Deposit guarantee scheme heralds an unhealthy new beginning for finance company sector
The government’s deposit guarantee scheme has brought new optimism to the decimated finance company sector, but this is not a healthy outcome, McDouall Stuart head of research John Kidd says in the company’s 2008 review of the sector.
“Just when investors were starting to appreciate that there is no such thing as a riskless return, the guarantee scheme signals that there is,” Mr Kidd says.
“The scheme ignores all the lessons of the past two years, where investors learned the hard way the consequences of mispricing risk.”
On the other hand, it should be recognised that the guarantees were introduced to deal with an irrational market, he says.
Investors have been quick to react to the guarantee scheme and grab higher deposit rates offered by finance companies.
Some companies are already unable to absorb the flood of new deposits and are dropping deposit rates quickly.
But McDouall Stuart’s 2008 report shows that few finance companies were left to partake in the spoils of the guarantee.
Just 11 companies met the criteria to be included in the report, down from 29 in the past year and 38 in 2006.
All of this shrinkage was due to company failures except for one deal, the Allied Nationwide purchase of Speirs Finance.
At least another 10 finance companies have defaulted so far this year, putting a further $2.2 billion of investors’ money at risk.
The global credit crisis and domestic property market downturn compounded problems in an industry that was already suffering a major crisis of confidence.
Mr Kidd says mezzanine property finance players capitulated this year, with defaults at Dominion Finance, North South Finance, St Laurence, Dorchester Finance, Strategic Finance, Hanover Finance and United Finance decimating the sector.
Of the $3.8 billion of debenture money at risk in distressed finance companies, almost $3 billion is tied up in property lenders.
But the outcome of this destruction is that the sector today is “probably fitter than it has ever been,” Mr Kidd says.
The value of the sector often gets overlooked, he says, and it’s arguably more important today than ever in financing development that banks cannot.
In particular, GE Money and GMAC’s exit from car financing could lead to further hollowing out in the car dealership industry if no other sources of funding come forward.
But the report is more scathing on the future for mortgage funds, which have also suffered from runs on funds this year. These vehicles are “fair-weather structures” at least two decades out of date, McDouall Stuart says.
The company also weighs in on the receivership versus moratorium issue, a key issue at the moment as Hanover, St Laurence and Dorchester try to negotiate with investors.
It’s an open question whether the moratorium or restructure options presented to investors recently are the best they could hope for, the report says.
“In some cases, bottom-ranked equity holders appear to have as much if not more to gain from restructure proposals than first-ranking security holders.”
The “stigmatising” of receiverships as costly and likely to result in fire-sales has also been overplayed, McDouall Stuart argues.
Finally, trustees should be helping to simplify the complex proposals that have been sent to investors, which have often been so involved that they are virtually meaningless to investors.