals to either acquire parts of the group or to recapitalise it.

"I instructed Treasury officials to work co-operatively with the firm on these options," English said. "However, all effectively amounted to a bailout by the Crown, with extra cost and risk to taxpayers. At no stage would the Treasury have recommended accepting any of these proposals."

Ultimately it was insolvency not a lack of liquidity that brought the curtains down on SCF. Once the receivership was completed, English said this would largely complete a cycle that started in October 2008.

"When the fees collected from the wholesale and retail guarantee schemes are included, the net cost is likely to be between NZ$300 million to NZ$400 million," said English.

"While this cost to taxpayers is considerable, this expenditure did help prevent the potential collapse of the financial system. In the light of ongoing bank bailouts around the world, this net cost is the premium our economy has paid to avoid potential catastrophic losses to the taxpayer over the last 18 months."

Opposition critcism

However, English and the Government came under attack from Labour's finance spokesman David Cunliffe and Green Party co-leader Russel Norman. Cunliffe said "serious questions" needed to be answered. These included how much the Government knew and when, whether SCF should have been in the guarantee scheme, whether it had been in breach of its eligibility, what deals were on the table to save it before it coollapsed into receivership and what other options were mulled and dismissed.

And Norman said Parliament's finance and expenditure select committee should hold an inquiry into SCF and the Government's actions.

Read Bill English's statement below:

I wish to make a ministerial statement under Standing Order 347, in relation to the receivership of South Canterbury Finance and its coverage under the Crown Retail Deposit Guarantee Scheme. The Deposit Guarantee Scheme was announced by the previous Government, who set the terms of the guarantee, in late 2008, and was supported by the incoming Government.

At that time the turmoil in world financial markets caused many OECD governments to take unprecedented steps to protect their financial systems, including nationalising banks and providing sweeping sovereign guarantees for most financial system deposits. Administration of the scheme was delegated to the Secretary to the Treasury, in accordance with policy guidance set by the Minister of Finance. South Canterbury Finance was admitted to the scheme on 19 November 2008.

The essential test for admission was whether it appeared necessary or expedient in the public interest. Under the Deed of Guarantee, participants could take on increased deposits and lending, but were required to pay fees in respect of any growth. Allowing participants to continue lending was a major aim of the guarantee scheme. At the time South Canterbury Finance appeared sound. In June 2008 Standard and Poor's had affirmed a stable BBB- credit rating, and commented that "asset quality is sound, underpinned by a modest risk appetite, proactive risk management, and sound underwriting standards".

However, this was not necessarily the case. In the four and a half years to December 2008 South Canterbury Finance's assets had almost doubled from $1.1 billion to $2.16 billion. As 2009 evolved, it became clear that much of this additional lending was not high quality. The balance sheet expanded slightly under the guarantee, peaking at $2.35 billion in June 2009. It is clear however that the great majority of problem lending occurred prior to entering the guarantee. In mid-2009, the Treasury appointed KordaMentha as advisors to report on the company's financial position. The June 2009 Crown accounts included a provision of $831 million for the Deposit Guarantee Scheme.

The majority of this related to South Canterbury Finance. Assessing the potential risk was complicated by related-party lending, generally poor credit and accounting processes, and more recently the departure of most of the senior management. Despite this deteriorating position, South Canterbury Finance remained in compliance with the Deed of Guarantee, and as such there was no ability or cause for the Crown to withdraw their guarantee.

If, for whatever reason, South Canterbury Finance's guarantee had been withdrawn, existing depositors would have still been covered for the full term, and the Crown's exposure would have remained. In September 2009, the Government moved, with unanimous support in the House, to extend the Retail Deposit Guarantee until the end of 2011, though on significantly more restrictive terms than previously.

On 1 April 2010, South Canterbury Finance was approved for entry to the extended scheme when it started in October 2010. Their admission into the extended guarantee did not materially change the Government's risk in the event of default. In the event, because South Canterbury Finance entered receivership before October, the extended guarantee never applied. Payments to depositors will be made under the terms of the original scheme.

During the period of the guarantee, the Treasury and their advisors were in close contact with the firm. Once it became apparent the firm was in difficulty, there were proposals either to acquire parts of the firm or to recapitalise. I instructed Treasury officials to work co-operatively with the firm on these options. However, all effectively amounted to a bailout by the Crown, with extra cost and risk to taxpayers. At no stage would the Treasury have recommended accepting any of these proposals.

At the request of its directors, South Canterbury Finance was placed in receivership on 31 August. The ultimate cause was insolvency, not lack of liquidity. The Government then moved promptly to ensure that depositors could be repaid swiftly. As well as repaying $1.6 billion of remaining depositors, the Government extended a loan facility of $175 million to the receivers to ensure prompt repayment of prior charge holders, and extended the guarantee to a small number of previously ineligible depositors.

These decisions were taken for commercial reasons. They avoided the need to pay ongoing interest that otherwise would have accrued over many months or years as investors submitted claims, and also the risk that receivership might be controlled by prior charge holders, to the potential disadvantage of the Crown. Treasury estimates that the net saving to the Crown is about $100 million as a result.

The Government's recent moves ensure that the receivership will be conducted in an orderly fashion that minimises disruption to businesses either financed or owned by South Canterbury Finance. The Receivers this week called for expressions of interest from possible buyers of South Canterbury Finance's assets. While the Crown has had to make good its guarantees to depositors, it will recover some of the proceeds out of receivership.

Once the receivership is finished, this will largely complete the cycle that began in October 2008.

When the fees collected from the wholesale and retail guarantee schemes are included, the net cost is likely to be between $300-$400 million. While this cost to taxpayers is considerable, this expenditure did help prevent the potential collapse of the financial system. In the light of ongoing bank bailouts around the world, this net cost is the premium our economy has paid to avoid potential catastrophic losses to the taxpayer over the last 18 months.