Minnows vulnerable as guarantee deadline looms

With less than two months to go for the expiry of the New Zealand government's retail guarantee scheme and with just a handful approved for extension, worries are growing that the finance sector will see a spate of collapses unless the government pledges some support.

Only six finance companies have been approved for extension of the guarantee until December 2011.  Large institutions like banks have decided not to opt in, and so have the finance companies which are subsidiaries of a bank.

This means a large number of small finance companies, mostly with assets below NZ$20 million, will have no guarantee shelter from 12 October. There are also companies with assets above NZ$20 million that will not have the benefit of guarantee because they don't have the minimum credit rating to qualify.

Most of the deposits of these finance companies are likely to mature before the guarantee expiry, as retail investors would not have taken the risk of investing beyond that period.  This means the companies are likely to face liquidity pressures from bunched-up maturities, and may end up going into receivership.

There was an expectation that finance companies would find new equity investors or raise additional equity, and there will be consolidation in the sector.  But apart from a few instances, mostly with larger finance companies, there has been little in the way of consolidation.

There was probably a recovery in the property sector that was factored in, but none of that has materialised so far. Also, while the New Zealand economy seemed on a path to recovery, it is, like most other countries, again showing signs of faltering and in any case the recovery was not reflected in the performance of the finance sector.

It's unclear what the government and the Reserve Bank of New Zealand are thinking at this stage. But allowing finance companies to wind-up on the eve of the guarantee expiry goes against the spirit of the extended guarantee scheme.

Not only will it hamper depositor confidence and pose a risk to financial system stability, it will also increase the cost to the government. Importantly, this will occur when there is talk of a double-dip recession, and risks from international markets are again a possibility

One argument advanced in favour of the guarantee extension is to avoid a concentration of defaults in the lead up to the end of the guarantee period,  depressing asset prices and reducing recovery rates.

While the guarantee extension has happened, with a just a few companies qualifying, it now seems the sector is back to where it started when it first received the guarantee support. And this only strengthens the argument now for some kind of support, though not as great as the extension that the better performing finance companies have.

Among the finance companies most at risk are Geneva Finance, which is currently under moratorium and had outstanding debentures totalling NZ$31 million in March; NZF Money, which had debentures totalling around NZ$64 million at the end of March, of which around NZ$39 million is due before September;  Asset Finance, which had debentures totalling NZ$18.5 million with nearly half of that classified as current as of the end of March; and Broadlands Finance, which had NZ$15.2 million in March 2009 - details about the current debenture stocks are not available.

The largest of the finance companies at risk is South Canterbury Finance, which has debentures of nearly NZ$1.4 billion and is the only finance company that is truly fighting hard for survival. SCF is expected to make an announcement on 31 August.

In addition, there are several small finance companies with assets below NZ$20 million.