Low participation in extended Crown guarantee raises questions over whether it's even needed

By Gareth Vaughan

Less than a week before the Crown’s extended retail deposit guarantee scheme kicks off, only seven companies - including the three “Heartland Bank” merger partners - have signed up for it, bringing into question whether there's any need for it at all.

The National-led government passed legislation, with unanimous support in Parliament, to enact the extended Crown retail deposit guarantee scheme last September. It kicks in when the initial two-year scheme introduced by the Labour-led government in October 2008 at the height of the global financial crisis, ends on October 12 and runs until December 31, 2011.

The handful of companies that have a signed up to it include merger partners Marac Finance, the Southern Cross Building Society and the Canterbury Building Society. Alongside them are just Equitable Mortgages, Fisher & Paykel Finance, PGG Wrightson Finance, and the Wairarapa Building Society.

An eighth company, the now in receivership South Canterbury Finance, had been accepted into the scheme. And others, such as Broadlands Finance and Allied Nationwide Finance, failed to make the cut due to their credit ratings being below the BB required for inclusion in the extended scheme. See full list of all savings institutions in our Term Deposit table. Those with the extended guarantee have a blue tick in the "E DGS" column.

Most banks opt out but Westpac keeps rivals' guessing

The major banks, meanwhile, have been told by Reserve Bank governor Alan Bollard they don’t need to partake in the extended scheme. Although ANZ, BNZ, Kiwibank and SBS Bank have said they won't, ASB and Westpac are yet to publicly rule out participating.

Westpac is certainly looking to keep rivals' guessing until the last possible moment. Asked yesterday whether the bank had made up its mind, a Westpac spokeswoman told interest.co.nz that she'd be happy to talk on October 12, but couldn't before then.

The seven companies approved to partake in the extended scheme are a stark contrast to the 90-odd names listed on Treasury’s website as participants in the initial scheme. A Treasury spokesman declined to say whether any more companies were likely to be added to the list, saying only that it was up to eligible companies to apply.

Finance Minister Bill English is currently overseas and couldn’t be reached to comment on whether he was surprised at how many companies had signed up to the extended guarantee scheme and whether it was still needed. When the extended scheme was rubber stamped by Parliament last year, English said it would provide certainty for depositors, financial institutions and taxpayers. He said Crown retail guarantees had helped maintain confidence in New Zealand’s financial institutions, but noted they also distort the market and impose costs.

Market distortion

The view that guarantees distort the market was widely canvassed by rivals of South Canterbury Finance before that company collapsed when it was offering investors interest rates of up to 8.25% per annum on government guaranteed deposits.

And Mark Darrow, chief executive of rural lender PGG Wrightson Finance, which has been approved for the extended scheme, says the guarantees have created a “three year market distortion” that all finance companies have been forced to carefully manage through. It created an “artificial maturity cliff” for the weaker finance companies. An example of this was Allied Nationwide Finance, where its trustee Guardian Trust, ultimately pulled the plug on August 20 due to concerns over how Allied Nationwide would cope with about NZ$70 million worth of debenture stock repayments due before October 31.

Darrow notes the other downside of the guarantee scheme is that it has had the effect of adding cost that’s ultimately passed on in lending rates to clients.

“I maintain that for PGG Wrightson Finance, as for any of the stronger finance companies, the guarantee scheme has not added any net value, but we work with it,” he says.

Cost the price to pay to avoid 'potential catastrophic losses'

The demise of South Canterbury Finance, and the near NZ$2 billion tab this created for the taxpayer under the initial Crown guarantee, has seen the taxpayer's exposure to the scheme - despite fees paid by participating companies, sink into the red to the tune of hundreds of millions of dollars.

English told Parliament last month that when the fees collected from the wholesale and retail guarantee schemes are included, the net cost to taxpayers' is likely to be between NZ$300 million to NZ$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," the Finance Minister said.

The extended scheme will see Treasury hike fees charged to participating companies. Exactly how much the Treasury has collected in fees from the initial guarantee scheme isn't clear, - yet. Treasury only releases the total sum collected from companies participating in the scheme with its June year end financial statements.

The June 2010 year statements aren't due to be released until October 14. From its October 2008 introduction until June 30, 2009, Treasury had received NZ$228 million in fees from participants. This included NZ$74 million collected in guarantee fees plus another NZ$154 million paid in advance by firms to cover future participation in the scheme. The bulk of the fees have been paid by the big banks. In a rare move ASB recently disclosed that it had paid fees totalingNZ$36.8 million precisely to participate in the initial scheme over its two year life time.

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