Financial Demons May Be Lurking

The great Crown Guarantee (or Government Guarantee on bank and finance company deposits) has now been around for almost ten months. So far it has only been called upon the once, when one finance company made the decision that they could no longer meet their obligations. A new finance company applied and received the crown guarantee. A couple of weeks later it was revoked. It certainly was not a good look.

Over the past couple of weeks, it appears that some of the finance companies have got the jitters. They have suddenly realised that their investment books have a lot of debentures due to mature just prior to that date that the crown guarantee is due to expire. Investors would have to be totally irrational to invest for a period longer than the crown guarantee. It is no wonder that the finance companies have a mismatch in their loan books.

Obviously the political lobbying has started in earnest. Meetings have occurred at the highest level. It has even been reported that they included the Prime Minister in at least one meeting. There is no doubt that simply having a cut off of the crown guarantee when it applied to finance companies is going to cause major funding problems for the finance companies. It could be that some may take steps to ensure that their depositors benefit from the crown guarantee.

Finance companies seldom go broke overnight. It takes time. They know when their loans are due to mature. Similarly they should know when their investors are due to be repaid principal and interest. Those who have lent on property will have been working with their borrowers for some months prior to the expected maturity date of the loan. If new deposits have not been taken in, the borrower will need to obtain funding from some other lender, or sell the property. This process invariably takes months.

It is not known if the crown guarantee has done anything to boost reinvestment rates or indeed attract additional funds into the finance companies. What it seems to have done is reduce the interest rate being offered to depositors, to levels close to those being offered by the banks. This is unlikely to entice investors away from the banks.

If the crown guarantee was to simply finish on schedule in October 2010, we would expect that this could well be the death knell of a number of finance companies. Some of these have probably survived this long by good luck rather than good management. Survivorship is not a “right” for companies. To lessen the impact for investors, we would like to see a staged reduction of the crown guarantee. Perhaps this could be over say three years and could go something like this: Year 1: 75% cover, Year 2: 50% cover, Year 3: 25% cover.

Effectively by the end of a scheme as outlined, the finance companies would have received government protection for around five years. This should allow the economy time to have healed considerably and property values to rise from their lows. Finance companies over that staging period will need to increase their interest rates to compensate investors for their progressive higher risk as the guarantee reduces.

The banking sector is also covered by the crown guarantee. Perhaps this should be allowed to continue indefinitely? This should come at a cost, and perhaps that cost should be to comply with the wishes of the Reserve Bank and pass on reductions of interest rates rather than use it as an opportunity to increase their margins.